Out of the “wild west” of the crypto industry, stablecoins have arisen as a first point of call for widespread regulation. Earmarked for their near-stable value while still incorporating the programmability and cross-border capabilities of cryptocurrencies, lawmakers have praised their capacity for driving innovation.
“Stablecoins have the potential to make payments faster and cheaper for all, and that’s why we want to offer firms the ability to utilize this innovation safely and securely,” said Sheldon Mills, executive director of Consumers and Competition at the FCA, to the FT.
The Bank of England, in its regulatory regime discussion paper, published in conjunction with a paper from the FCA on November 6, 2023, recognized stablecoins as an “example of recent innovation in payments”. Regulation was deemed important so that innovation could be adopted safely in the wider financial landscape.
However, as the economy opens out to different forms of fiat-backed digital money, each with its own issuer, preserving the new money’s singleness becomes ever more critical.
Why might “Preserving the Singleness of Money” be important?
According to the Bank of International Settlements (BIS), the “singleness of money” ensures that the value of a monetary exchange doesn’t fluctuate between different forms of money, whether it be privately issued or public. The unit underlying the money is defined and incapable of negotiation.
“One of the questions that we had is, why is the singleness of money a good idea? Shouldn’t we be encouraging competition to provide features for the benefit of users of currencies?” said Jannah Patchay, Executive Director and Policy Lead for the Digital Pound Foundation, during a webinar discussing the topic. “So perhaps a good way to start might be to look at what happens if the singleness of money is not preserved.”
The discussion turned to 1837 America, when, as Elise Soucie, Director of Policy & Regulation at GBBC Digital Finance, explained, a number of states changed how they offered bank charters, allowing “virtually anyone” to open a bank. Banks had to back their issuance one-to-one, but there was no national consistency at the time.
“They didn’t trade at par from the issuing bank,” explained Soucie. “So, for example, if I had a note issued by someone in Tennessee, it might circulate at a 20% discount in Chicago. During this time, the discounts were published in newspapers, and the prices reported were secondary market prices.”
She explained that while this approach had a number of implications for instances of fraud, it resulted in economic efficiency. “You had constant haggling and arguing over the value of notes and transactions, and trust was eroded,” she continued. “The delay and trouble of operations in that era were so much so that it essentially deprived the community of the ease and efficiency of money itself.”
“Singleness isn’t about preventing new forms of digital money from existing or emerging. It’s ensuring that they can all work together so that those economic efficiencies are still achieved.”
In today’s world, money exists in a number of forms, from prepaid cards to bank deposits to cash. The singular value of the currency is agreed upon and accepted across the economy, and redemption of that value is guaranteed.
“If we’ve got money on a card, or wherever it happens to be, We’re not going to lose it,” said Martin Hargreaves, Chief Product Officer at Quant. “Because we have the regulatory framework in place for that.”
Stablecoins Entering the “Real” Economy
Stablecoins, while pegged to fiat currencies, have had issues maintaining consistent singleness.
Earlier this year, holders of Circle’s USDC watched in horror as the currency lost its dollar peg and dropped as low as $0.87. The fall followed news that $3.3 billion of Circle’s reserves were held at the, then malfunctioning, Silicon Valley Bank.
They are not alone, one quick Google News search unearths stories of many other privately issued stablecoins losing their peg over the course of this year. For some, the value more than halved.
In the crypto world, where volatility is almost baked into digital currencies, the stablecoin is the most stable asset there is. The currency, at times, depegs, but for the more widely-used fiat-backed currencies, the variance is normally described as “momentary”. If holders continue to hold, in most cases, the peg has been regained.
In the “real” economy, this variance could cause catastrophic effects.
A Tall Task
The UK regulator’s proposals aim to shape stablecoins into a currency that can maintain the confidence that currently exists in the British monetary system. They aim to do this while preserving some of the benefits stablecoins, as digital currencies, hold – a task that is not short of challenges.
Preserving singleness alone may be a tall task. While the requirement that each stablecoin issued for systematic use is backed by deposits in the central bank may avoid a number of reasons for de-pegging, other elements may contribute.
During the Digital Pound Foundation’s webinar, interoperability and arbitrage were discussed as possible issues that could damage stablecoins’ ability to preserve a singular value. Already, the proposals have outlined a regime that creates different areas of regulatory jurisdiction, which the participants in the call felt could create regulatory arbitrage.
For those stablecoins that are used at a “systematic” scale (for now, none of the existing stablecoins) the Bank of England has been marked as the supervisor. For those who aren’t, “payment system operators” would have to be appointed to asses risks and make sure there are appropriate controls.
The programmability of stablecoins, while coined as a potential benefit to the digital currency, was also seen as a challenge to preserving singleness. “Despite the fact that we have money from different commercial banks, it’s all ultimately taken much the same form and been settled in the same way,” said Patchay. “Here, we have the potential that a trading desk might value the settlement efficiency of a CBDC or stablecoin above the nondigital format and price this in, in their trading of the form of the currency. How do we prevent arbitrage from happening on that basis?”
However, Soucie explained that the resolution could lie in how the development of the underlying infrastructure is handled.
“It’s pretty clear that people will arbitrage literally anything, even in not particularly liquid markets, if they see any basis,” she said. “But for those efficiencies to actually be priced in by a desk, you would need to have the infrastructure in place for those efficiencies to exist in the first place.”
“While we’re building the foundations of the infrastructure, we should be thinking ahead about these arbitrage risks and thinking about solutions. But I do think that arbitrage in many different forms is a real challenge that would need to be overcome.”
Steady Introduction of Stablecoin Regulation
Regulators stated that the proposals published on November 6 are the first “exploratory phase” in creating a new regime to include digital currencies. As stated in an earlier consultation, it is their intention to facilitate and regulate the use of fiat-backed stablecoins in UK payment chains.
However, while they are seen as a “sensible”, first draft, there are still many attributes of stablecoins, in addition to preserving singleness, that have to be considered in shaping them for widespread use in the “real” economy.
Secondary legislation, bringing activity related to fiat-backed stablecoins into the regulatory perimeter, has been set for early 2024. But are said to remain broad to allow for future regulatory flexibility.
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