How can stablecoins maintain credibility, particularly in light of recent hackings and value depreciations?
“Fundamentally, a stablecoin must be able to hold its value such that users can be confident that they are holding a stable method of payment that will not fluctuate in value. This is where the challenge with some stablecoin structures lies. For those that are in essence a tradable asset that can be used for payments, there is the potential for the value of these stablecoins to fluctuate as a result of their tradable features. And this means that it does not behave entirely like a currency, but potentially more as a commodity that is used as a means of payment.”
“It is also important to distinguish between user types, and between different types of user behaviour. Client classification is a well-established component of EU and UK financial regulation, with clients broadly being classified into Retail or Professional (and Eligible Counterparty) categories, and subject to appropriate protections based on their sophistication. User behaviour can be split across those who are holding stablecoins as a store of value or investment asset and are primarily interested in their tradability (ie more speculative behaviour), and those who are more risk averse, and see the benefits of digital currency for payments and settlements, but do not want to expose themselves to price fluctuations.”
“Most stablecoin issuers (with the exception of those that are currently subject to the e-money regime) are not currently subject to any prudential or conduct regulatory requirements.”
Jannah Patchay
“In the current absence of a regulatory regime for stablecoins (which is soon to change in the EU with the introduction of the MiCA regulations, and in the UK, to some extent, with the broadening of the current e-money and payments regimes to encompass certain types of fiat-backed stablecoins), most stablecoin issuers (with the exception of those that are currently subject to the e-money regime) are not currently subject to any prudential or conduct regulatory requirements. So, whilst they can purport to offer a “stable” coin, there is actually no requirement for them to demonstrate or maintain its stability. And even with the best intentions, the case studies mentioned above show that the current regulatory infrastructure is not as robust as it needs to be.”
“For systemically important stablecoins, in particular, to be truly “stable”, there are some clear risk-mitigating steps that can be taken, including lessons that can be learned from the e-money regime. Again, the proportionality of the stablecoin’s usage, and the risk it poses, should always be taken into consideration when determining how this risk can be managed through regulation. Rather than being prescriptive about the types of stablecoins that “should” be allowed, or how all stablecoins should be regulated, it will be important for regulators to consider the types of risks that can arise based on different stablecoin structures – including algorithmic stablecoins – and how these might be addressed in a proportionate manner.”
Can you explain more about the wholesale side and what this means?
“A wholesale central bank digital currency (CBDC) would be used by financial institutions for the use cases in which wholesale market infrastructure is currently used, eg payment vs payment (PvP, and FX) or delivery vs payment (DvP, or securities settlement) transactions. There are however also wider implications for introducing greater efficiencies in cross-border settlement as well as for underpinning the evolution of digital asset markets (including not only cryptocurrencies, but also tokenised securities, other financial instruments and new asset types). A wholesale CBDC has the potential to radically reduce the operational inefficiencies in wholesale financial markets at present, and to improve intra-day risk and liquidity management through the enabling of instantaneous atomic settlement of transactions.”
“Nevertheless, full realisation of the benefits associated with a wholesale CBDC is dependent on a great deal of transformational work being undertaken on the part of financial market participants. Significant front-to-back systems change would be required to support their adoption within individual financial institutions, whilst on a cross border basis, there is a need to central banks to collaborate on implementing mechanisms for interoperability between different CBDCs (there is potential for the private sector to assist with this, for example SWIFT’s recent work in this area).”
Read the first part of our interview with Jannah Patchay