FSB paper tackles stablecoin risks to emerging markets, developing economies

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The Financial Stability Board (FSB), an international body that monitors and makes recommendations about the global financial system, released a paper on the risks posed by global stablecoins to emerging market and developing economies (EMDEs). It highlighted increased interest in U.S.-backed stablecoins in emerging markets and the potential dangers to those economies of non-domiciled coins.

The paper, titled “Cross-border Regulatory and Supervisory Issues of Global Stablecoin Arrangements in EMDEs,” was published on July 23 and focused on what it refers to as global stablecoins (GSCs), which are stablecoins that could be widely used as a means of payment and/or store of value across multiple jurisdictions.

The FSB argued that EMDEs may be exposed to macro-financial risks arising from using foreign currency pegged stablecoins, which can increase financial stability risks by destabilizing financial flows and straining fiscal resources.

Prominent examples are the U.S.-dollar-pegged Tether (USDT) and Circle’s USDC, the two most widely circulated stablecoins globally; the latter is U.S.-domiciled, while the former claims to be decentralized (although Tether Limited, the entity behind the stablecoin, is technically owned by British Virgin Islands–based company iFinex Inc).

“The collapse and de-peg of certain stablecoins since the outbreak of the crypto-asset market turmoil in 2022 highlights the potential fragility of stablecoins that are not adequately designed and regulated,” warned the FSB.

This would appear to be a reference to the collapse of the Terra-Luna ecosystem in May 2022, when ‘stablecoin’ TerraUSD (UST) lost its peg to the dollar.

On May 7, 2022, UST, which was supposed to be pegged to the U.S. dollar 1:1 via an algorithmic relationship with Terraform Lab‘s native Luna token, decoupled from its pegged asset after a rapid selloff on digital asset exchanges. By May 9, it had fallen from $1 to 35 cents. Meanwhile, Luna, which was meant to stabilize UST’s price, fell from $80 to a few cents by May 12.

The fiasco wiped out a market capitalization of around $45 billion and started a domino effect in the rest of the digital asset market, which tanked the price of other assets, including BTC, and led to an estimated loss of $300 billion in value across the industry.

This kind of systemic risk, warned the FSB, is of particular concern to emerging and developing markets.

“Stablecoins also present concerns related to financial integrity, illicit finance, data privacy, cyber-security, consumer and investor protections, market integrity, fiscal stability, and macroeconomic stability,” said the FSB. “While these risks and challenges are global, some emerging market and developing economies (EMDEs) may be exposed to additional risks and challenges associated with global stablecoin (GSC) activities.”

In addition, the FSB warned that a stablecoin may become a systemic risk in an EMDE before reaching the threshold for becoming systemically crucial in the country from which it is issued.

“An EMDE authority may not have the tools and adequate enforcement powers to comprehensively regulate a foreign-issued stablecoin which is already systemic in that EMDE but not considered systemic in the jurisdiction in which the stablecoin is domiciled,” said the FSB.

To address these heightened risks, the FSB suggested the widescale implementation of its ‘High-level Recommendations for the Regulation, Supervision and Oversight of Global Stablecoin Arrangements.’

The global supervisory body published its final recommendations for global stablecoins last July, advocating for a “same activity, same risk, same regulation” approach and a focus on the need for issuers to provide users with a legal claim for prompt redemption. It also recommended that if a stablecoin is tied to a single fiat currency, redemption should match that currency’s value, and national authorities should ensure redemption rights, stabilization mechanisms, and adherence to prudential standards for stablecoins.

“Comprehensive supervisory and regulatory frameworks, consisting at least of implementation of the FSB’s crypto-asset and GSC recommendations, along with other relevant international standards, will help address financial stability and financial integrity risks while supporting macroeconomic policies and addressing other risks,” said the FSB, in its latest publication.

It suggested that “comprehensive supervision and regulation include efficient and effective cross-border cooperation and information-sharing among both AE [advanced economies] and EMDE authorities.”

EMDEs interest in stablecoins

The FSB argued that two case studies, based on public blockchain data and preliminary analysis submitted by select EMDE authorities, suggested a higher level of interest in and activities related to stablecoins in emerging and developing markets compared to “advanced” economies.

It suggested that this can be explained by a combination of factors: a perceived preference for U.S. dollar (USD)-pegged stablecoins as a store of value in countries with high inflation and currency devaluation; liquidity benefits to taking speculative positions in various digital assets against USD-pegged stablecoins, as opposed to other trading pairs; and, in a few cases, facilitation of cross-border payments and remittances.

To account for the increased interest in stablecoins among EMDEs, the FSB recommended that “a targeted policy and regulatory response may be necessary to address the cross-border risks of foreign currency-pegged stablecoins in EMDEs.”

It also suggested additional measures “that go beyond the global regulatory baseline to address specific risks, depending on their country-specific circumstances.”

These measures included technical assistance, addressing data gaps, listing requirements for offshore stablecoins, improving digital payments infrastructure, and regulatory sandboxes.

The FSB rounded off its analysis of the risks associated with stablecoins and its recommended remedies by noting its commitment to ongoing research and monitoring of the issue:

“As EMDE authorities continue to make progress on the implementation of the FSB recommendations, the FSB will continue to explore whether any additional initiatives are needed to strengthen international cooperation to address the challenges identified in this report.”

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