Stablecoins have been one of the long-term hot topics in the cryptocurrency market. Stablecoins can improve the efficiency of financial services, including payments, and at the same time, promote financial inclusion. For stablecoins, they may also provide a new means of asset exchange and value preservation. Stablecoins are starting to redefine the way our modern financial structures are structured.
In 2020 and the first half of 2021, stablecoins have seen amazing growth under the boom of the DeFi market. However, stablecoins also carry many risks that can cause harm, and they are not as stable as they are supposed to be.
When stablecoins are being used all over the world, dont forget to think about its systemic risks. Stablecoins, if not discontinued, could have a disruptive effect on the cryptocurrency market, and potentially serious implications on the real financial market, unless financial regulation is able to enter.
What are stablecoins?
What are stablecoins?
In simple terms, a stablecoin is a cryptocurrency that is pegged to and/or backed by an underlying real-world asset, which could be a fiat currency, a commodity, or even another cryptocurrency.
Stablecoins, as their name suggests, are designed to have a value that remains (fairly) stable relative to traditional currencies or underlying commodities. Many stablecoins are collateralized 1:1 with their pegs and can be traded on exchanges around the world.
Stablecoins were created to overcome the price volatility of cryptocurrencies like Bitcoin or Tether, which stems from the fact that there is no robust mechanism for determining their real-world value. Given the high level of mistrust in these cryptocurrencies, investors tend to bet on other safer options such as stablecoins. This choice leverages the benefits of cryptocurrencies and blockchain without losing the assurance of trust and stability that come with using fiat currencies.
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Types of Stablecoins
According to the different types of collateral, Maoqiu Technology divides stablecoins into four main types: fiat currency collateral, cryptocurrency collateral, commodity collateral, and algorithmic or non-collateralized.
Fiat Collateralized Stablecoins
Fiat-collateralized stablecoins are the simplest and most common type. They are pegged to a fiat currency such as the U.S. dollar or euro, usually backed 1:1, and hold a basket of assets denominated in dollars or euros. This means that for every such stablecoin that exists, there is a corresponding fiat currency in a bank account. Traders can exchange their stablecoins and redeem USD directly from exchanges at any time. Currently, the most popular fiat-collateralized stablecoins are Tether (USDT) ($62 billion market cap) and USD Coin (USDC0 ($27.3 billion market cap).
Commodity Collateralized Stablecoins
These stablecoins are stablecoins backed by commodity assets such as precious metals, gold, silver, real estate or oil. This theoretically suggests to investors that these stablecoins have the potential to appreciate in value as their underlying assets increase, increasing the incentive to hold and use them. An example of these stablecoins is PAX Gold (PAXG) ($330 million market cap), which relies on gold reserves.
Cryptocurrency Collateralized Stablecoins
Another type is cryptocurrency-collateralized stablecoins. These stablecoins serve as collateral against other cryptocurrencies. Since the value of cryptocurrencies is inherently unstable, these stablecoins need to use a protocol to ensure that the price of the stablecoin issued remains at $1. They are typically backed by a diversified reserve of cryptocurrencies that can withstand shocks and keep prices stable.
Another mechanism involves over-collateralization, which means that for a 1:2 pegged cryptocurrency-backed stablecoin, for each stablecoin, twice the value of the stablecoin will be reserved. Since everything happens on the blockchain, these cryptocurrency-backed stablecoins are more transparent, have open source code, and can operate in a decentralized manner, unlike their fiat-backed counterparts.
However, due to the cumbersome setting mechanism of such stablecoins, they are also more complicated and difficult to understand, so they lack popularity. The most popular cryptocurrency-backed stablecoin is Dai ($56.8 million market cap) created by MakerDAO, whose face value is pegged to the U.S. dollar and collateralized by ethereum.
Algorithmic or non-collateralized stablecoins
The fourth category is the so-called algorithmic stablecoins, also known as non-collateralized stablecoins. This is a very different design as it is not backed by any collateral. It works in the same way that fiat currencies do, i.e. managed by a sovereign institution such as a country’s central bank. Given the apparent difficulty these stablecoins have in maintaining value stability, their usefulness is limited.
Algorithmic stablecoins use manipulation of the total supply to maintain the peg. The basic mechanism is to create a new coin, set a peg, and then monitor the price on exchanges. This can be done algorithmically, in a decentralized manner, with open source code that everyone can see and audit. This so-called re-pegging is a speculative investment asset with a probability of gain and a probability of loss greater than zero.
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How do stablecoins work?
Some central stablecoins, such as Tether, require a custodian to oversee the currency and then reserve a certain amount of collateral. Tether holds dollars in a bank account. The amount held must equal the amount they issued in order to maintain order in the system, and in this way, price volatility should be prevented.
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Why use stablecoins?
Stablecoins are used in the cryptocurrency market for a variety of reasons. Chief among these is that cryptocurrency owners may convert profits into stablecoins in the short term with the intention of investing in other cryptocurrencies when the opportunity arises, rather than converting profits into fiat currency and transferring them to bank accounts.
Stablecoins are also invested in cryptocurrency exchanges or decentralized finance (DEFI) applications to return interest and yield. Investing in cryptocurrency exchanges in particular offers a safe and attractive alternative to traditional savings methods offered by traditional finance.
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The Case for Stablecoin Usage
As the number of stablecoins increases, so do the use cases for using them.
Convert between volatile cryptocurrencies and stablecoins
safe harbor"safe harbor", able to reduce a traders crypto asset risk without leaving the crypto ecosystem.
Allows the use of smart contracts
Stablecoins allow the use of smart financial contracts that can be executed over a long period of time. These are self-executing contracts that exist on the blockchain network and do not require the involvement of any third party or central authority. These automated transactions are traceable, transparent and irreversible, making them ideal for salary/loan payments, rent payments and subscriptions.
mainstream business
payment method
payment method
The Risks of Stablecoins
The Risks of Stablecoins
While stablecoins have the potential to improve the efficiency of financial services, they can also pose risks to financial stability, especially if they are adopted at scale. Some stablecoins are actually riskier than they appear. Stablecoins may carry risks in terms of asset transfers, collateral, and accountability. Maoqiu Technology believes that the risks that stablecoins may bring to the financial system in terms of systemic risks should not be ignored, thereby weakening the power of sovereign currencies.
Not all stablecoins are stable
Despite their name and the implication that their value is fairly stable, not all stablecoins are truly 100% price stable. Their value depends on their underlying assets. Stablecoins are only truly stable if they are 100% backed by cash.
The reason is that issuers of fiat-collateralized stablecoins need to manage the supply of their coins through issuance and redemption to ensure that the value of their coins remains roughly 1:1 with fiat currencies. The same is true for commodity-backed stablecoins and cryptocurrency-backed stablecoins.
This promise only works if the stablecoin issuer properly manages the reserves. Because the prices of cryptocurrencies can fluctuate wildly, cryptocurrency-backed stablecoins are more susceptible to price instability than other collateralized stablecoins.
Risk of asset sprawl
The rapid growth of stablecoin issuance could, over time, have an impact on the functioning of short-term credit markets. Certain stablecoins are economically equivalent to money market funds, and in some cases their practices could result in a reduction in value, causing significant losses in the broader cryptocurrency market.
There is potential asset contagion risk associated with the liquidation of stablecoin reserve holdings. These risks vary primarily based on the size, liquidity and riskiness of their asset holdings, as well as the transparency and governance of the operator.
Stablecoins that are fully backed by safe, highly liquid assets pose less risk.
One of the most well-known and widely traded stablecoins is Tether. Every Tether token is pegged 1:1 to the US dollar. But the true value of these tokens depends on the market value of their reserves. Tether has disclosed that as of March 31, it held only 26.2% of its reserves in cash, trust deposits, reverse repurchase notes and government securities, and 49.6% in commercial paper (CP).
collateral consequences
It is also worth noting that there are further collateral ramifications, especially since the recent surge in cryptocurrency prices has been largely debt-fueled. One thing to note is that it is doubtful whether stablecoins can be liquidated quickly to meet demand. In the larger cryptocurrency ecosystem, the consequences of this inability to handle sudden waves of withdrawals could be severe.
lack of accountability
The downside of fiat-collateralized stablecoins is that they are not transparent and cannot be audited by everyone. They operate like non-bank financial intermediaries, providing services similar to traditional commercial banks but outside normal banking regulation.
Therefore, they may avoid responsibility. In the case of fiat-backed stablecoins, traders need to blindly trust an exchange or operator to trade these currencies, or try to find and check out their financial disclosers themselves to ensure that the stablecoin is fully fiat-backed, even if they are not Publication of audit results.
Financial Stability and Systemic Risk
Stablecoins may also pose risks to financial stability. Some of these fiat-pegged tokens are not backed by actual fiat currency, but instead are backed by a riskier portfolio of assets. This not only puts stablecoin holders at risk, but has the potential to threaten overall financial stability if a run on stablecoins causes the price of the asset and other cryptocurrencies to collapse.
There is also the issue of systemic risk. A widely used stablecoin like Facebook’s Libra (now called Diem) may be used in one or more jurisdictions and across jurisdictions (so-called"Global Stablecoin"secondary title
Why do stablecoins need regulation?
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and"Global Stablecoin"Relevant activities and the risks they may pose may span banking, payments and securities/investment regulatory regimes, both within jurisdictions and across borders. In particular, if stablecoins are to become an important part of payments and finance, a regulatory framework will be needed, so Maoqiu Technology believes that it will be very important to ensure that appropriate regulatory approaches are adopted across industries and borders in various jurisdictions. important.
Regulatory review of stablecoins by various countries or institutions
A range of regulators, from the G7 to the Federal Stability Board (FSB) to the Bank for International Settlements, have begun issuing guidelines. Most of them highlighted risks and challenges, including issues of financial stability, consumer and investor protection, anti-money laundering, countering terrorist financing, data protection, market integrity and monetary sovereignty, as well as competition, monetary policy, cybersecurity, operational resilience and Regulatory uncertainty and other issues.
G7 Summit
At the recent G7 summit in Cornwall (UK) in 2021, delegations collectively concluded that common standards would be maintained through international cooperation as well as standards from the Financial Standards Council. Their conclusion is that no global stablecoin project should start operating until the relevant legal, regulatory and supervisory requirements are fully met through proper design and adherence to applicable standards.
Basel Committee on Banking Supervision
The Basel Committee on Banking Supervision also recently released a consultation paper on the prudent handling of stablecoin risks. While the document notes that banks exposure to risk is currently limited, continued growth and innovation in crypto-assets and related services, combined with high interest from some banks, could increase global financial Stability issues and risks to the banking system.
Bank for International Settlements (BIS)
In a recent announcement, the Bank for International Settlements’ Basel Committee “assumes” that the cryptocurrency class will be divided into products such as stablecoins and tokenized assets, which will be eligible for treatment under the Basel framework, which is Banking regulation provides standards. The proposed roadmap hints at more regulation, such as stablecoins being subject to stricter capital reserve policies.
Financial Stability Board Recommendations
The Financial Stability Board (FSB) has agreed on 10 high-level recommendations to address"Global Stablecoin"Regulatory, supervisory and supervisory challenges posed by arrangements. The recommendations echo calls by the G-20 to study"Global Stablecoin"regulatory issues arising from the arrangement and, where appropriate, make recommendations on multilateral responses, taking into account the perspectives of emerging market and developing economies.
The Financial Stability Board believes that the emergence of global stablecoins (GSCs) may challenge the comprehensiveness and effectiveness of existing regulation and supervision. Therefore, they proposed some principles for regulating stablecoins, including limits on reserves, limits on risk, and transparency requirements. This should promote coordinated and effective regulation, supervision and inspection of global supply chain arrangements that address financial stability risks posed by global supply chains, both domestically and internationally. These recommendations call for regulation, oversight and oversight commensurate with the risks. As such, they support responsible innovation and provide sufficient flexibility for jurisdictions.
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Regulatory approach by country or agency
While various international regulatory and supervisory bodies are actively working, it is still uncertain which regulatory approach will be chosen. How they will be regulated remains uncertain, either proposing a dedicated regime for stablecoins, banning them outright, or incorporating the asset class into its existing regulatory framework.
There are a number of regulatory approaches that are starting to shape how stablecoins are governed and more strictly define their use. The most advanced is the European Union, where the European Commission has presented their MICA proposal, although details of the timetable and planned changes are still unclear or subject to change. Now, of course, regulatory activity in countries like the U.S. and the U.K. is also accelerating.
Market Regulation of Encrypted Assets in the European Union (MICA)
Europe is currently assessing the number of comments it received during its consultation period for the proposed Markets in Cryptoassets Regulation (MICA), published last September. MICA pays special attention to the rules governing stablecoins, especially those that have the potential to become widely accepted and systemic, as well as providers of encrypted assets such as exchanges. The purpose is to provide a comprehensive and transparent regulatory framework, establish a unified set of rules, provide investor protection, have transparency and governance standards, and ensure that the digital asset ecosystem thrives.
Accordingly, the regulation divides stablecoins into categories such as electronic currency tokens (stablecoins whose value is pegged to a single fiat currency) and significant asset reference tokens, which are designed to maintain a stable value by reference to the value of a fiat currency. These major asset reference tokens will be subject to strict regulatory standards in terms of transparency, operation and governance.
Unlike other cryptocurrencies, stablecoins require authorization from regulators to be traded within the European Union. Authorization requirements also apply to stablecoins already in circulation. Apart from existing credit institutions, everyone else who wants to engage in stablecoin activities must also obtain prior permission from their national regulators.
The MICA regulations stipulate that stablecoin projects are legally obliged to publish white papers and submit them to their national financial regulators. The regulator has the power to prohibit issuers from issuing their planned stablecoins. Most importantly, the regulation prohibits the payment of interest on e-money tokens. By passing the interest ban, EU lawmakers are arguably protecting the interests of the European banking sector by discouraging cryptocurrency profits from being invested in stablecoins.
Bank of England
While the U.K. is far behind in regulatory activity around stablecoins compared to the EU, U.K. regulators are now also speeding up their steps to regulate stablecoins. Earlier this year, the U.K. Treasury published a general consultation and call for evidence on cryptoassets and stablecoins.
However, the UK proposal is narrower in scope than the EU MICA proposal, reflecting the adoption of"Phased and proportionate approach"intention of. In particular, the UK proposes to initially only regulate"Stablecoins as means of payment"。
A recently launched Bank of England discussion paper kicked off the conversation on digital currencies, stating that stablecoins are often backed by fiat or other assets but issued by private companies, and if they become widespread and could affect financial stability, they need to be handled by banks as they are currently Payment methods are regulated.
US Biden administration
As activity around stablecoin regulation in the U.S. also accelerates under the new Biden administration, optimism is growing that U.S. regulators and lawmakers will “witness substantial progress” in 2021 to better understand the technology and clarify the regulatory framework.
stability act
In December 2020, just before the end of the U.S. Congress, a draft of the Stablecoin and Bank Licensing Enforcement Act (the Stability Act) was introduced. The law would authorize the use of stablecoins and cryptocurrencies as legal alternatives to other real-time payment systems. However, the bill proposes a significant increase in regulatory oversight of stablecoins. It will limit who can issue stablecoins, require stablecoins to be issued by banks, and will dictate certain standards. However, it is doubtful that a bill in this form would actually be approved by the US Congress.
Federal Reserve Bank of America
The U.S. Federal Reserve is now also taking note of the rise in stablecoin usage. They announced that they would publish a report later this year to begin a major public consultation on the regulation of cryptocurrencies, and stablecoins in particular, outlining the risks and benefits associated with stablecoins and potentially a digital dollar.
Federal Reserve Chairman Jerome Powell said U.S. regulation of these digital currencies was at a critical point, arguing for new rules for stablecoins similar to those applied to bank deposits and money market mutual funds, where the U.S. has a Fairly strong regulatory framework. The issuance of stablecoins should be conditioned on following risk-limiting practices to ensure that the tokens are actually worth the price.
Presidents Task Force on Financial Markets
The President’s Task Force on Financial Markets, the top U.S. financial regulator, met in July to discuss how stablecoins should respond. It marked the first publicly announced meeting of the group of regulators since Joe Biden took office earlier this year. Topics discussed included the rapid growth of stablecoins, their potential use as a means of payment, and potential risks to end users, the financial system, and national security. Of course, this discussion is clearly only just beginning.
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The future of regulation
Stablecoins pose special challenges for regulators, requiring narrow cooperation between regulators and the stablecoin industry, as well as global regulatory cooperation.
Stablecoins do not represent a uniform category, but rather a variety of cryptocurrency instruments, which may vary significantly in legal, technical, functional and economic terms. To effectively limit risk and not interfere with innovation, the stablecoin industry must work with regulators to come up with a framework that reassures them while protecting this nascent industry from over-regulation.
The Venture Capital Department of Maoqiu Technology believes that another major regulatory challenge related to global stablecoins is the international coordination of regulatory work among different economies, jurisdictions, legal systems, and different levels of economic development and needs. Regulators around the world do not yet have a unified regulatory approach to stablecoins. The call for harmonized legal and regulatory frameworks also includes areas governing data use and sharing, competition policy, consumer protection, digital identity and other important policy issues.
These all help stablecoins to be more stable.
