From the four perspectives of stablecoin characteristics, risks, existing policies and regulatory recommendations, interpret the G20 Group’s regulatory attitude towards stablecoins and the direction of future stablecoin branches.
Original title: “Analysis of G20 Group’s Attitudes towards Stablecoin Supervision”
Written by: Cui Chen, working at HashKey Capital Research
Audit: Zou Chuanwei, Chief Economist of Wanxiang Blockchain and PlatON
On October 13, 2020, the FSB issued a final report on the global stablecoin regulatory recommendations, which foretells the G20 Group’s regulatory attitude towards stablecoins. Stablecoins that can be circulated globally have become the main regulatory goal. Regulatory agencies and international standard setting agencies in various jurisdictions must ensure that stablecoins carry out various risk management in related activities and meet the requirements of all jurisdictions laws and regulations before the launch of stablecoins. At the same time, all jurisdictions should strengthen cooperation to achieve “same affairs, same risks, and same rules.” Judging from the actual situation, there will be a certain gap between developed and developing economies in terms of specific policy formulation and stable currency operation.
The extremely high volatility of cryptocurrency limits its application in real life. Compared with sovereign currencies, stablecoin prices are stable and have great potential for improving the efficiency of financial services, including cross-border payments and inclusive finance.
Initially, the main application scenarios of stablecoins were cryptocurrency hedging and pricing tools, with a small market share. With the continuous expansion of the number of users and market size, stablecoins are gradually being applied to other financial services, which also attracted the attention of regulators. Especially after the release of the Libra white paper, regulatory issues related to stablecoins have triggered worldwide discussions. The G20 Group calls on the FSB (Financial Stability Board, Financial Stability Board) to review the regulatory issues brought about by global stablecoins.
This article combines the relevant content of the FSB’s final report on global stablecoin supervision recommendations, from the four perspectives of stablecoin characteristics and risks within the scope of supervision, the application of existing policies and regulatory recommendations, and interprets the G20 Group’s comments on stablecoins. The regulatory attitude and direction of future stablecoin branches.
Background of stablecoin and FSB report
Although the scale of stablecoins has not been large enough to threaten financial stability, the number and scale of users can rapidly expand because stablecoins are mainly based on network services. The supply and trading volume of stablecoins are currently on the rise, and there will be breakthroughs in the future. Coin Metrics data shows that from the beginning of 2020 to the end of September, the total amount of stablecoins increased from 6 billion US dollars to 20 billion, and the transaction volume on the chain increased from 23 billion US dollars to 145 billion.
Regarding the risks that stablecoins bring to the existing financial markets, and how to deal with them, it is a concern of various countries’ regulatory agencies. On October 13, 2020, the FSB (Financial Stability Board, Financial Stability Board) published the final report on the global stablecoin regulatory recommendations, providing guidance for policymakers in various jurisdictions. FSC was established in 2009 with the purpose of coordinating the cooperation between national financial institutions and international standard-setting bodies at the international level, and promoting the formulation and implementation of regulatory and other fiscal policies to solve the problem of financial vulnerability. FSB and IMF (International Monetary Fund), World Bank, FATF (Anti-Money Laundering Financial Action Task Force), BCBS (Basel Committee on Banking Supervision), CPMI (Payments and Market Infrastructure Committee), IOSCO (International Organization of Securities Regulators) ) And other international organizations also have close cooperation.
At present, stablecoins issued and circulated based on distributed ledger technology have no restrictions on borders and administrative regions. Therefore, international cooperation in supervision is very important to follow the principle of “same affairs, same risks, and same rules” and to avoid stability The currency issuer conducts regulatory arbitrage and makes use of the policy differences of different countries for profit. Therefore, an organization is needed to coordinate relevant decision-making and communication. The FSC report was born under this background.
Characteristics of stablecoins within the scope of supervision
There are many types of stablecoins, but for regulators, the most important type of stablecoin is based on distributed ledger technology, issued by unofficial institutions, and can be circulated freely on a global scale. The characteristics of this stable currency are obvious. Generally speaking, it contains the following:
Stabilization mechanism
The stability of stable currency refers to the price anchoring of a single asset or a basket of assets. There are currently two ways to achieve stable currency price stability: asset reserve mechanism and algorithmic mechanism.
Asset reserve mechanism
Under this mechanism, stablecoins need to have asset reserves behind them. These assets can be cash, financial instruments, commodities or encrypted assets. Under the condition that the issuance and redemption channels are unblocked, if the price of stablecoins deviate from the anchor price, there will be profit margins, and users can participate in arbitrage to achieve the return of stablecoin prices. The specific implementation is in the “Stablecoin Theory and It has been discussed in Practice (No. 15, 2020).
Algorithm mechanism
The algorithmic mechanism can indirectly adjust the price of stablecoins by adjusting the supply of stablecoins according to changes in the demand for stablecoins. For example, when the demand for stablecoins increases and the price exceeds the anchor price, the system will automatically issue a corresponding number of stablecoins to reduce the price of stablecoins and make them tend to be anchored, and vice versa. From the perspective of theory and practice, the algorithm-based stablecoin should not be feasible.
Functions and related activities
Stablecoins are often used as payment and value storage tools. These functions are achieved through corresponding activities, such as currency transfers and transactions that require users to use wallets to operate, and stablecoin managers are required to verify transactions. The risks of stablecoins stem from these activities. The following will specifically analyze the current mainstream countries’ response to risks.
Table 1: Functions and corresponding activities of stablecoins
Can be circulated globally
Among all types of stablecoins, stablecoins that can be circulated on a global scale, namely global stablecoins (GSCs), are the focus of regulatory attention. A major feature of global stablecoins is that they have no geographical restrictions, so the risks to the financial system are also global. The characteristics of openness can also achieve rapid user growth. Although the current market share of stablecoins is small, there are always discussions about its regulatory issues.
As for how to judge whether a stablecoin is a global stablecoin, and how to determine its influence, the FSB provides 12 reference judgment standards, including: 1. The number and type of stablecoin users; 2. The number and value of transfers; 3. The scale of reserve assets; 4. The scale of circulation of stablecoins; 5. The market share of payments and remittances within the scope of cross-border use; 6. The number of jurisdictions where stablecoin users are located; 7. The use in each region Based on the market share of payment; 8. Whether one or more foreign currencies can be redeemed; 9. The degree of relevance to financial institutions; 10. Whether digital services or platforms (such as social networks) are integrated; 11. Whether it can be used Stable currency payment in time; 12. The complexity of business, structure and operation.
The risks of stablecoins to the global financial system
The risk of stable currency to financial stability
Whether used as a payment or value store tool, the impact of stablecoins on the financial market is huge. As a payment tool, if the stablecoin infrastructure is imperfect and cannot carry large-scale transaction volume, problems such as running stalls and interruptions will occur, which will directly affect the actual economic activities. If it is used as a store of value, users’ assets are easily affected by stable currency fluctuations. Especially for emerging markets and developing economies, there is a greater demand for stable coins as a store of value. In addition, these two functions will cross-influence during use. If there are failures such as network paralysis during the stablecoin payment process, it will affect the user’s trust in the stablecoin, which will trigger asset redemption and weaken the role of stablecoin in the storage of value.
Financial institutions in the stablecoin system perform different functions, and their participation will increase risk exposure. When the same financial institution assumes multiple roles, it may cause systemic risks. These roles include dealers, market makers, wallet providers and managers of reserve assets. If the institution falls into a negative crisis in one aspect, it will affect users’ confidence in using stablecoins, and also affect the functions of stablecoins in payment and value storage.
Risks in the use of stablecoins
As mentioned above, various activities are involved in the use of stablecoins, and these activities bring different risks to stablecoins. For example, when it comes to managing reserve assets, the conditions that trigger liquidation and the liquidity status of reserve assets will become sources of risk.
Table 2: Types and sources of risks in stablecoin-related activities
The risks of cross-border payments
The unbounded nature of the network allows stablecoins to naturally have cross-border capabilities. The stablecoins issued in one region can easily circulate through the network to another region, and related network security risks will also spread. Regulatory policies usually only apply to activities that occur locally, but the positioning of network services is a difficult point for supervision, so there may be regulatory loopholes and related regulatory arbitrage. In addition, cross-border payments pose greater challenges for emerging markets and developing economies, because stablecoins are easier to accept and spread in developing economies than in developed economies.
Research on current stablecoin regulatory policies
Supervision and deficiencies in various jurisdictions
Currently, most jurisdictions do not have a regulatory mechanism for stablecoins. The most common approach is to list the various activities involved in stablecoins during operation, and then find existing regulations to supervise them. Related activities include the issuance and redemption of stablecoins, reserve asset management, providing custody services for reserve assets, trading stablecoins (including selling to retail users) and private key custody (wallets).
Some regions have provided relevant guidance to help stablecoin providers achieve compliance with current regulations, some regions are beginning to formulate corresponding regulations to manage cryptocurrencies, and some regions have prohibited cryptocurrency-related behaviors. In terms of the qualitative aspects of stablecoins, advanced economies generally regard them as e-money and collective investment schemes (CIS), followed by deposits, securities other than CIS and derivatives. Emerging markets and developing economies define it as e-money and payment instruments. This depends on the nature of the claims made by stablecoin holders to the issuer. Their nature will affect their applicability under the regulatory system. .
The difference between developed economies and developing economies is also reflected in the authority’s regulatory power over stablecoins issued outside their jurisdictions when they are used within their jurisdictions. This is related to whether cross-border stablecoins can be classified under the domestic regulatory framework. . If stablecoins can be placed under the existing legal framework, then most of the jurisdictions’ authority will have the same power over stablecoins. In contrast, advanced economies have more power at home and abroad.
Figure 1: When stablecoins are operated abroad and used domestically (incoming), the authorities’ regulatory powers over them
Stablecoins may undergo changes in various aspects, including structural changes (changes in the composition or stabilization mechanism of reserve assets), changes in corresponding powers (changes in reserve asset claims) and changes in actual use (as a means of payment, used for credit, Use scale changes), these changes may affect its regulatory classification.
Most financial regulators said that they may need to adjust the existing framework in the future, and some said that they will take legislative actions to resolve the missing parts of the regulatory system, or completely adopt a comprehensive new structure. In this regard, there is little difference in attitudes between developed and developing economies.
Figure 2: Changes in future regulatory policies
In general, developed economies have relatively comprehensive regulations covering stable currency activities, which are somewhat different from the regulatory policies of emerging markets and developing economies. Regulatory differences in different jurisdictions may cause regulatory arbitrage. For example, in some regions, the inaccurate classification of stablecoins may result in no existing regulatory framework for stablecoins. Some related activities, such as stable currency transactions and wallet services, seem to be supervised under current regulations in terms of economic behavior, but due to their special design, they are actually not applicable. Similarly, risks such as market integrity, consumer or investor protection, network security, and data privacy have not been resolved.
Even under the existing regulatory system, the particularity of stablecoins will make the problem difficult to solve. For example, there are no clear capital and liquidity requirements for reserve assets, network security cannot be effectively guaranteed, the underlying technical risks of operating infrastructure, verifying transactions, and storing keys, and the lack of security guarantees for unmanaged wallets, and the lack of security guarantees for consumers or investments In terms of security protection of the people, the recovery of funds and legal assistance lack legal certainty. Countries also lack sufficient competition policies to give consumers and companies the rights and guarantees to join stablecoins (such as requiring interoperability agreements) to promote appropriate competition among market participants.
Multinational organizations’ regulatory policies on stablecoins
At present, some international financial standards may be applicable to relevant stablecoins. The international financial standards formulated by standard setting agencies such as BCBS, FATF, CPMI, and IOSCO will involve relevant regulatory systems.
In the BCBS study, banks are subject to a series of direct and indirect risk exposure channels. For example, as issuers, investors, lenders, custodians and market makers, they will face network, deception and other operational risks, as well as legal, Third party and performance risks. BCBS’s sound management principles for operating risks can avoid risks by establishing a strong control environment, appropriate internal control, and business flexibility and continuity plans.
FATF believes that stablecoins, like virtual assets, need to bear the same money laundering and terrorist financing risks. The revised FATF standard also applies to stablecoins. Relevant entities involved in stablecoins have anti-money laundering and combating terrorist financing obligations. Specific entities will be judged based on the nature of stablecoins and the activities involved.
CPMI and IOSCO conducted a preliminary analysis of the application of the Financial Market Infrastructure Principles (PFMI) to stablecoin-related activities. The principles include a sound legal foundation, promotion of safety and efficiency and support for stable governance of the financial system, risk management and business resilience. PFMI’s responsibility E provides a framework for cooperation between central banks, market regulators and other relevant authorities.
IOSCO’s research indicates that some principles and standards can be applied to potential stablecoin issuance, including IOSCO’s policy recommendations for money market funds (2012); issues, risks and regulatory considerations for crypto asset trading platforms (2020); exchange trading Fund Management Principles (2013); Special Report on Cross-border Supervision (2015), etc.
Problems faced in cross-border cooperation
As mentioned above, the risk of stablecoins in cross-border use stems from the fact that they can be easily used in different regions through the network. Therefore, cross-border cooperation and information sharing are very necessary to solve the problem of cross-border use of stablecoins. Officials need to understand the operating mechanism and communication channels of stablecoins. They also need to understand the scope of the counterparty’s regulatory framework and the interaction between them.
In determining the degree and nature of cross-border cooperation, relevant information that needs to be understood includes: 1. The scope of use of stablecoins and the location of users; 2. The location of the formulation and execution of stablecoin-related decisions; 3. The issuance and redemption of stablecoins The location and the place where the reserve assets are managed; 4. The transfer mechanism of the stable currency and the method of transaction and sales; 5. Whether the storage of data and records is centralized and the storage location; 6. The location of the wallet and platform providers and their Whether the operation of the stablecoin is cross-border; 7. Whether there is vertical integration among the operators of stablecoin function activities.
At present, in the cross-border supervision of financial institutions and financial market infrastructure, the methods of home supervisor and host supervisors are usually adopted. The main supervisor refers to the supervision of the headquarters of the financial institution and the jurisdiction where the main body is located, and is responsible for the supervision of related institutions. In this case, efficient joint supervision can be accomplished through coordination and cooperation between the main supervisor and the supervisor (host supervisor) in the jurisdiction where the subsidiary and branch are located.
But the regulation of stablecoins is different from these two methods. First, stablecoins do not have the same entity, which connects unrelated entities located in different jurisdictions through the network. In addition, the functions behind stablecoins go beyond the scope of traditional finance and financial market infrastructure. Every part of a stablecoin, including entities, policies, processes, and technologies, will affect each other. But the overall principle cannot be deviated from the “home-host” principle, especially in some specific circumstances, such as no entity responsible for the governance of stablecoins, or the core functions behind stablecoins are located in different entities in different jurisdictions.
The direction of future stablecoin regulatory policies
Based on the above considerations, in order to promote the efficient and consistent supervision of stablecoins in various jurisdictions, the FSB put forward ten high-level recommendations, including:
- Officials should use necessary power tools and resources to comprehensively supervise the relevant behavior of stablecoins and effectively implement corresponding laws and regulations.
- Officials should implement comprehensive supervision of stablecoins based on their risks and implement relevant international standards on a functional basis.
- Officials should strengthen cooperation at the domestic and international levels, promote efficient communication and negotiation between each other, support each other in performing their respective duties, and ensure comprehensive supervision of cross-border and cross-regional stablecoins.
- Officials should ensure that stablecoins have a comprehensive governance framework that clarifies the distribution of responsibilities for each functional activity.
- Officials should ensure that stablecoins have an effective risk management framework in terms of reserve asset management, operational flexibility, network security, and anti-money laundering/anti-terrorism measures.
- Officials should ensure the stability of the stablecoin system in terms of data collection, storage and protection.
- Officials should ensure that stablecoins have appropriate recovery solutions.
- Officials should ensure that stablecoins provide users and stakeholders with comprehensive and transparent information to understand how stablecoins work, including their stability mechanisms.
- Officials should ensure that, where applicable, stablecoins provide users with the nature and enforceability of redemption rights, as well as a legal statement on the redemption process.
- Officials should ensure that stablecoins meet all applicable laws and regulations in specific jurisdictions before launching, and adapt to new regulatory requirements when necessary.
In general, these regulatory recommendations include several directions. First of all, it is necessary to improve and implement relevant laws, including regulations and international standards within the jurisdiction, to ensure that stablecoins and corresponding activities can remain stable in all aspects. Among them, bilateral and multilateral cooperation is very necessary. Second, we must ensure the stability of stablecoins. This not only refers to price stability, but also requires responsibility for the stability of the financial system, ensuring risk management in all aspects, and protecting data information and user rights. Finally and most importantly, stablecoins cannot be launched online until they meet the requirements of laws and regulations in all jurisdictions.
Thinking and summary
From the above discussion, it can be seen that the stable currency-related activities involved in retail-type (that is, publicly available) stablecoins will be more complicated, so the regulatory policies involved will also be more complicated. Relatively speaking, non-retail stablecoins mainly involve application scenarios between institutions, including real-time full settlement, synchronized cross-border transfers, etc. The relevant institutions will undergo strict inspections, and their control and review are relatively easy, such as Morgan Coin (JPM Coin) is issued on the private chain Quorum, mainly for B-end institutional users.
Retail stablecoins will have a greater impact on developing economies and require strong government regulatory measures. It is foreseeable that, compared with developed economies, the supervision of developing economies will be further tightened in the short term. At the same time, in order to prevent the impact of anchoring other asset stable currencies, developing economies will be more motivated to pay attention to retail CBDC, especially China’s DC/EP, which has now become the world’s leading retail CBDC. The proposed amendment to the People’s Bank of China Law will give DC/EP legal status, but will prohibit the issuance and circulation of RMB stablecoins.
In countries with strong currencies, the regulatory policies for stablecoins will be more open. For example, USDC’s issuer Circle has obtained the BitLicense license in the United States, including New York State, which can be issued to retail users and used as a legal payment tool. Therefore, in the application and supervision of stablecoins, developing economies and developed economies will form different situations in the short term.
