Stablecoins are a promising innovation at the heart of the new digital financial system, fueling frictionless cross-border payments and digital assets transactions. But it’s important that evolving stablecoin regulations don’t end up undermining the fundamental value of this global technology through onerous localisation requirements with unintended consequences.
In this blog, we’ll be exploring ways to balance regulatory priorities around consumer and market protections while preserving the benefits of internationally fungible stablecoins; setting out the risks of local issuance; and outlining key recommendations for policymakers as the $200bn+ stablecoin market continues to boom.
One thing is clear: for jurisdictions that wish to become cryptoasset and tokenisation hubs, enabling a variety of high-quality stablecoins - including those issued overseas - will be a major competitive and economic advantage.
The unintended consequences of local issuance
Some crypto and stablecoin regulatory frameworks, in particular Markets in Crypto-Assets (MiCA) regulation, include requirements for stablecoins to be issued by a local regulated entity, with the backing assets held with locally regulated institutions. Such requirements are motivated by regulators’ desire to mitigate the risk of disruption to services or losses to local customers, in the event of problems in other regions.
However, requirements like these risk undermining the benefits of the underlying technology. One of the primary benefits of blockchain technology in financial services is that it is borderless. Much like the internet today, blockchains support the ‘internet of value’, allowing value to be delivered anywhere in the world with minimal friction.
Stablecoins are a key building block of this internet of value. They are globally fungible and can be transferred between market participants, allowing value to be delivered anywhere in the world quickly and at low cost. This is more than just a feature of stablecoins; it is fundamental to their value.
Requirements for local issuance introduce frictions and risk reducing the benefits of stablecoins. This is because the legal claim for redemption may need to shift between entities when a transfer occurs, and backing reserves may need to flow to the local entity to ensure the local entity can meet possible redemption requests from users in that jurisdiction.
Local issuance also adds an operational burden for stablecoin issuers who generally do not have a direct relationship with end users and hence would need to rely on exchange partners to confirm the location of users. In some cases, where stablecoins are transacted using decentralised exchanges or without an intermediary, it may not be possible to trace the location of users (who in many cases may not be stationary).
In extreme scenarios, there is a risk that locally issued stablecoins could be seen as having different risk profiles and may trade at different values. For example, if a local bank fails where the issuer’s reserves are held, it may have an outsized impact on the value of the locally issued stablecoin, whereas the impact would be diffused if the local bank was one of many banks, within and outside the region, holding the issuer’s reserves.
Local issuance requirements are likely to increase costs for users and reduce the attractiveness of the jurisdiction as a destination for innovation and investment.
Increasing stablecoin fungibility
In order to understand how internationally fungible stablecoins could meet regulatory objectives, issuance can be broken down into three different elements:
Technological: Even if a stablecoin has multiple issuers, it can still be one and the same from a technological point of view. This means the stablecoin is issued from the same address on the blockchain and is completely fungible from users’ point of view. For example, a smart contract or payment can transfer a stablecoin without reference to which entity issued it. This is critical for stablecoins to operate effectively, and is consistent with regulatory objectives.
Legal: In certain jurisdictions, local issuance may also mean that the local regulated entity is responsible for honouring claims for redemption from users in that jurisdiction. This is likely to be important for regulators, as it means they can hold the local entity responsible for ensuring it is able to meet these redemption requests at all times, including in stress scenarios.
Backing: Finally, local issuance can also mean that some of the backing for the stablecoin is held in the local jurisdiction. From a regulatory point of view, this guards against risks in meeting cross-border redemption requests, such as delays in moving funds.
While the transferable nature of stablecoins is a defining feature and underpins the benefits, it also complicates the approach to local issuance, for two reasons.
First, while the likely redemption requests from a local issuer in a stress scenario can be based on how much that entity has issued, this is complicated by cross-border transfers. When stablecoins are transferred into and out of the jurisdiction, the value of stablecoins held there (and therefore the possible redemption requests) may differ from net issuance. To compound the problem, because stablecoin issuers do not have a direct relationship with their users, local holdings of the stablecoin are not known and need to be estimated.
Second, in meeting redemption requests, the issuer is able to draw not only on the minimum reserves held locally to support net issuance, but also other resources including globally fungible buffers and the ability of the issuer to arrange for credit support from credit worthy financial institutions (e.g. a bank guarantee or letter of credit).
An overly strict implementation of local issuance would be operationally burdensome for the issuer and inefficient, since reserves would be fragmented across jurisdictions and may be in excess of possible redemption requests.
Regulatory recommendations for stablecoin issuance
There are a few key take-aways for policymakers when it comes to stablecoin regulation.
First, to support the development of digital asset markets it is preferable to allow a variety of stablecoins circulating, including those issued overseas. This would increase choice and support innovation and development of the ecosystem.This is particularly relevant for jurisdictions that wish to become hubs for cryptoassets and/or tokenisation of real world assets.
Second, jurisdictions should take a proportionate and risk-based approach to overseas issuers. Overseas-issued stablecoins should generally be permitted to circulate in a jurisdiction without a requirement for local issuance so long as reasonable safeguards are in place.
For example, in Singapore, overseas-issued stablecoins are regulated as digital payment tokens (DPTs) rather than being subject to the full framework for Single Currency Stablecoins. This means that value stability and redemption isn’t regulated, while minimum standards are applied for Anti-Money Laundering (AML) and Combatting the Financing of Terrorism (CFT) obligations, consumer protection, and market integrity, allowing overseas-issued stablecoins to be used as a means of payment under the Payment Services Act, 2019.
Regulators may wish to confirm that overseas-issued stablecoins are subject to a sufficiently high standard of regulation in their home jurisdiction that meets agreed international standards. For example, the overseas issuer might be required to secure an expert legal opinion on the home regulatory regime, including redemption arrangements.
Third, where local issuance is required, regulators should take a holistic approach to ensuring the local regulated entity is able to meet redemption requests. This should be based on reasonable scenarios for redemption requests, including in stress, and should reflect all the resources the redeeming entity can draw on including globally fungible buffers.
Finally, close supervisory cooperation between jurisdictions can underpin these arrangements and unlock greater fungibility. Supervisory co-operation can help a host jurisdiction to understand the risks posed, assess the protections in the home jurisdiction and monitor how an arrangement is working. In the longer term, more formal mechanisms which are used in other sectors, like regulatory colleges and/or equivalence arrangements, could further support international fungibility of stablecoins.
The global regulatory landscape for stablecoins and other digital assets is vast and varied. As the market and subsequent policy frameworks continue to evolve, regulators and policymakers will play a key role in paving a path forward for greater institutional and end-user adoption of fiat backed stablecoins.
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