i. What are stablecoins?
Stablecoins are a subset of crypto-asset, which vary considerably in design, but whose purpose is to maintain a stable value, by reference to other assets. There are two broad sub-sets of stablecoin, “Collateralised Stablecoins” and “Algorithmic Stablecoins”.
Collateralised stablecoins are designed by pegging against reserve assets, such as dollars, gold or a basket of commodities. Algorithmic stablecoins do not seek to stabilise their value through underlying collateral. Instead algorithms are used to pre-programme
the supply of the token to match demand, thereby stabilising the price. At present, stablecoins are often used to facilitate trades on crypto exchanges, thereby reducing fees associated with transferring other cryptocurrencies into fiat. They are also considered
to have potential for improving efficiencies in and reducing the fees of cross-border transactions.
ii. Regulations: the status quo
In many developed economies, there is little in the way of structured regulation of stablecoins. Naturally, there are those that argue that regulators should not interfere. Stablecoins use similar technology to that underpinning Bitcoin, which sought to
establish a system of electronic cash, using a distributed ledger in order to avoid the need for any centralised administrator of the network. This led to some to argue that Bitcoin might be the first “self-regulating currency”, which represented a
shift in power from the sovereign State to the individual. Those who view Bitcoin and its successors from such a perspective might argue that state-imposed regulation is an attempt by the State to impose its authority over an aspect of the financial system,
over which it has not had control in recent years. Less philosophically, there are those that argue that, given that the primary users of stablecoins are crypto traders, who are aware of the risks, regulation is not justified. Moreover, given that the evolution
of stablecoins is still in relative infancy, it might be said that regulation risks stifling innovation. Finally, regulatory requirements may risk creating barriers to entry for new entrants into the market.
However, policy makers in the EU, USA and UK consider that the status quo is no longer acceptable. Specifically, concerns have arisen as to consumer protection (by way of example only, in relation to redemption rights), financial stability risks (in circumstances
where the market capitalisation of stablecoins is broadly similar to that of all listed companies in Poland and growing fast) and the lack of supervision by regulators regarding reserve assets (in the case collateralised stablecoins). Therefore, whilst the
EU is further ahead in terms of its timeline for enacting legislation, given that in March 2022 this year, the European Parliament adopted its negotiating position on the draft Markets in Crypto Assets Regulation (“MICA”), broad outlines have also emerged
in the USA and the UK in recent months, showing a diversity of approach.
iii. Different approaches: EU, USA and UK
MICA specifically targets stablecoins, which categorises as either “asset-referenced tokens”, which “purport to maintain a stable value by referring to the value of several fiat currencies that are legal tender, one or several commodities or one
or several crypto-assets” [Article 3(1)(3)] or “electronic money tokens”, which seek to maintain stability by reference to only one fiat currency. As for algorithmic stablecoins, Recital 26 provides that they are not to be considered as ‘asset-referenced
tokens’, “provided they do not aim at stabilising their value by referencing one or several other assets”.
MICA requires that, in order to provide cryptoassets services throughout Europe, legal persons will be required to obtain authorisation from a national competent authority. The process for obtaining authorisation requires compliance with stringent requirements,
such as capital requirements, ICT security obligations, consumer protection obligations, maintenance of policies on conflicts of interest and many others. Issuers of stablecoins are subject to additional obligations beyond those applying to simple cryptoassets
service providers. By way of example, they will be required to publish a whitepaper, which must contain detailed information as to (among other things) the coin’s design, the rights and obligations of holders, the underlying technology and an explanation of
the risks relating to the issuer.
In November 2021, the US Treasury published broad recommendations for regulating stablecoin issuers. The report is notable for pressing for immediate action on the part of legislators to combat the risks said to be posed by unregulated stablecoins. In particular,
the Treasury notes its belief that “legislation is urgently needed to comprehensively address the prudential risks posed by payment stablecoin arrangements” and the “rapid growth of stablecoins increases the urgency of this work”. Even more striking
is the recommendation that stablecoins should only be permitted to be issued by ‘insured depositary institutions’, which refers to “any bank or savings association the deposits of which
are insured” and which “are subject to appropriate supervision and regulation”. If this proposal were adopted, significant limits may be placed on the entities able to issue stablecoins and would mean a similarity of treatment of stablecoin issuers
and commercial banks. Some have argued that such an approach is inappropriate, since, unlike commercial banks (which create money by lending it into existence) stablecoin issuers do not lend, but accept fiat currency in exchange for digital assets. Nevertheless,
it remains to be seen whether this approach will be adopted by legislators.
Finally, in the UK, which is similarly behind the EU in terms of the timeline for legislation, HM Treasury issued in April 2022, broad proposals for regulating stablecoins. As with MICA, algorithmic stablecoins will be excluded. The thrust of the proposal
is to bring stablecoins, where used as a means of payment, within the FCA’s regulatory perimeter and for them to be regulated in a broadly equivalent manner to e-money providers. This would impose safeguarding rules designed to protect funds in the event that
the issuer becomes insolvent, such as the requirement that the reserve assets be held in a separate account from the issuer’s working capital, be invested in high quality liquid assets or covered by an appropriate insurance policy. In practical terms, HM Treasury
seeks to guarantee that each £1 token issued will be safeguarded with £1 in reserve and that the reserve funds cannot be used for any other purpose. Moreover, Part 5 of the Banking Act 2009 will be extended to apply to activities relating to stablecoins that
are considered to pose a systemic financial risk.
iv. Conclusion
There is therefore a clear trend towards regulating stablecoins. It will be interesting to examine whether (and in what terms) legislators continue with the current proposed approaches. Moreover, the different regulatory approaches are also likely to impact
upon the market for stablecoin issuers across jurisdictions.