Analysts at the Bank of Canada have published an analytical note delving into the nature of stablecoins and at the heart of the paper is a recommendation for sterner regulation for the asset class.
The research note from the banking regulator highlighted the steady increase in stablecoin usage, noting that adoption rates had soared by a staggering 30-fold in under two years. The global stablecoin market capitalization currently stands at an impressive 161 billion, as the researchers pointed out the potential pitfalls.
“These cryptoassets could bring efficiencies and greater competition to payment services, especially in a more digitalized economy. However, without safeguards, they could pose significant risks to the stability of the financial system,” the paper read.
Top of the list in the pitfalls identified by the Canadian central bank is “run risk” occasioned by a situation when stablecoin holders lose faith in their ability to redeem their tokens at the same value as fiat currency. The bank noted that the run risk can be triggered by a lack of adequate disclosures or when the reserve asset price plummets.
Another risk identified by the Bank of Canada is contagion risk, which threatens the survival of centralized virtual currency platforms. TerraUSD’s de-pegging from the U.S. dollar triggered a contagion effect that led to the liquidity crisis in firms like Three Arrows Capital (3AC), Vauld, Zipmex, and Celsius, amongst others.
The paper highlighted concentration risks arising as a result of the “dominance” of a few stablecoins over the entire ecosystem. Tether (USDT), USD Coin (USDC), and Binance USD (BUSD) control 44%, 33%, and 13% of the stablecoin market capitalization. Other pitfalls resulting from the increasing use of stablecoins include consumer and investor protection risks, governance risks, and national security and financial risks.
Regulation is the only way out
Given the novel nature of stablecoin usage, the central bank’s researchers have identified parliamentary action as the best way to mitigate the risks. Citing the Financial Stability Board’s (FSB) recommendation, the researchers suggested that stablecoin issuers should be treated like banks on the basis of “same activity, same risk, same regulation.”
The central bank implored legislators to create anti-money laundering and counter-terrorist financing measures, and ensure the strict regulation of banks’ exposure to stablecoins while encouraging the passing of “custom-made” legislation tailored to the Canadian market.
“Furthermore, holders of these assets should have the legal right to redeem them at any time, subject to any clearly disclosed redemption restrictions,” the report read. The bank stated that another way to mitigate the inherent risks is to ensure that the reserves of stablecoins should be liquid assets that are separated from the issuer’s funds.
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