State of play in global stablecoin regulation

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Love them or hate them, stablecoins abound in the digital asset space as a medium of exchange, a store of value, a trading asset and a way to make payments. Tether (USDT), the most widely used stablecoin on the market, is third in overall market cap, behind only BTC and Ethereum (ETH) in the digital asset space.

However, USDT has a higher trading volume than both BTC and ETH combined. Herein lies—one of—the problems. The utility of stablecoins, such as USDT and USDC (managed by U.S. firm Circle), has led to a situation where the continued functioning of the digital asset space is over reliant on these coins retaining their value.

Stablecoins differ from speculative tokens in that their value is pegged 1:1 to a more stable asset—typically fiat currency. In the case of USDT and USDC, it is the U.S. dollar. So, in theory, they should provide the digital asset space with a less volatile alternative for settling trades and making payments.

This is the second major problem: their reliability, and the reliability of the systems they underpin, only exists if the market has confidence that the stablecoins are fully backed, secure and redeemable—which is not a given.

The only way to ensure stablecoins are and remain what they claim to be, and keep the markets they facilitate safe, is to regulate them.

“The whole ethos of legislative and regulatory efforts is all focused on stablecoins, and that’s really where the key emphasis has been, for a number of reasons,” says Dr. Michael Huertas, Partner at PwC Legal Germany and Financial Services Legal Leader for PwC’s Global Legal Network.

Speaking with CoinGeek, he goes on to explain that one of these reasons revolves around “the perceived risks of financial stability, that someone besides a central bank would be issuing an asset that could be outside the purview of the central bank-led monetary policy.”

Such risks, perceived or real, are why “regulators around the world are finalizing their conceptual approaches to how they like to regulate and supervise stablecoins.”

Fortunately, most right-thinking people—lawmakers are no exception—now believe that digital assets should be regulated in some form or another, and, as Huertas suggests, stablecoins appear to be at the top of the agenda.

However, while lawmakers around the world might be in agreement that stablecoins should be regulated, they decidedly disagree about what exactly that regulation should look like.

This has led to the non-ideal situation in which we find ourselves, with varying approaches to stablecoin legislation around the globe. The lamentable state of affairs reached a point that in April the Financial Stability Board (FSB) of the of the Bank for International Settlements (BIS)—an international financial institution of central banks—felt the need to publish a study lamenting the lack of uniformity and calling for a more consistent approach to stablecoin regulation globally.

“Despite commonalities in the regulatory efforts, the regulatory landscape remains diverse and fragmented,” said the study.

“The resulting fragmentation may pose significant challenges for an integrated financial system. Therefore, a consistent regulatory framework, as well as its global implementation, is essential to address stablecoins’ risks, prevent regulatory arbitrage and ensure a level playing field in the digital asset ecosystem.”

The differing approaches of the European Union (EU), United Kingdom (U.K.), and United States (U.S.) serve as an example of this fragmentation.

As with much digital asset-related legislation, the EU leads the way, with stablecoin provisions of the bloc’s landmark Markets in Crypto Assets Regulation (MiCAR) set to come into force at the end of June; the U.K. is not far behind, lawmakers hinting at incoming stablecoin rules in July but holding back on specifics; while in the U.S. legislation stagnates in the lead up to a November election that will set the tone for future regulatory effort.

Before looking in more detail at these various attempts at stablecoin regulation, realized and unrealized, it’s worth clarifying what we’re actually talking about with this thorny subject because not all stablecoins are created equal, and some are of more concern to lawmakers than others.

Stablecoins

On a basic level, stablecoins are digital assets that aim to maintain a stable value relative to a specified asset or pool of assets. Assets of equal value to the stablecoins in circulation are supposed to be held to achieve stability. This stability makes it useful for things like buying goods and services or trading other digital assets without the big price swings that often happen with them.

When it comes to the underlying assets, there are broadly three different types of stablecoins:

• Stablecoins backed by real-world assets like the U.S. dollar or other fiat currencies. Each stablecoin is usually backed by a corresponding amount of fiat currency held in reserves;
• Stablecoins backed by other digital assets, instead of fiat currency, which use smart contracts to maintain stability;
• And algorithmic stablecoins that don’t rely on any collateral, instead maintaining value through algorithms and smart contracts that adjust the coin’s supply based on demand, aiming to keep its value stable.

There is also a fourth, or parallel, category: what the U.K. Bank of England describes as ‘systemic stablecoins,’ or systemically important stablecoins, and the BIS describes as ‘global stablecoins.’ These are stablecoins that are in wide enough circulation to potentially disturb broader financial stability, should they fail.

Regulating stablecoins

When it comes to the regulation of stablecoins, it can broadly be broken down into rules that affect the assets/coins directly, and those intended to govern the issuers and custodians of stablecoins.

According to a 2022 International Monetary Fund (IMF) paper titled Regulating the Crypto Ecosystem: The Case of Stablecoins and Arrangements:

“Any global regulatory framework for stablecoins should be comprehensive, risk-based, and flexible, and it should provide a level playing field. The regulatory framework should be comprehensive, adequately covering all entities carrying out core functions, including issuers and crypto asset service providers that interact with the stablecoin, such wallets, exchanges, and reserve managers.”

The paper also posited several regulatory approaches to stablecoins:

• Narrow the universe of stablecoin issuers to entities that are already regulated and for which an established supervisory framework exists.
• For unregulated/underregulated entities allowed to perform functions in the stablecoin ecosystem, authorities must develop bespoke regulation or revise existing regulatory frameworks to ensure that all entities that perform these functions are licensed or authorized.
• Regulation, supervision, and oversight for the various components should be proportional to the risks and functions to be performed and should adhere to the principle of “same risk, same activity, same regulation,” while considering the novel risks of the underlying technology.
• If issuers become “systemically important,” authorities need to address the risks as well as contagion risks arising from stablecoin activities to other parts of their financial sector, such as applying requirements comparable to those applicable to systemically important banks—e.g., more intensive supervision, safety and soundness obligations, and stress testing.

But what the IMF thinks stablecoin regulation should look like, is not necessary what it does look like. So, which of these measures, if any, have different jurisdictions adopted?

EU first to the party

In 2021, the EU outlined its proposed approach to stablecoins. It considered three options: (i) to take bespoke legislative measures, (ii) to bring them under EMD 2 (the second electronic money directive, developed to align EU requirements and supervise electronic money institutions), and/or (iii) to limit their use.

In the end, it decided to go with the two first options, to take bespoke legislative measures and use secondary legislation to complement requirements on digital asset service providers; and to regulate certain specific stablecoins under EMD 2—namely stablecoins pegged to a fiat currency, or what the EU refers to as E-money tokens (EMT).

When MiCAR’s stablecoin rules come into force on June 30, issuers of asset-referenced tokens (ARTs)—stablecoins that purport to maintain a stable value by referencing another value or right—and EMTs will have the following regulatory obligations:

• A requirement to be authorized by the Central Bank and to publish a white paper containing information on the relevant token for investors;
• Conduct and governance requirements around marketing, disclosure of information, and dealing with conflicts of interest;
• Prudential requirements to ensure sufficient liquidity and the ability to meet redemption requests;
• And no stablecoins can be offered to the public or admitted to trading on a trading platform for digital assets unless the issuer is authorized in the EU and publishes a ‘white paper’ approved by the national competent authority (NCA).

Issuers of EMTs must also comply with existing EMD 2 obligations, which include informing authorities on how they safeguard funds received in exchange for e-money issued, ensuring they can “redeem at any moment and at par value” the monetary value of the e-money held, e-money institutions must hold initial capital of not less than EUR 350 000 at the time of authorisation, and e-money institutions are subject to anti-money laundering legislation.

Some ARTs or EMTs may also be considered significant due to their size or other factors and as a result may present an increased systemic risk.

For these, MiCAR mandates additional measures, which have been compared to the regime applied to classify global systemically important banks. As such, the European Banking Authority (EBA) will have supervisory responsibilities for issuers of stablecoins that are deemed to fall into this category.

Under MiCAR, a stablecoin is classified as significant or systemic if it meets any three of seven criteria, including having more than €5 billion (US$6.28 billion) in reserves, over 10 million users, or processing over €500 million daily. Other considerations include whether it’s interconnected with the financial system and if it’s used for payments on a global scale.

These impending rules for stablecoins in the EU have met with mixed reception.

“In the EU European authorities are pushing out final technical standards of what various different firms need to do,” says Huertas. “MiCAR is a good start, but I don’t think it’s the finished product…it is already scheduled into the legislation that MiCAR will need to be updated and reviews of stablecoin rules, appropriateness, fitness in design, fitness in deployment. But it’s a good base.”

This idea that MiCAR’s stablecoin rules, in their current form, are perhaps not quite the finished product, has been somewhat reflected in market reaction.

In February, a paper published by stablecoin issuer Circle criticized the EU approach as flawed, saying it would only push issuers away; while Tether’s CEO Paolo Ardoino—perhaps unsurprisingly—also signaled the behemoth stablecoin issuer’s displeasure with EU rules in an April interview, in which he stated his unwillingness to secure permission to operate under the MiCA framework.

Specifically, Ardoino said he was “rather pessimistic about the development of crypto in Europe,” and that MiCA signaled that “Europe does not want crypto with regulation that largely limits access to it, especially for retail investors.” Ardoino particularly pointed to MiCAR’s “very restrictive measures on stablecoins” as an example of this, key complaints being the requirements to hold significant portions of fiat reserves in cash deposits in local banks and to spread those deposits across multiple banking institutions.

However, the likes of Circle and Tether will need to make peace with MiCAR sooner rather than later. The regulation became law on June 30, 2023, and the new framework will start to apply in two phases: the part of MiCA regulation containing specific rules applicable to ARTs and EMTs will start to apply as of June 30, 2024, and rules applicable to digital asset service providers will begin to apply as of December 30, 2024.

For Huertas, “there’s a lot of aspects to the drafting which could potentially have been better, but it’s a step in the right direction, and 30th of June is going to be a major milestone event certainly in the EU and for anyone in the digital asset space.”

He also suggests that other jurisdictions lagging behind in regulation will likely be following MiCAR’s progress with great interest.

“Where we currently stand is that the EU is ahead of the game and it’s offering the ability for other non-EU jurisdictions to think about whether to emulate before MiCAR is fully live, or to wait and see to figure out how to offer something better, or at least offer some sort of conceptual equivalence,” says Huertas. “But I think we’re in a much better place with MiCAR on the legislative books than we would be in the UK or the US where there’s just a lot of legal uncertainty.”

It’s probably safe to say that legal certainty is preferable in almost every situation, but one of the jurisdictions mentioned by Huertas may not be suffering with uncertainty for much longer. The U.K. could be imposing its own stablecoin rules this summer.

Mooted UK

On April 15, the U.K.’s Economic Secretary, Bim Afolami, announced plans to introduce new laws to regulate the issuance and usage of stablecoins by June or July.

“We are now working at pace to deliver the legislation to put our final proposals for our regime in place,” Afolami said. “Once it goes live, a whole host of crypto asset activities, including operating an exchange, taking custody of customers’ assets and other things, will come within the regulatory perimeter for the first time.”

The economic secretary was sparing with details on exactly what the new legislation may look like, but what is certain is that it will build on the foundation laid down by the passage, last June, of the Financial Services and Markets Act (FSMA) 2023, which allowed for stablecoins and digital assets to be treated as regulated activities in the United Kingdom.

It will also likely have some influence from a Bank of England (BoE) discussion paper and a Financial Conduct Authority (FCA) discussion paper, both published November 2023, so some assumptions can be made about the shape of the possible new rules.

Firstly, the passage of FSMA 2023 extended the banking rules of the previous FSMA iteration—such as maintaining adequate capital to withstand financial shocks, implementing robust risk management practices, and providing clear and transparent information to customers—to stablecoins and digital assets.

It also gave the FCA and Prudential Regulation Authority (PRA)—the former being the country’s top financial sector regulator and the latter the banking watchdog—the necessary powers to begin implementing the HM Treasury’s goals set out in its February 2023 consultation on the Future Regulatory Regime for Cryptoassets.

Meanwhile, the BoE discussion paper set out its proposed regulatory framework for systemic payment systems using stablecoins and related service providers, focusing on sterling-denominated stablecoins because it considers these the most likely digital settlement assets to be used widely for payments. It proposed a ‘same risk, same regulatory outcome’ approach, which included:

• Requiring that there is an entity across the payment chain that can be identified as the payment system operator. This entity would need to be able to overview and assess all the risks arising from the different parts of the payment chain and ensure there are appropriate controls;
• Requiring issuers to fully back stablecoins with deposits at the BoE, with no interest to be paid on these deposits;
• And wallet providers would need to ensure that coinholders’ legal rights and ability to redeem stablecoins at par in fiat are protected at all times.

The BoE paper was published alongside the FCA paper, which outlined its regulatory approach to stablecoin issuers and custodians. It proposed applying several existing regulatory standards, that currently already apply to many FCA-authorized entities, to the realm of stablecoin activities. This included adherence to the FCA’s overarching ‘Principles for Business,’ and certain rules within the FCA’s Conduct of Business sourcebook, such as those concerning inducements, client categorization, and the disclosure of costs and charges.

Beyond applying existing regulatory provisions, the FCA is considering specific rules tailored to the unique nature of stablecoin issuers and custodians.

The two principal expectations for issuers are to ensure that their stablecoins consistently maintain their value relative to the designated reference currency and that holders can promptly redeem their value at par.

In order to achieve this, the FCA proposed that issuers be required to hold backing assets that are not only stable in value but also sufficiently liquid (a potential problem for any stablecoin that isn’t fiat-backed), allowing for quick redemption by consumers.

For custodians of stablecoins, the FCA also proposed several measures, including segregating client stablecoins from the custodian’s own assets, maintaining records to clearly establish asset ownership, and implementing effective organizational controls to mitigate the risk of loss or diminution of clients’ custody assets.

Together, the BoE and FCA discussion papers will likely form the backbone of the regulation mooted by Economic Secretary Afolami for this summer.

“I think the FCA is doing a pretty good job in terms of finalizing what they want the future state to look like,” says Huertas.

However, he points out that U.K. lawmakers and authorities are having to walk a tightrope when it comes to digital asset regulation:

“This is the first piece of legislation where the FCA is faced with a problem politically, and it’s not just the FCA it’s the PRA and the Treasury, they need to balance how to ensure that the UK remains an attractive place for crypto assets, the wider spillover effects to the economy overall, to the city, but still deliver this is in line with the better regulation framework post-Brexit.”

Navigating this balancing act is probably at least part of the reason the country is still in regulatory limbo when it comes to stablecoins.

While the U.K. finalizes its new rules, it may look to the EU to see how MiCAR progresses. Equally, Huertas suggests that EU lawmakers may be taking note of U.K. legal manoeuvres.

“There’s a lot of very positive developments out of the UK where the EU policymakers are looking at it with a degree of ‘Oh, that’s interesting, why haven’t we thought of that. Maybe we can borrow some stuff from what the UK is doing.”

Huertas suggests that the world’s largest digital asset market, the U.S., might also be “looking across the Atlantic” at both the EU and U.K. for inspiration on its own stuttering regulatory efforts.

US quagmire

In the area of stablecoin regulation, as with much digital asset regulation, the U.S. once again finds itself lagging behind other major economies. This can be attributed to a number of factors, from the sluggish nature of the U.S. legislative process to conflictual partisan politics, which holds things up further.

However, there is a real push of late in Congress to get stablecoin legislation over the line, as well as bills in both the Senate and House of Representatives with bipartisan support and a chance of success.

On April 17, Senators Kirsten Gillibrand (D-NY) and Cynthia Lummis (R-WY) released a draft of their new Lummis-Gillibrand Payment Stablecoin Act of 2024. The bill is an updated version of the stablecoin language in the pair’s Responsible Financial Innovation Act that was introduced in 2022 but failed to pass during that Congressional session.

The bill would prohibit so-called ‘algorithmic stablecoins’ like UST, the Terraform Labs token that claimed to maintain its 1:1 peg with the U.S. dollar through a link to Terraform’s own LUNA token. Both UST and Luna collapsed in the spring of 2022 when this setup was exposed as essentially a fantasy.

The bill would also require stablecoin reserve assets to be held on a 1:1 cash or cash-equivalent basis—similar to measures proposed in the EU and United Kingdom.

The ‘payment stablecoin’ phrasing of the bill mirrors the Clarity for Payment Stablecoins Act of 2023, currently stalled in the House of Representatives.

Despite being stuck in the quagmire of the U.S. legislative process, buffeted by the winds of partisan politics, in October last year, the bill’s champion, House Financial Services Committee Chair Patrick McHenry (R-NC), reemphasized his determination to pass stablecoin regulation.

The Clarity for Payment Stablecoins Act of 2023 was authored by McHenry but does have bipartisan support, with House Financial Services Committee Ranking Member Maxine Waters (D-CA) also in favor.

If enacted, the legislation would create a regulatory framework for the issuance and oversight of payment stablecoins, including:

• Defining stablecoins and establishing a clear regulatory framework for their issuance and operation;
• Mandating stablecoin issuers to obtain licenses from state regulators and ensure compliance with their relevant rules, as well as calling for supervision and reporting requirements for stablecoin issuers;
• Requiring issuers to maintain reserves equal to the value of the stablecoins in circulation, held in a manner that ensures the stability and liquidity of the stablecoin;
• Imposing consumer protections that require stablecoin issuers to disclose relevant information about the stablecoin, including its underlying assets, reserve holdings, and any potential risks, as well as establishing a mechanism for resolving disputes and addressing consumer complaints;
• And requiring stablecoin issuers to implement robust anti-money laundering and know your customer procedures;

“The bill protects consumers by establishing necessary federal guardrails, while at the same time fostering innovation in the U.S. through a tailored approach for new entrants into the marketplace,” said McHenry when the bill passed its first committee vote in July 2023.

However, Huertas is not so optimistic about seeing U.S. regulation cross the line this year:

“I would imagine a lot of other people are going to be looking with interest to see what happens as the US develops. The one thing that I would caution is, at least within the EU, it’s pens down ahead of the European elections. MiCAR has pretty much done building, the fine tuning is coming out, but the US has a comparably longer way to go, during an election year. Frankly, people say, ‘we’ll just wait until things settle down in November.’”

Despite delays and much pessimism about anything substantial getting over the line before the November U.S. elections, in an April interview with Bloomberg TV, Representative Waters predicted that she and McHenry would soon have a deal on stablecoin legislation, adding that lawmakers have also discussed the bill with the Federal Reserve, Treasury Department, and White House.

If no deal is done by November, the wait could be even longer for stablecoin regulation in the U.S., and as Huertas points out, “that’s a long time and in a market where a lot of people are just getting on with trying to continue to do business and play by the rules and avoid getting sanctioned.”

Regulatory convergence

So, the state of play in stablecoin legislation, in the EU, U.K. and U.S. at least, can be summed up as an imminent and comprehensive work-in-progress; pending and unspecified, but potentially promising; and hopeful but up against the clock—respectively.

But what could the future of stablecoin regulation look like, and what is the ultimate goal?

“The overarching goal of supervisory, regulatory and supervisory practice—convergence,” argues Huertas. “This is a truly global market where more so than ever before firms are, from the get-go, pursuing a multi-jurisdictional, multi-financial center operational base strategy in how they set up, which means they have to comply with multiple rules and sometimes convergence or divergence, and sometimes competing obligations.”

In this truly global market, it makes sense that convergence in regulation would be a more ideal situation. Certainly, if there was a global standard companies would have an easier time understanding their obligations and staying in compliance; and from a regulatory perspective there would be no excuse for non-compliance if obligations were the same around the globe.

While the EU, U.K., and U.S. might be at different stages of their regulatory journeys, if the BoE and FCA discussion papers indicate the U.K.’s direction of travel and the bills currently languishing in Congress indicate how U.S. stablecoin regulation will eventually look, there are some similarities on which to cling.

Stablecoin issuers having to obtain licenses, maintaining liquid reserves equal to the value of the stablecoins in circulation, and increasing transparency and disclosure requirements are examples of features that appear to be priorities for lawmakers and regulators across all three jurisdictions.

More convergence along these lines would certainly please observers, such as Financial Stability Board of the BIS, who lament global fragmentation of stablecoin regulation. However, such a global agreement is never guaranteed.

“It has persisted since the dawn of time: certain authorities and policymakers think that ‘my standards are better than yours.’ This is a global market,” says Huertas.

Speaking from his perspective in Germany, he gives an example that “the EU has rightly or wrongly said, ‘we’re building MiCAR, the world’s largest digital single market,’ and they’ve done it in a very short period of time, by EU standards. And the EU doesn’t have much impetus at the moment to say, ‘let’s figure out how we can increase connectivity with Switzerland, with the UK, with the UAE’.”

This position makes sense for the early adopters of regulation, particularly comprehensive, well-thought-out regulation such as MiCAR. But as more jurisdictions bring in their own rules and we see how the market reacts to different measures, the best model will likely be the one that is able to adapt to and integrate what is working well elsewhere.

So perhaps the ultimate message, when it comes to the fast-moving technology space, is that evolution is key, and regulation must adapt.

“The market is evolving, it means a better, more stable standard for stablecoins and digital assets more broadly, and regulators will need to respond as well. Regulation is a journey of course, at some point, everyone thinks they know what the end goal is, but the end goal continues to evolve.”

Only time will tell whether this process will result in a natural convergence on a global stablecoin regulatory standard.

Watch: Centi releases first stablecoin on BSV and it’s backed by Swiss bank