Author: TaxDAO
Current Situation and Outlook of Stablecoin Regulation
A stablecoin is a type of cryptocurrency that is pegged to fiat currency or other assets, aiming to reduce price volatility and improve payment efficiency and financial inclusion. As stablecoins are tied to sovereign currencies, they can have implications for financial stability, consumer protection, anti-money laundering, taxation, and even threaten the status of sovereign currencies. This article aims to explore the current status and issues of international stablecoin regulation, analyze the importance of stablecoin regulation, review the regulatory attitudes and policies of various countries towards stablecoins, discuss the relationship and impact of stablecoins on fiat currencies and DeFi, and provide suggestions and outlook for future stablecoin regulation.
1. The Imperative of Stablecoin Regulation: Concepts and Background
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1.1 Concepts and Classification of Stablecoins
1.1.1 Concept of Stablecoins: Developed in Practice
A stablecoin is a type of cryptocurrency that is pegged to fiat currency or other assets, aiming to reduce price volatility and improve payment efficiency and financial inclusion. The emergence of stablecoins is to address the high volatility and low liquidity issues of traditional cryptocurrencies while preserving their advantages such as decentralization, transparency, and programmability.
The earliest stablecoin projects appeared in 2014, such as BitUSD and NuBits, which issued stablecoins backed by other cryptocurrencies. Stablecoins issued in this way have lower stability as other cryptocurrencies have significant market fluctuations. In 2015, Tether launched USDT, a fiat-collateralized stablecoin anchored to the US dollar, which is currently the highest market capitalization and largest trading volume stablecoin.
In 2018, fiat-collateralized stablecoins flourished, and well-known stablecoins such as USDC, LianGuaiX, and TUSD emerged during this period. They all claimed to have sufficient reserves of fiat currency and accepted audits and supervision from third-party institutions. In addition, there are also some commodity-backed stablecoins, such as LianGuaiXG, DGX, which are anchored to physical commodities such as gold.
In 2019, Facebook announced the Libra project, an algorithmic stablecoin anchored to a basket of fiat currencies and bonds, aiming to create a global payment network. However, due to its scale and influence, it has triggered strong opposition and concerns from governments and regulatory agencies around the world.
Since 2020, algorithmic stablecoins have become a new hotspot. They do not have any anchors or collateral but achieve price stability through algorithmic supply adjustment. Representative algorithmic stablecoins include Ampleforth, Basis Cash, Frax, etc.
1.1.2 Classification of Stablecoins
The historical development of stablecoins also reflects the differences between different types of stablecoins. Stablecoins can be divided into four categories based on their stability mechanisms: Fiat-collateralized Stablecoin, Crypto-collateralized Stablecoin, Algorithmic Stablecoin, and Commodity-backed Stablecoin.
Fiat-collateralized Stablecoin: This is the most common type of stablecoin, which uses fiat currency or other traditional assets (such as gold, US bonds, etc.) as collateral and is held by centralized issuers or custodians. The price of this type of stablecoin is consistent or close to the collateral and has high liquidity and convertibility.
Crypto-collateralized Stablecoin: This is a type of stablecoin that uses other cryptocurrencies (such as Bitcoin, Ethereum, etc.) as collateral and is managed in a decentralized manner through smart contracts or other mechanisms. The price of this type of stablecoin is negatively correlated with the collateral, meaning that when the price of the collateral falls, the price of the stablecoin rises, and vice versa.
Algorithmic Stablecoin: This refers to stablecoins that do not have any collateral and achieve price stability through algorithmic supply and demand adjustments. The price of this type of stablecoin is positively correlated with market demand, meaning that when market demand increases, the algorithm increases the supply to lower the price.
Commodity-backed Stablecoin: This refers to stablecoins that use commodities (such as gold, silver, oil, etc.) as collateral and are held by centralized or decentralized issuers or custodians. The price of this type of stablecoin is consistent or close to the collateral and has high inflation resistance and store of value functions.
1.2 Market Status and Risks of Stablecoins
The market size of stablecoins has grown rapidly in recent years. According to a report by CoinGecko, as of September 2023, the global market capitalization of stablecoins is $138.4 billion. Among them, USDT occupies 49% of the market share, USDC and BUSD occupy 30.9% and 11.4% of the market share respectively. At the same time, the importance and influence of stablecoins in the cryptocurrency market are also increasing. In January 2022, stablecoins accounted for 7.3% of the total cryptocurrency market capitalization, and in January 2023, this proportion rose to 12.9%.
However, behind the rapid growth of the stablecoin market, there are also growing shadows, which are mainly manifested in the following aspects.
Firstly, like other cryptocurrencies, stablecoin transactions involve tax regulatory risks and financial business risks. The cross-border nature and anonymity of stablecoin transactions increase the risks of tax evasion and tax leakage, and the transactions also involve multiple areas of financial business, posing regulatory challenges to tax authorities in various countries.
Secondly, the potential credit risks of centralized stablecoins have also attracted attention from governments around the world. Taking USDT as an example, Tether claims that for every 1 USDT issued, it will deposit 1 US dollar in the reserve account to ensure the stability of the value of USDT. However, USDT does not have the endorsement of a national credit and lacks sufficient regulatory mechanisms. Therefore, Tether is often suspected of the risk of over-issuing USDT for profit. If the collateral deposited by exchanges is insufficient, the value of stablecoins will decouple from the assets they are pegged to, directly affecting the financial market.
More importantly, the development of stablecoins brings about risks in monetary policy. If stablecoins (especially global stablecoins) are widely used, they may affect the currency supply of various countries, thereby affecting the effectiveness of exchange rates, interest rates, and other monetary policy tools, and even threatening the monetary sovereignty and financial stability of countries.
In view of these risks, the International Monetary Fund (IMF) has called for the establishment of a global unified regulatory system for stablecoins on multiple occasions. In a blog post titled “Crypto Contagion Underscores Why Global Regulators Must Act Fast to Stem Risk” published by the IMF in January of this year, it stated that without appropriate regulation, stablecoins may undermine the effectiveness of monetary policy and trigger financial crises, both in developed and developing economies. Previously, in a financial technology briefing document in September 2022, the IMF emphasized the need for strong, comprehensive, and globally consistent regulation of crypto assets.
2. Current Status of Stablecoin Regulation: Seeking Unity in Diversity
2.1 Origins of Stablecoin Regulation
Overall, stablecoin regulation has gradually gained attention from governments around the world since 2019. Previously, stablecoins were usually subject to unified regulation along with other digital assets, rather than having their own regulatory requirements.
In 2019, the issuance plan of Libra drew global attention and concerns about stablecoins, and financial risk issues related to stablecoins also began to come to the forefront. In October 2019, the G7 Stablecoin Working Group released the “Global Stablecoin Assessment Report,” formally introducing the concept of “global stablecoins” and pointing out their potential challenges in financial stability, monetary sovereignty, consumer protection, and other aspects. Subsequently, the G20 entrusted the Financial Stability Board (FSB) to review the Libra project and released two sets of regulatory recommendations on global stablecoins in April 2020 and February 2021 respectively.
2.2 Overview of Stablecoin Regulation in Major Countries and Regions
Under the guidance of the FSB’s regulatory recommendations, some countries and regions have also proposed their own stablecoin regulatory policies, with the United States, the European Union, Hong Kong (China), and Singapore having more advanced regulatory policies. This article summarizes the major regulatory policies of these four countries/regions since 2019, as shown in the table below.
Among them, the “Stablecoin Payment Act Draft” in the United States is expected to become the world’s first formal legislation specifically regulating stablecoins, while the policies in Hong Kong and Singapore are still in the stage of discussion and have not formed formal legislation. Looking at the current legislative trends, several commonalities can be observed in stablecoin regulation.
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Stablecoins should be treated as special cryptographic assets and subject to dedicated regulation, rather than being included in existing financial regulatory frameworks;
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Stablecoin issuers and operators should be required to obtain relevant licenses or registrations and be subject to supervision and auditing by relevant authorities;
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Stablecoin issuers and operators should be required to maintain reserves equal to the value of the stablecoin and provide transparent information disclosure on the type, value, and risks of the reserves;
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Stablecoin issuers and operators should be required to comply with anti-money laundering and counter-terrorism financing obligations and design measures to protect traders and prevent network risks;
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Restrictions or bans should be imposed on stablecoins denominated in foreign currencies to safeguard the sovereignty and stability of the domestic currency;
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Communication and coordination should be maintained with international organizations and other jurisdictions to address cross-border stablecoins.
3 Regulation of Stablecoins: Policy Outlook
3.1 Stablecoins and Fiat Currency: Conflicts and Future
In the cryptocurrency trading market, stablecoins primarily serve as a “replacement” for fiat currency, acting as a unit of value for transactions involving other assets. This is because the exchange between fiat currency and cryptocurrency usually requires centralized exchanges or other third-party institutions, which increases transaction time, costs, and risks. Stablecoins, on the other hand, can facilitate decentralized transactions directly on the blockchain, improving transaction efficiency and security.
Stablecoins depend on fiat currency, but they also have an impact on fiat currency. On one hand, fiat-collateralized stablecoins rely on fiat currency as the anchoring object to maintain their value stability, and are also subject to fiat currency regulatory policies. For example, according to the US Stablecoin Act, fiat-collateralized stablecoins require centralized issuing entities and custodians to hold fiat assets and provide proof of reserves to demonstrate sufficient collateral assets. However, on the other hand, stablecoins also have the potential to challenge the status of fiat currency, as they offer higher transaction efficiency, anonymity, and transparency, which may attract more users and capital inflows. If a certain stablecoin (such as USDT) is widely accepted, it may play a role similar to M0 or M1 in the national currency system, thereby affecting the money supply. At this point, the money supply is no longer solely determined by the central bank, but jointly determined by the central bank and stablecoin issuers, equivalent to the country losing some of its coinage rights.
Therefore, countries often adopt a cautious approach to the regulation of stablecoins, especially for super-sovereign currencies pegged to fiat currency. Based on existing policy directions, regulation of fiat-collateralized stablecoins is expected to become increasingly stringent.
3.2 DeFi and Stablecoins: Perfect Match
Stablecoins are the underlying assets and transaction medium of DeFi, which can promote the development and innovation of DeFi.
Stablecoins are vital to DeFi. They maintain an anchored price in the highly volatile virtual currency field, thus separating the risk/reward calculation of DeFi services from the high volatility of digital assets. For DeFi services, stable prices are necessary for value exchange in financial transactions. Investors also need a stable unit of account. Stablecoins play multiple roles in DeFi, such as:
Stablecoins can serve as loans or collateral in the lending market, providing low-cost, efficient, and collateral risk-free lending services. For example, MakerDAO is a decentralized lending platform based on Ethereum, where users can generate DAI (a decentralized stablecoin pegged to the US dollar) by over-collateralizing crypto assets like ETH. Users can use DAI for trading or investment, or redeem collateral at any time.
Stablecoins can serve as trading pairs or liquidity providers in the trading market, offering low slippage, high liquidity, and no market-making risks. Take Uniswap as an example, it is a decentralized exchange protocol based on Ethereum, where users can deposit tokens into liquidity pools to earn trading fees. Stablecoins occupy a significant portion of the liquidity pools in Uniswap because they can reduce impermanent losses and improve trading efficiency.
Stablecoins can serve as compensation or insurance funds in the insurance market, providing low barriers, high coverage, and no trust risks for insurance services. For instance, Nexus Mutual is a decentralized insurance platform based on Ethereum, where users can purchase or provide insurance against smart contract failures on the platform, based on the mechanism of a Risk Sharing Pool (RSP), to earn interest and rewards or assume the responsibility of insurance claims. In Nexus Mutual, stablecoins are the only assets that can be used to purchase or provide insurance.
In conclusion, stablecoins and DeFi have a mutually beneficial and interdependent relationship. Stablecoins provide a stable value foundation and transaction medium for DeFi, while DeFi offers a broad range of applications and innovation space for stablecoins.
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