Tightening the reins: Regulating stablecoins

The Financial Stability Board (FSB), which coordinates the work of the national financial authorities of the G20 member states, recently released its high-level recommendations for cryptocurrency regulation. The recommendations underline FSB's risk-centric approach in shaping its global crypto framework. Notably, in a significant departure from past norms, they require stablecoin issuers to secure local licences before operating in specific jurisdictions. This change could reform operational tactics and compliance methods for stablecoin providers, ultimately impacting their worldwide operations. Acknowledging the potential and risks associated with stablecoins, the G20 nations and international organisations are adopting a proactive approach to regulating stablecoins.

In a significant departure from past norms, they require stablecoin issuers to secure local licences before operating in specific jurisdictions.

As the current G20 president, India has issued a note on cryptocurrencies, aiming to influence global regulations. This note is significant as it presents India's recommendations for the International Monetary Fund (IMF) and FSB synthesis paper slated for publication post the G20 Summit in September. It suggests effective FSB implementation, evaluating impacts on emerging markets, involving non-G20 jurisdictions, and assigning IMF-FSB coordination roles. Introduced prior to hosting the G20 summit, the note showcases India’s proactive approach to shaping cryptocurrency regulations, bolstered by collaborative input from diverse nations during Finance Ministers and Central Bank Governors’ meetings. Maximising the benefits of stablecoins hinges on effective regulation, making India’s effort particularly noteworthy.

Advancing regulation

The FSB’s high-level recommendations indicate the potential revisions to global sectoral standards and principles across crypto-asset activities with financial stability concerns. They emphasise comprehensive crypto regulation, including compliance with basic rules like segregating client assets and separating functions on crypto platforms, underscoring the need for cross-jurisdictional collaboration among regulatory entities. The recommendations have significantly focused on the global regulation, supervision, arrangement, and oversight of “Global Stablecoins” (GSCs). They advise national regulators to control, supervise, oversee, and potentially limit stablecoin activity inside their jurisdictions. Specifically, they urge regulators to oversee GSC issuance by identifiable and accountable entities, referred to as a “governance body”, allowing swift human intervention when necessary, given the accountability and governance challenges of open ledgers or similar systems followed by GSC issuers. Open ledgers are decentralised systems of monitoring and storing transactions outside the ambit of a government or centralised authority.

The FSB’s high-level recommendations indicate the potential revisions to global sectoral standards and principles across crypto-asset activities with financial stability concerns.

GSC issuers must additionally follow Anti-Money Laundering/Combating the Financing (AML/CFT) standards and the Financial Action Task Force’s (FATF) “Travel Rule” and provide sender and recipient information. Data management systems must also provide privacy while adhering to local data protection rules. These recommendations are timely, given the gradual diminishing of Bitcoin's position as the favoured cryptocurrency for unlawful activities or money laundering. The progression of the cryptocurrency sector has ushered in decentralised finance protocols, mixing services and stablecoins and providing criminals with new avenues to explore. Another crucial recommendation is the exclusion of assets that are speculative and volatile by the reserve assets supporting stablecoin value to maintain a level equal to or exceeding the stablecoins in circulation. Though the recommendations exempt commercial bank equivalents from such exclusion, GSC issuers must secure licences in individual jurisdictions, ensuring compliance with pre-commencement regulatory prerequisites. Maintaining reserve assets and upholding broader trust in cryptocurrencies is critical for stablecoins' functionality, considering past experiences. For example, Tether settled for US$41 million over allegations of deceptive claims about fully backing tokens with fiat currencies. The Commodity Futures Trading Commission exposed Tether's false assertions, revealing that only US$ 61.5 million backed it from June to September 2017, despite 442 million coins in circulation. Tether's significant role in Bitcoin trading and widespread circulation raised worries about potential market disturbances and financial insecurity.

Past and present

 The high-level recommendations have, thus, drawn insights from previous challenges posed by stablecoins and misconduct linked to cryptocurrencies. However, it is crucial to grasp the current stance of stable coin issuers. Two giants within the startup ecosystem, PayPal and Meta, play an active role.

The involvement of large private entities creating their own stablecoins introduces an additional layer to this complex issue.

PayPal introduced PayPal USD (PYUSD), its stablecoin linked to the value of the United States (US) dollar, to mitigate cryptocurrency volatility. It is issued by Paxos Trust Company and is fully backed by US dollar deposits and cash equivalents, maintaining a consistent 1:1 ratio. PYUSD enables users to transfer funds between PayPal and external wallets, conduct person-to-person payments, make purchases, and convert supported cryptocurrencies. This stablecoin simplified virtual payments within the platform, facilitated swift remittances and international transfers, and supported content creators. The influence of stablecoins on monetary sovereignty has become a prominent topic of global discussion and debate. The involvement of large private entities creating their own stablecoins introduces an additional layer to this complex issue. Originally known as Libra and later rebranded as Diem, Meta’s cryptocurrency once held the potential to challenge government-backed currencies like the Dollar and Euro due to its extensive network. This global influence sparked apprehensions among international leaders. French Finance Minister Bruno Le Maire resisted Diem's evolution into a sovereign currency and competing with national ones. The European Central Bank's Executive Board member Benoît Coeuré had stressed the need for regulation. These were valid concerns, as a significant portion of cryptocurrency usage is linked to illicit activities, and Meta's privacy issues further amplified worries regarding consumer safeguarding. The recently-concluded regulatory hearings with the House Financial Services Committee and the Senate Banking Committee investigated these issues. While the issue in the US ended in a stalemate because of a lack of consensus among the Republicans and Democrats, the European Union (EU) passed a cryptocurrency law, Markets in Crypto Assets (MiCA), providing stricter control over cryptocurrencies.

The recently-concluded regulatory hearings with the House Financial Services Committee and the Senate Banking Committee investigated these issues.

The apprehensions related to the introduction of Meta's Diem and PayPal's stablecoin primarily revolve around monetary currency control and the role of central banks in issuing currencies. Central banks like the Fed expressed reservations about stablecoins resembling fiat currency pegs while relying on financial assets rather than the sovereign, likening them to money market fund mechanisms.

Charting the Future

 The apprehension surrounding significant private entities creating their currencies under the guise of empowering individuals raises concerns about unsettling monetary sovereignty. This trend could alter how people engage with money and make transactions. The FSB’s high-level recommendations of more stringent regulations, thus, resonate with the global sentiment among governments for heightened accountability and transparency of stablecoins. India's stance on stablecoins is fairly clear. The global proliferation of stablecoins notably contributed to the inception of the digital rupee. The Reserve Bank of India's Deputy Governor, Rabi Sankar, emphasised that stablecoins pose a significant challenge to policy sovereignty and primarily benefit only a handful of nations. Sankar highlighted that central bank digital currencies (CBDCs) offer more reliable and steady solutions for every country, given the concerns associated with stablecoins. He also asserted that stablecoins hold merit for economies like the US and Europe, particularly when connected to their respective currencies. However, he cautioned that in countries like India, stablecoins could potentially supplant the usage of the domestic currency, the rupee, within the local economy.

The Reserve Bank of India's Deputy Governor, Rabi Sankar, emphasised that stablecoins pose a significant challenge to policy sovereignty and primarily benefit only a handful of nations.

Stablecoins bring numerous advantages to the world of cryptocurrencies. Pegging to reliable assets like fiat currencies ensures stability, mitigating the volatility seen in other cryptocurrencies. However, the regulation of stablecoins is necessary to safeguard financial stability, consumer protection, prevent illicit activities and uphold the overall integrity of the financial system. Proper regulation can mitigate risks associated with potential misuse, money laundering, and fraud. It also establishes a clear framework for their operation, safeguards against market manipulation and ensures compliance with anti-money laundering and counter-terrorism financing measures. By instituting regulations, authorities can strike a balance between innovation and safeguarding the interests of users and the global economy.

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Sauradeep Bag is an Associate Fellow at Observer Research Foundation

• International Affairs
• Economics and Finance
• India
• USA and Canada
• The Pacific, East and Southeast Asia
• CRYPTOCURRENCIES
• FSB RECOMMENDATIONS
• Global stability
• India
• SAFEGUARDING
• STABLECOIN BENEFITS
• TIGHTENING

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