What Are Stablecoins?

Cryptocurrency has existed for more than a decade, but it still hasn’t made its way to mainstream commerce. One reason is volatility — the value of cryptocurrency is often driven by untamed speculation.

Crypto investors have become millionaires overnight, only to lose much of their wealth just weeks later. While this can be exciting to witness, it also shows the unreliable nature of popular cryptocurrencies like bitcoin — especially as a means for paying for goods and services.

Bitcoin’s value fluctuates dramatically. Source: Coinbase

This is where stablecoins come into play.

Stablecoins are designed to have a value that is much more fixed than normal cryptocurrencies. This is because they are pegged to other assets, such as the US dollar or gold.

The vision is that stablecoins can enjoy the benefits of being a cryptocurrency without the associated extreme volatility — this would go a long way to helping cryptocurrencies be seen as a viable way to actually buy something. After all, most businesses aren’t interested in accepting a form of payment that might tank in value the very next day. If traditional crypto is like investing in a high-risk stock, stablecoins are like withdrawing cash from an ATM.

And stablecoin demand is surging: From October 2020 to October 2021, the total value of stablecoin assets grew by roughly 495%, according to The Block.

This reflects the momentum driving the so-called “stablecoin invasion.” There are now more than 200 stablecoins globally, comprising a market that’s worth nearly $130B. Additionally, two USD-backed stablecoins, the Paxos Standard (PAX) and Gemini Dollar (GUSD), have been approved and regulated by the New York State Department of Financial Services.

Financial services incumbents are also eyeing the opportunity — JPMorgan Chase, for example, has piloted and launched a stablecoin, JPM Coin, for its corporate clients. Meanwhile, a survey of central banks in January 2021 found that two-thirds of respondents are actively researching the potential impact of stablecoins on financial stability.

News coverage of stablecoins has continued to grow since taking off in 2018.

And yet — despite being the purported answer to cryptocurrencies’ volatility — stablecoins are now under close scrutiny, with regulators in the US and China saying they pose a serious risk to financial systems.

In this explainer, we dive into stablecoins, from what they are to why they’re emerging as a disruptor across the crypto space to why pressure is mounting to tighten the regulation of these digital coins. We also analyze the different types of stablecoins, as well as their applications and limitations.

TABLE OF CONTENTS

• What are stablecoins?
• Why use stablecoins?
• Types of stablecoins
• Real-world applications
• Limitations
• Risks and regulations
• Looking ahead

What are stablecoins?

Stablecoins — in the form of digital money — aim to mimic traditional currencies.

A stablecoin is typically a cryptocurrency that is collateralized by the value of an underlying asset. What that underlying asset may be varies from coin to coin, which we’ll dive into later in this piece.

Many stablecoins are pegged at a 1:1 ratio with certain fiat currencies, such as the US dollar or the Euro, which can be traded on exchanges. Other stablecoins are pegged to other kinds of assets, such as precious metals like gold or even to other cryptocurrencies.

Why use stablecoins?

Stablecoins are not subject to the extreme price volatility that many other cryptocurrencies are affected by.

In 2010, for example, a programmer purchased pizza for 10,000 bitcoins — worth roughly $688M at bitcoin’s peak in November 2021. On the flip side, any merchant that accepted those bitcoins at that peak price would have lost more than $200M by the end of the year.

Source: Quartz

As a result, many businesses are skeptical of crypto as a viable means of payment. Microsoft, for example, first started accepting bitcoin as a payment in 2014, only to put a temporary halt on it in 2018 due to volatility. Online gaming platform Steam was forced to do the same.

Stablecoins, on the other hand, aim to gain the potential benefits of cryptocurrencies — such as transparency, security, immutability, and decentralized control — without losing the guarantees and stability that come with using fiat currency.

Initially, early crypto holders used stablecoins as a safe haven in the event of a market decline or crash. If the price of bitcoin began to drop rapidly, a holder could convert their bitcoin to a stablecoin within a matter of minutes on a single platform, avoiding potentially massive losses.

Without this option, the crypto holder would have had to move their capital back into a fiat currency. However, many cryptocurrency exchanges either do not allow fiat on the platform or take a large fee from the transfer into fiat.

But stablecoins are showing promise in other emerging applications. For example, they could benefit industries and individuals that need to make international payments quickly and securely, from migrant workers sending money back to their families to big businesses looking for a cheaper way to pay overseas suppliers.

Stablecoins could also find uses across the financial services ecosystem.

For decentralized cross-border lending, for example, stablecoins could help provide a secure, online environment for peer-to-peer (P2P) transactions to take place without needing to use a volatile cryptocurrency like bitcoin or pay fees to convert money into local currencies.

But before diving further into use cases, we need to understand the different types of stablecoins.

Types of stablecoins

Stablecoins fall into 4 main categories.

FIAT-COLLATERALIZED STABLECOINS

The most common type of stablecoins are collateralized — or backed — by fiat currency.

Fiat-backed stablecoins are backed at a 1:1 ratio, meaning 1 stablecoin is equal to 1 unit of currency. So for each stablecoin that exists, there is (theoretically) real fiat currency being held in a bank account to back it up.

When someone wants to redeem cash with their coins, the entity that manages the stablecoin will take out the amount of fiat from their reserve and it will be sent to the person’s bank account. The equivalent stablecoins are then “burned” or permanently removed from circulation.

Fiat-collateralized stablecoins are pretty much the simplest structure a stablecoin can have, and simplicity has big advantages. It’s easy to understand for anyone new to cryptocurrencies — which, in turn, can allow for more widespread adoption.

As long as the economy of the country a stablecoin is pegged to stays relatively stable, the value of a pegged coin shouldn’t fluctuate much either.

However, although issuers of fiat-collateralized stablecoins typically claim that their cryptocurrency is backed by fiat currency at a 1:1 ratio, this is not always true. The stablecoin issuer might place cash reserves in other assets, such as corporate bonds, secured loans, or investments.

Such has been the case with Tether (USDT) and USD Coin (USDC), the most popular USD-backed stablecoins. Both have stirred controversy in recent years as their claims of a 1:1 stablecoin-to-fiat ratio have come under scrutiny.

An investigation by the Commodity Futures Trading Commission (CFTC) found that from 2016 to 2019, Tether falsely claimed to have held an equivalent amount of fiat currency for every single USDT. In October 2021, the CFTC ordered Tether to pay a fine of $41M.

See Tether Limited’s asset breakdown in its June 2021 attestation report:

Source: Tether Limited

Tether’s attestation report shows that only 10% of its reserves were in cash and bank deposits at that time — a far cry from a 1:1 ratio.

A similar controversy surrounds USDC, which is managed by a consortium that includes digital currency company Circle and cryptocurrency exchange Coinbase. USDC’s issuers have claimed that it is “always redeemable 1:1 for US dollars” and fully backed by US dollars held in a bank account. However, Circle revealed in July 2021 that only 61% of USDC reserves were in cash and cash equivalents; the rest comprised certificates of deposit, US Treasuries, commercial paper, corporate bonds, and municipal bonds. The following month, Circle announced that USDC reserves going forward would comprise only cash and US Treasury bonds.

Despite these issues, demand for the two stablecoins remains high — USDT is the third-largest cryptocurrency by market capitalization as of January 2022, behind only bitcoin and ethereum.

 

Source: CoinMarketCap

In fact, the two coins have captured more than two-thirds of the stablecoin market, with USDC steadily chipping away at USDT’s market share.

 

Source: CoinMetrics, The Block

Some stablecoin issuers have submitted to strict regulatory oversight to help assure their customers of their cash reserves.

Such is the case with the Pax Dollar (USDP) and Gemini Dollar (GUSD), two USD-backed stablecoins that are regulated by the New York State Department of Financial Services. The issuers of the two coins publish monthly reserve audits that are verified by independent accounting firms.

There are numerous other fiat-collateralized stablecoins around the world. In Singapore, payments processor Xfers launched the XSGD stablecoin, which is backed 1:1 by the Singapore dollar. In Europe, tokenization platform Stasis’ EURS token is collateralized by the euro.

COMMODITY-COLLATERALIZED STABLECOINS

Commodity-collateralized stablecoins are backed by other kinds of interchangeable assets. The most common commodity to be collateralized is gold. However, there are also stablecoins backed by oil, real estate, and various precious metals.

Holders of commodity-backed stablecoins are essentially exposed to the value of a real-world asset. These assets have the potential to appreciate — or depreciate — in value over time, which can affect the incentives for trading these coins. Commodity-backed stablecoins are sometimes marketed as a way to open up certain asset classes, like real estate, to smaller investors.

Digix Gold (DGX), for example, is an ERC-20 token (built on the Ethereum network) backed by physical gold, where 1 DGX represents 1 gram of gold. This gold is stored in a vault in Singapore and gets audited every 3 months. The creators of DGX claim they have “democratized access to gold.” DGX holders may even redeem their coins for physical gold — they just have to go to the vault in Singapore to do so.

SwissRealCoin (SRC) is another example, which is backed by a portfolio of Swiss real estate. Token holders can even vote on the investment choices.

CRYPTO-COLLATERALIZED STABLECOINS

These are stablecoins backed by other cryptocurrencies.

In theory, this allows crypto-backed stablecoins to be more decentralized than their fiat-backed counterparts since everything is conducted using blockchain tech.

To reduce price volatility risks, these stablecoins are often over-collateralized so they can absorb price fluctuations in the collateral.

For example, to get $500 worth of stablecoins, you would need to deposit $1,000 worth of Ether (ETH). In this scenario, the stablecoins are now 200% collateralized, and even in the event of a 25% price drop, the $500 worth of stablecoins are collateralized by $750 worth of ETH.

And if the price of the underlying cryptocurrency drops low enough, the stablecoins will automatically be liquidated. Additionally, they are often backed by multiple cryptocurrencies in order to distribute risk.

They can also allow more liquidity than commodity-backed stablecoins, as they can be quickly converted into their underlying asset.

Crypto-backed stablecoins are a relatively complex form of stablecoin and have not gained as much traction as other approaches.

The most popular example of a crypto-collateralized stablecoin is Dai.

Created by MakerDAO, Dai is a stablecoin that has a face value pegged to USD, but was initially designed to be backed by ETH that is locked up in smart contracts.

Like USDC, Dai has become crucial to many DeFi applications. By nature of being decentralized, anyone can generate, buy, or sell Dai. Developers in particular can easily build decentralized apps, or dapps, on top of the Ethereum blockchain using Dai as a stable medium of exchange.

However, Dai is infamous for Black Thursday, a black swan event in March 2020 where a momentary increase in its price (triggered by the confluence of an ETH price crash and a clogged Ethereum network) led to $8M worth of liquidations for zero Dai.

MakerDAO appears to have learned the perils of relying solely on volatile crypto assets. It is now diversifying its collateral base to include stablecoins like USDC and “real-world assets.” For example, French bank Société Générale-Forge has proposed backing Dai with $40M in bonds.

Confidence in the stablecoin has since rebounded — Dai’s market cap increased by 800% from September 2020 to September 2021, and it remains one of the top five most popular stablecoins globally.

Another crypto-backed stablecoin is Jarvis Network’s jFIATs, which track the price of their respective currencies against the American dollar and are backed by USDC. For example, $100 (roughly £75) worth of jGBP would be equivalent to 100 USDC.

There are several jFIATs, each of which acts as a digital version of a fiat currency, including euros, Canadian dollars, Swiss francs, and more. These coins can be used on Polygon, a protocol that lets developers build and connect Ethereum-compatible blockchain networks.

NON-COLLATERALIZED STABLECOINS

Non-collateralized stablecoins are not backed by anything, which might seem contradictory given what stablecoins are. But the idea isn’t as outlandish as it sounds.

Remember, the US dollar used to be backed by gold, but that ended decades ago, and dollars are still perfectly stable because people believe in their value. The same idea can apply to non-collateralized stablecoins.

These types of coins use an algorithmically governed approach to control the stablecoin supply. This is a model known as seignorage shares.

As demand increases, new stablecoins are created to reduce the price back to the normal level. If the coin is trading too low, then coins on the market are bought up to reduce the circulating supply. In theory, prices of these stablecoins would remain stable as they are driven by market supply and demand.

This is the most decentralized form of stablecoin as it isn’t collateralized to any other asset.

However, non-collateralized stablecoins require continual growth to be successful. In the event of a big crash, there is no collateral to liquidate the coin back into.

One example comes from Ampleforth, which launched its AMPL token in late 2018. Ampleforth’s algorithms adjust AMPL supply on a daily basis according to demand in an effort to avoid the volatility of fixed-supply cryptocurrencies. In the event of a surge in demand, the Ampleforth protocol will increase the supply of AMPL to bring back the equilibrium between price and supply.

An emerging alternative model is the use of an algorithm and associated reserve token to peg a stablecoin to USD — instead of using cash reserves. Such stablecoins are considered decentralized, as they do not rely on a single entity to maintain the collateral.

Are non-collateralized stablecoins built to fail?

Despite protective hedges built into these coins’ design, some critics argue that algorithmic stablecoins backed with secondary tokens instead of other assets are “built to fail.” When the price of the stablecoin drops, investors may panic and sell. In the process, they mint more tokens, reducing their value and making a bank run more likely. This, in turn, causes the stablecoin’s value to drop, leading to a cycle known as the “death spiral.” When the Iron stablecoin and its Titan token fell victim to this spiral, the token’s value fell to almost zero.

Making a stablecoin useful in an everyday sense would help shield it from such a scenario as demand for it would be less likely to plummet quickly. This is the premise of Terra, an algorithmic stablecoin with Luna tokens as their reserve asset. Both are created by Terraform Labs.

An algorithmic market module incentivizes users to burn or mint Terra to keep it at its target peg price. For every Terra minted, an equivalent Luna is burned and vice-versa; this helps keep the stablecoin’s value at a near-constant level. The higher the demand for Terra, the greater the worth of Luna.

Use cases drive adoption, and Terraform Labs has built a lot of utility into the Terra ecosystem. Chai, its payment system, reportedly processes $1B+ per year and had about 2.5M users in 2020. More than 2,000 merchants in Korea use Chai.

For consumers, Chai connects to banks to enable payment. For businesses, Chai has an API to let e-commerce sites accept different payment options. In both cases, currency is converted into Terra, which is transferred to the recipient on the blockchain and converted back into fiat.

This allows Chai to offer lower processing fees compared to some traditional payment processing systems. It also means that consumers might not even know they used a stablecoin — let alone need to understand how it works — when paying for a cup of coffee or an online purchase.

CENTRAL BANK DIGITAL CURRENCIES

A central bank digital currency (CBDC) is a digital token or electronic record of a country’s official currency. CBDCs are not generally categorized as stablecoins but can fill a similar function depending on the use case — there’s even ongoing speculation around if both stablecoins and CBDCs can co-exist over the long term.

As CBDCs are issued, controlled, and regulated by a country’s central bank or monetary authority, they are exchangeable on a 1:1 ratio with their equivalent fiat and are likely to be considered as legal tender. According to the International Monetary Fund (IMF), CBDCs can help reduce the cost of managing cash and can promote financial inclusion, as people will not need to have traditional bank accounts to use these digital currencies.

At least 9 countries have now launched their own CBDCs, 14 have started pilot programs, and more are conducting research into the concept.

 

Source: Atlantic Council

One CBDC that has been officially launched is Nigeria’s eNaira. It is built using blockchain tech and can be used globally by anyone with an eNaira wallet. The Central Bank of Nigeria has indicated that eNaira adoption could boost remittances, cross-border trade, and financial inclusion. It could also increase tax collection by providing greater transparency around informal payments, as transactions will be much easier to trace compared to cash.

Meanwhile, China has rolled out large-scale trials of its digital yuan, also called the e-CNY. As of October 2021, around 140M people had made e-CNY transactions worth a total of 62B yuan ($9.7B). By issuing its own CBDC, the country hopes to increase usage of the yuan globally and to lower the cost of cross-border payments.

Real-world applications

Stablecoins have many potential real-world uses. Here are just a few examples.

A day-to-day currency

Well-designed stablecoins have the potential to be used just like any other currency for commerce.

In South Korea, consumers can pay for their morning coffee with Chai. Crypto cards can also serve as a channel for stablecoins to enter mainstream spending. For example, both Visa and Mastercard have launched payment cards that allow transactions in USDC.

Stablecoins could also find applications for overseas money transfers since there doesn’t have to be any conversion of different fiat currencies. A person in India could receive USD-backed stablecoins without converting them into rupees and losing a percentage to fees.

Streamlining recurring and P2P payments

Stablecoins also allow the use of smart financial contracts that can be enforceable over time.

Smart contracts are self-executing contracts that exist on a blockchain network, without requiring any third party or central authority to enact them. These automatic transactions can be traceable, transparent, and irreversible, making them well-suited for salary and loan payments, rent payments, and subscriptions.

For example, an employer could set up a smart contract that automatically transfers stablecoins to their employees at the end of each month. This is especially beneficial for businesses that have employees all over the world, as it provides a way to sidestep the high fees and days-long process of transferring and exchanging fiat currency from, say, a bank account in New York to one in China.

In another scenario, a smart contract could be set up between a landlord and a tenant to automatically transfer payment for rent on the first of each month.

The same idea can apply for automatic payments of loans or monthly subscriptions like gym memberships.

Fast and affordable remittances for migrant workers

In today’s world, many migrant workers rely on businesses like Western Union to send money back to their families and loved ones. This can be a slow and costly process, where families end up losing a big chunk of their funds to high fees.

Cryptocurrency offers the potential for fast transactions and low fees, but there’s still the problem that a cryptocurrency like bitcoin could fluctuate wildly in value overnight.

Stablecoins, however, could provide a better alternative. Workers and their families across the globe could use digital wallets to receive stablecoins from anywhere in the world almost instantly — with low fees and without price volatility.

With billions being transferred in global remittances every year, this is a massive use case for stablecoins.

This is the main use case behind the Novi crypto wallet by Meta (Facebook), which was launched with a pilot program for transferring money between users in the US and Guatemala. Novi currently uses PAX, but the company maintains that it will launch its own stablecoin, Diem, once regulators approve it.

Banks themselves could also lead the adoption of stablecoins for this purpose. Shinhan Bank in South Korea and Standard Bank in South Africa are testing out a proof-of-concept for using stablecoins for cross-border remittances.

Projects like these will shed light on how much traction stablecoins can gain with the public and on how cost-efficient this use case can be in the real world.

Protection from local currency crashes and market volatility

In the event of a fiat currency crashing in value, local citizens could quickly exchange their crashing currency for relatively safe USD-backed, EUR-backed, or even gold-backed stablecoins, thus protecting them from further drops in value.

Stablecoins could also offer protection amid global market volatility. The uncertainty of the Covid-19 economic crisis, for instance, drove demand up for stable digital assets, especially as more volatile cryptocurrencies like bitcoin saw massive short-term value declines in response to initial lockdowns.

Improved cryptocurrency exchanges

Few cryptocurrency exchanges currently support fiat currencies due to strict regulations. But the use of stablecoins allows exchanges to get around this problem and offer crypto-fiat trading pairs, by simply using a USD-backed stablecoin instead of actual dollars.

This supports the adoption of cryptocurrency trading as a whole, as it makes the process of obtaining cryptocurrency easier for newcomers and they can continue to think in terms of dollars or euros, instead of constantly fluctuating bitcoin values.

Humanitarian aid

In the event of a crisis, stablecoins can be a fast and cost-efficient way to send humanitarian aid to another country. As they are traceable through the blockchain, stablecoins can also improve transparency and accountability in donations. (Read our What Is Blockchain explainer for more.)

In June 2020, Grameen Foundation, a nonprofit, sent emergency cash assistance to entrepreneurs in the Philippines. During community-wide lockdowns, it was difficult for the recipients to claim cash, as restrictions on people’s movement made it challenging to make withdrawals at banks and remittance centers. The foundation instead used Celo stablecoins to send almost $160,000 worth of financial aid to at least 730 entrepreneurs.

However, stablecoins are not a panacea to cross-border humanitarian aid problems. The World Economic Forum (WEF) points out that the intended users of these “humanitarian stablecoins” might lack digital literacy, as well as access to digital tools or even an internet connection. And although some aid organizations have floated the concept of a global stablecoin to be used for aid, the WEF warns that this could centralize aid delivery and thus widen the gap between large organizations with vast resources and their smaller, local counterparts.

Facilitating decentralized forex

In September 2020, Waves.Exchange launched decentralized forex (DeFo). There are at least 10 stablecoins on the platform, including for the US dollar, British pound, Turkish lira, and Brazilian real.

Unlike traditional forex that opens on specified market hours and can take a while to settle transactions, Waves.Exchange’s platform is open 24/7 and promises instant swaps.

Limitations

Stablecoins have their limitations.

The Tether scandal provides an example of how a stablecoin can go wrong. Fiat-backed stablecoins are centralized, meaning they are run by a single entity. This requires trust that this entity is actually backing up their stablecoins with real fiat.

To solve this trust problem, stablecoins could adopt approaches like providing regular audits from third parties to bolster transparency.

Fiat-backed stablecoins are also constrained by all of the regulations that come with fiat currency, compromising the efficiency of the conversion process and the potential efficacy of the digital asset. For example, Facebook’s Libra currency promised a stablecoin backed by a basket of global fiat currencies, thus broadening the coin’s appeal and utility. However, it received so much regulatory blowback that the project’s management dropped its multi-currency aim, distanced itself from Facebook, and rebranded altogether. To this day, the network is still struggling to get regulators to sanction its own stablecoin.

By nature of being more regulated, stablecoins may also have less liquidity than regular cryptocurrencies.

This is especially true for commodity-backed stablecoins. If you ever wanted to get your real bars of gold, for example, it could take months and an expensive trip to a physical vault.

Moreover, there’s always the risk that the underlying asset crashes in value.

Think about “Black Wednesday” in the UK in 1992, or the 1998 Ruble crisis that occurred in Russia. If such an event occurs to the fiat a stablecoin is pegged to, it would be disastrous for that stablecoin as well.

Crypto-backed stablecoins also come with their own set of issues.

Being pegged to other cryptocurrencies makes them much more vulnerable to price instability in comparison to fiat- or commodity-backed stablecoins.

They are tied to the health of a particular cryptocurrency (or combination of cryptocurrencies), which means if that crypto takes a deep nosedive, the stablecoin ultimately will as well. In the event of a price crash, they will be auto-liquidated into the underlying crypto asset.

This is another disadvantage to crypto-collateralized stablecoins: they’re difficult to understand, which introduces a much higher risk for people holding them to face unexpected events.

Finally, even where stablecoins may offer the potential to streamline financial services, they will likely face pushback from local governments. For instance, in a country with high inflation rates, the government may look to block stablecoins pegged to foreign currencies in order to protect demand for the local currency.

Risks and regulations

Systemic risk and loss of value

A recent US Treasury report on stablecoins discussed the systemic risk that a single stablecoin could pose if it becomes widely adopted. The risk is especially high with centralized coins, such as those backed by fiat and issued by private organizations, as economic power would be disproportionately concentrated on a single entity.

Tether is among the more likely coins to present such a risk, given its current market share of more than 50%. If Tether fails, it could undermine an entire ecosystem of apps, businesses, and consumers that use it. If the economy overheats and the value of Tether’s non-cash collateral plummets, investors might try to cash out their stablecoins, only to find that the issuer can’t give them back their money on a 1:1 ratio. This scenario could destabilize not just the crypto market, but also the wider financial system.

The widespread use of stablecoins in payment platforms also presents a systemic risk, according to the same report. The novel operational risks tied to the validation and confirmation of stablecoin transactions can interfere with payment systems. If millions of users can’t access money in their e-wallets and businesses can’t receive payments, economic activity would be greatly disrupted.

Threats to market integrity and investor protection

The ease and speed of transacting with stablecoins is conducive to speculative trading of digital assets, which can threaten market integrity and investor protection, according to the US Treasury Department.

Risks include market manipulation, insider trading, and front running. For instance, coin holders could speculate on an issuer’s intention to change or rebalance its portfolio of reserve assets. The holders might buy and sell different assets while also making stablecoin purchases or redemptions in order to front-run their purchases.

A conflict of interest could arise when the stablecoin issuer also plays other closely related roles, such as operating a custodial wallet or owning an e-commerce platform that disproportionately incentivizes the use of their own coin.

There is also a lack of clarity and transparency on how the prices of some stablecoins are determined. In the aftermath of Black Thursday, MakerDAO users claimed they were told they would take only up to a 13% haircut in a liquidation event. However, many users completely lost their holdings.

Illicit activity

Stablecoins may be misused to break laws on anti-money laundering (AML) and countering the financing of terrorism (CFT). They may also help enable other illicit activities. A report by Chain Analysis reveals that much of the cryptocurrency used for illicit activities goes to scams and the darknet market. However, ransomware is an increasing threat — from 2019 to 2020, the amount of cryptocurrency funds lost to ransomware rose by 311%.

Factors that contribute to the risk of illicit activity include the increased use of stablecoins for cross-border transactions, the lack of global standards for stablecoin providers, the uneven implementation of AML/CFT standards among different countries, and the potential for anonymity when transacting in stablecoin.

Tighter regulation

In 2021, the US Treasury recommended tighter regulation to address the prudential risks of stablecoins. Recommendations include:

• Requiring stablecoin issuers to be insured depository institutions
• Requiring custodial wallet providers to be subject to “appropriate federal oversight”
• Requiring the implementation of interoperability standards among stablecoins

The report is expected to set off a lobbying spree that might actually lead to less, not more, oversight, according to a former SEC lawyer quoted in The New York Times. Andreessen Horowitz, a venture capital firm that has made numerous crypto investments, has reportedly proposed draft legislation that will exempt some crypto-related companies from complying with certain requirements relevant to AML, consumer protection, and tax reporting.

Beyond the USA, the Committee on Payments and Market Infrastructures and the International Organization of Securities Commissions published a report advising that systemically important stablecoin arrangements should adhere to international standards for payment, clearing, and settlement systems. The Financial Action Task Force has also recommended the implementation of its revised AML/CFT standards to stablecoin arrangements. Meanwhile, the European Union has proposed a law meant to ensure full traceability of cryptoasset transactions. The law will require companies handling cryptoassets to obtain customer details, such as their full name, date of birth, and account number.

In response to the impending regulations, Rune Christensen, founder of MakerDAO, is preparing for “the worst.” On the other hand, Jeremy Allaire, the CEO of USDC backer Circle, says he welcomes plans to regulate stablecoin issuers as banks.

Looking ahead

While it is impossible to predict what the future has in store in the constantly changing world of blockchain, stablecoins could help bring cryptocurrencies further into the mainstream.

Already, financial services players — from bank incumbent JPMorgan to payments network Visa — are giving nods to stablecoin technology through partnerships and internal R&D. Further, stablecoins are making inroads with regulatory bodies.

Each form of stablecoin comes with its own unique set of benefits and drawbacks, and none of them are perfect. Yet the value and stability they could provide to businesses and individuals globally — by enabling better access to established national currencies, streamlining payments and remittances, and supporting emerging financial applications — could be disruptive.

Widespread adoption of digital currencies more broadly will depend on whether or not crypto can find a role for everyday users and use cases. Stablecoins are a clear step toward this.

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