Regulate stablecoins to unlock their economic potential

Calls for regulating stablecoins, which serve as crucial linchpins and safe havens in the emerging Web3 ecosystem, are getting louder. This isn’t surprising, given their potential as an alternative means of payment to fiat currencies, their rapid growth, and the brutal way recent crypto market volatility has shown some of them to be stable in name only.

We approach this issue from our perspective as a payment service provider, driven by a mission to enable businesses and their communities to thrive in the digital economy. We continually challenge ourselves to find new ways to improve businesses' payments performance, help them innovate, and equip them to reach new customers and markets.

Stablecoins have the potential to do all of these things, and we’re starting to bring the benefits to merchants through our stablecoin settlements proposition.

But our research finds that only 27% of consumers perceive stablecoins to be a lower-risk form of crypto assets than unpegged crypto coins. And while 36% of CFOs tell us they would like to settle payments in stablecoins, over half of the merchants (55%) believe holding any kind of cryptocurrency on their balance sheets would be risky.

As a result, we think the economic potential of stablecoins would be felt more widely by bringing them into a well-calibrated regulatory framework that manages their potential risks, gives businesses and consumers more confidence to hold and use them, and still allows space for innovation to occur.

Why all the regulatory interest?

Seen from the perspective of governments and financial regulators, stablecoins represent an alternative system of money and payments to the existing fiat-based systems they oversee — one they concede offers potential benefits but also poses risks to people who hold these coins, businesses who interact with them, and the wider financial system.

The launch of Facebook’s Diem initiative in 2019 grabbed the attention of governments and central bankers, prompting fears about the systemic impacts of a stablecoin payment system operating on a global scale.

Although Diem ultimately foundered, the remarkable growth of other stablecoins, whose market capitalization increased from $5.6 billion at the start of 2020 to $152 billion in June 2022 — together with question marks about the veracity of public disclosures on stablecoin reserves, the failure of some algorithmic stablecoins, and other AML and privacy-related concerns — has ensured continuing scrutiny.

The key enabling role of stablecoins in the broader Web3 ecosystem is now better understood in policymaking circles, and the recent crash of the algorithmic stablecoin Terra was a wake-up call.

It demonstrated the risks to holders of these tokens. It also made clear the need for legal consensus on a central issue: if a consumer or business wants to hold value or make payments in stablecoin, they need to be sure that the token they are using is stable in practice, as well as in name.

Where are we now?

At the international level, standard-setting bodies have been thinking about how best to regulate stablecoins for some time.

The Financial Stability Board agreed on high-level principles for regulating global stablecoins in 2020, and the Bank for International Settlements’ Committee on Payments and Market Infrastructures (CPMI) and the International Organization of Securities Commissions (IOSCO) published final guidance in July 2022, confirming that stablecoin arrangements should observe international standards for payment, clearing and settlement systems.

The European Union has been at the forefront of efforts to regulate the digital asset economy. In June 2022, after nearly two years of negotiations, EU institutions agreed on their Markets in Crypto-Assets Regulation. This will bring crypto assets, including stablecoins, along with crypto assets issuers and service providers, into regulation for the first time in the EU. The regulation will likely come into force in early 2023 and then be implemented over 18 months.

However, the EU isn't the first jurisdiction to create a legal framework for stablecoins — far from it. In the US, state-level regulation has existed for several years. New York State’s Department of Financial Services (DFS) imposed requirements, standards, and controls on the stablecoins issued by its regulated entities in 2018. Some of the largest stablecoins by market cap, including USDC, BUSD and USDP, are issued by entities operating under this framework.

But we’re now also seeing federal-level legislative initiatives in the US. Most recently, Senators Lummis and Gillibrand published a bipartisan legislative proposal on digital assets in June 2022. This includes a tailored framework for ‘payment stablecoins,’ laying down requirements in areas such as backing reserves and related public disclosures and redemption rights for tokens. While there may not be immediate progress on this or related legislative initiatives that emerge, given the forthcoming midterms, there now seems to be the basis for possible cross-party consensus on stablecoins further down the line.

There have also been early movement on stablecoin regulation in the APAC region. In Singapore, stablecoins were brought into the scope of domestic regulation by the country’s Payment Services Act 2019.

And Japan passed legislation in June 2022 that will regulate stablecoins. Coming into force in 2023, its new law defines stablecoins as digital money, restricts their issuance to licensed financial institutions, and requires them to be linked to the yen, dollar or another legal tender.

In the UK, policymakers are taking a more incremental approach to crypto regulation, starting with stablecoins — and efforts in this area are now gathering momentum. As part of its broader plans to make the UK a global crypto hub, the UK government confirmed in April 2022 that it would bring stablecoins used for payments into regulation, primarily by amending existing electronic money and payments legislation. It will do this through a new Financial Services and Markets Bill, which UK parliamentarians will start to review in autumn 2022.

Meanwhile, in MENA, the Dubai Financial Services Authority (DFSA) consulted in spring 2022 on proposals for regulating crypto assets outside the scope of its existing laws, which cover investment tokens. Although its proposed definition of ‘crypto tokens’ would include many stablecoins, the DFSA plans to prohibit algorithm-based stablecoins.

What is needed from forthcoming regulation?

Although seemingly in conflict with crypto's decentralized ethos and foundations, regulation has seen increasing support within the crypto sector. It will give market participants the certainty they need, but currently lack, to continue investing in their propositions. And it will help to build trust in the broader Web3 ecosystem, which is vital to its long-term success.  

Ultimately, as a payment services provider, Checkout.com wants to give the businesses we serve as much optionality and choice as possible in how they can receive payment from their customers and move value more broadly. We see potential in different kinds of crypto assets.

However, what holders of stablecoins need, perhaps most of all, from regulation — especially in light of the Terra collapse – is the confidence that these tokens will actually 'do what they say on the tin' and provide stable value. We think it's reasonable for any issuer to meet some core requirements if they wish to launch a stablecoin that claims to maintain a stable value relevant to a specific reference fiat currency.

They should, in our view, be subject to safeguards such as, but not limited to, the following:

• Clear regulatory oversight: Issuers should be licensed or similarly authorized by regulatory authorities and subject to ongoing supervision to ensure they remain compliant with applicable regulatory obligations.
• Robust reserve requirements: To build trust and confidence, we think it's essential for issuers to maintain backing reserves of fiat and high-quality liquid assets equal to the value of their stablecoins in circulation in the regulated financial system. In our view, these should be held either with licensed or chartered depository institutions with deposit insurance or a custodian approved by the relevant regulator and segregated from the proprietary funds of the issuer.
• Openness and transparency: Issuers should also provide monthly public disclosures on the composition and value of those backing assets – another measure we believe is vital to building trust in these digital tokens. Disclosures should, in our view, be verified under relevant accounting attestation standards.
• Protections for stablecoin users: Crucially, issuers must grant holders a right to redeem their stablecoins on demand for the reference-fiat currency on a one-for-one basis.

One way or the other, regulation is coming. Well-calibrated guardrails for stablecoin issuers and holders should reinforce the vital role of stablecoins in digital markets. In addition, we believe it will position these digital tokens to break into the wider economy as a genuine alternative to existing payment methods, giving consumers more choice and businesses a new means of reaching new customers and new markets.  

Learn what Wolfgang Bardorf, SVP Corporate Treasury at Checkout.com, Adam Levine VP Corporate Strategy, Fireblocks, and Stefan Sabo, Head of Research, Gemini have to say about how stablecoins will change the business of banking.