Regulators come for stablecoins, but what should they start with? – News Couple

Regulators come for stablecoins, but what should they start with?

‘stablecoin’ might have a fun loop – wouldn’t it be nice to have something stable in volatile cryptocurrencies? – But for critics, they are nothing less than a time bomb. Whether or not this is true, the push to regulate stablecoins is gaining momentum. The United States and the European Union are close to formalizing their own rules of play, and given the history of financial regulation emerging from Washington and Brussels, as well as the FATF’s guidance on cryptocurrency over the past few years, it’s safe to say that the rest of the world will Follow suit.

However, organizing stablecoins is not an easy task, as these coins come in all shapes and sizes, making a one-size-fits-all solution a problem. The top three stablecoins by market capitalization – Tether (USDT), USDCoin (USDC) and Binance USD (BUSD) – are all pegged to the US dollar. According to their respective developers, they are backed by reserves of green currencies and various other financial instruments to maintain their value at $1 at all times.

Tether has already found itself under legal scrutiny over the viability and sources of its reserves, which has led the other two projects to reveal the assets backing each other. The USDC disclosure, for its part, highlights a large amount of “commercial paper” – not necessarily high-quality or highly liquid – in its own reserve. For many, the revelation has led to the conclusion that the company is behaving like a bank and not a paying business.

Other, more obscure stablecoins use a large number of alternative methods. It can be linked to commodities, such as gold or oil, as with the controversial Venezuelan Petro. More exotic options include coins tied to carbon credits, such as UPCO2, crypto-backed coins such as Dai, and perhaps the rarest of all, stablecoins such as Terra (UST) that have no collateral at all and instead rely on algorithms to maintain prices stable.

Of course, some might say that regulation will only slow innovation, so governments should stay out of the cryptocurrency path, but this argument lacks historical context. Earlier, in the unbridled age of banking, private currencies issued by rogue banks often left people buying with worthless notes, so the dollar was enshrined as the only national currency of the United States. The same reasoning applies to the 2008 money market fund crisis when federal authorities instituted new rules to protect the average citizen from large investors withdrawing large sums from them.

Time and time again, we, as a society, have determined that consumers need to be protected from scams or simply bad judgment by those who hold, transfer value, or provide similar services. We have implemented rules and regulations to regulate who can issue and redeem what we consider cash, and have written an operating guide for those who handle money in amounts that can send shock waves through the economy if mishandled. Why not do the same with stablecoins, a market that has a total cap of over $133 billion? Simply put, there is no point in keeping the Damocles sword of a crypto bank hanging above the heads of investors and traders. So where do we start?

One-to-one approach

The best way to start regulating stablecoins is to establish rules and protocols that will ensure that they comply with their demands. Christine Lagarde, President of the European Central Bank, said in a recent interview that stablecoins should be backed by 1:1 securities, adding that the projects behind the issuance of any stablecoins should:

“[…] They are checked, supervised and regulated so that consumers and users of these devices can be assured against any misrepresentation eventually.”

The European Union has a long history of Electronic Money Institutions (EMIs), which can issue and redeem digital euros, and these institutions back their digital euros with real euros held in a bank, or in some cases in a central bank. This may set an example for regulators in other jurisdictions, who appear to be heading in the same direction.

Here, we can compare the capital requirements of banks or payment companies, such as EMIs, to ensure that users of stablecoins can trade their fiat currencies at any moment through the company that minted those currencies. For reference, one of the main ways banks make money is by lending money deposited by others. The process needs to be organized simply to ensure that the bank has enough in its stockpile to repay clients who may want to withdraw their funds, but not necessarily a 1:1 ratio for each active deposit.

For a stablecoin issuer, selling their coins for fiat currency may technically be closer to a deposit, but the question is what are you going to do with the money next? If he lends, then he is engaged in banking activities. If it processes a transaction, it handles payment activities. If the money is invested in high-return assets, it technically relays orders to a brokerage firm or acts as an intermediary in its own right. Once again, for context, we, as a society, have given the management of these activities to the organizers.

Related: Stablecoins in Examination: USDT Stands by the Rope of ‘Paper Trade’

Appropriately, with stablecoins, regulators must first establish transparency standards for issuers, who must determine what financial activities they engage in, just as banks and payment firms do. Money market funds can be a good benchmark here. It is only reasonable to expect each stablecoin issuer to release reports on their holdings, including, where appropriate, the entities that issued specific securities and their amounts. Without this, there is no way for stablecoin users to be sure that their assets hold the intrinsic value.

For stablecoins pegged to more exotic assets, the rule of thumb should be the same: they must be able to prove that the assets they claim to be behind the coin exist. But this is where we jump right into a deep, deep rabbit hole. A commodity-backed stablecoin, for example, is, by law, a commodity-based investment contract, and it needs to be regulated as such, not “cash” in any way. And algorithmic stablecoins are finding it more difficult to fit into the regulated world.

The outer edge

Algorithmic stablecoins are not as massive as those embedded with fiat currencies. TerraUSD, which is pegged to the US dollar but technically lacks underlying collateral, is the fifth largest stablecoin, and ETH-backed DAI is the fourth largest, according to CoinMarketCap. Tether makes up about half of the total stablecoin market capitalization.

From a regulatory point of view, algorithmic and crypto-backed stablecoins are not currently as closely intertwined with the traditional financial system as those that hold traditional financial instruments in their reserves. These coins are usually fully wired into the larger crypto system or their networks. However, given the size and activities of these organizations – carrying out value transfer, in essence, is not always in line with the laws of the jurisdiction – they are just as worthy of a crossover with regulators as other stablecoins.

As an open and immutable ledger, the blockchain is open to auditing, and thus, oftentimes, it is the smart contracts that underpin such projects. Assuming the identity can be attached to wallets, transparency is not necessarily an issue. What is the problem, although at least this is likely to happen, is sparking the imaginations of the entities used to deal with traditional finance while at the same time encouraging crypto projects to find solutions to comply with the regulations that govern our society.

In theory, regulators could go a long way to setting a standard for integrating automated reporting and audits into the code that powers coins. Practically speaking, doing something like this begs the question of a larger regulatory framework for cryptocurrencies as such. Several organizers are working on this game guide as well, but there’s still a way to go before it’s complete.

Related: Stablecoins present new dilemmas for regulators as mass adoption approaches

Given the clear focus on cash-backed giants like Tether, the first order of business would be to categorize them according to activities (payment, banking, investing) and apply the required licensing requirements accordingly. Algorithmic stablecoins are likely to be put into a regulatory stalemate until the powers that be as a commodity are established, or even banned outright – and either will be forced to choose between adapting to regulations or marginalizing.

Regardless of the way things go, stablecoins are clearly in the rude awakening of regulators around the world, and rightly so. With its market cap rising, stablecoins are now one of the main pillars of the crypto ecosystem as such. By embracing regulation, the crypto community will simply make sure that this giant doesn’t have feet of mud.

This article does not contain investment advice or recommendations. Every investment and trading move involves risks, and readers should do their own research when making a decision.

The opinions, ideas and opinions expressed here are those of the author alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.

Bob Reed He is the CEO and co-founder of Everest, a financial technology company that leverages blockchain technologies for a more secure and comprehensive multi-currency account, digital/biometric identity, payment platform and e-money platform. As a licensed and registered financial institution, Everest provides comprehensive financial solutions, facilitating eKYC/AML, digital identity and regulatory compliance associated with the movement of funds. He was an advisor to Kai Labs, General Manager Licensing at Bittorrent and Vice President of Strategy and Business Development at Neulion and DivX.