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This is the second installment in a series exploring
stablecoins and central bank digital currencies (CBDCs).
In the first installment, we discussed fundamental similarities
and differences between these two novel financial
In this article, we focus on stablecoins – the risks
they pose and the regulatory frameworks proposed by governments and
regulatory bodies to address such risks.
The global financial system recognizes that cryptocurrencies can
no longer be dismissed as fad. As such, regulators are trying to
enact legislative frameworks that protect investors. In developing
their proposed frameworks, regulators contend with a number of
serious challenges posed by the rise of stablecoins.
A financial instrument can only be viable and reliable when
there is widespread confidence and consensus as to its value. For
stablecoins, such confidence is rooted in the asset to which the
stablecoin is pegged, and its redeemability.
Fundamentally, the reliability of a stablecoin is only as strong
as its underlying asset. If, for example, the U.S. dollar
experienced a significant shift in value, there could be a
“run” on stablecoins pegged to U.S. dollars, such as Tether’s USDT (which has a
market cap of roughly US$80 billion).
In a “run,” holders seek to redeem their stablecoins
by exchanging them for the underlying asset (e.g., U.S.
dollars). This would require the stablecoin issuer, like Tether, to
provide fiat on a one-to-one basis. However, not all stablecoin
issuers keep an equivalent amount of U.S. dollars (or any other
applicable pegged asset) in reserve. On a large scale, such an
event could severely disrupt the financial system and broader
For stablecoins to become a widely accepted form of payment,
operational issues disrupting the validation of transactions and
settlement issues preventing the secure transfer of funds must be
avoided. Otherwise, the public’s trust and confidence will
This risk is not unique to stablecoins, but it may manifest in
novel ways. In traditional payment systems, the central payment
operator and direct participants in those networks manage this
risk. But in a decentralized system, there is no single point of
accountability in the event of operational or settlement
Most jurisdictions recognize that the need to regulate the
stablecoin space is unavoidable, and that failure to do so could
result in that jurisdiction becoming a hub for illicit stablecoin
Despite the fact that stablecoin risks posed are similar across
the globe, there are few cross-jurisdictional similarities in
proposals to regulate them.
On Jan. 12, 2022, the Hong Kong Monetary Authority (HKMA), its
central banking institution, released a discussion paper detailing its
proposed expansion of Hong Kong’s regulatory regime to capture
the particularities of stablecoins. The HKMA set out to address the
above risks, while recognizing that any new framework needs to be
agile, risk-based and proportionate.
The HKMA specifies that priority for any new framework should be
to regulate the activities surrounding payment-related stablecoins,
which pose an immediate threat to its financial system. While the
framework should be agile enough to lend itself to other types of
stablecoins, the HKMA accepts that payment-related stablecoins are
more likely to be incorporated into global financial markets in the
near future, and should therefore be regulated first.
The range of stablecoin activities the HKMA proposes to regulate
is expansive, and includes the issuing/destruction of stablecoins,
the management of reserve assets (to which the value of a
stablecoin may be tied), the validation of stablecoin transactions,
and ensuring the efficiency of executing stablecoin transactions.
Interestingly, the HKMA has signalled that only entities
incorporated in Hong Kong will be able to carry out regulated
activities. This means that foreign companies seeking to provide
stablecoin-related services in Hong Kong will have to incorporate a
subsidiary within that jurisdiction and apply for a licence.
The European Union (EU) released what is arguably the most broad
and comprehensive study of stablecoin regulation to date.
On Nov. 19, 2021, the EU published its 400-page Proposal for a Regulation of the European
Parliament and of the Council on Markets in
Crypo-assets (MiCA), which aims to regulate a broad
swath of crypto-related products. The publication of MiCA marked
the arrival of the next step in the European legislative adoption
process, whereby adoption of the regulation will now be negotiated
between EU’s primary regulatory bodies.
Interestingly, MiCA creates two distinct classes of stablecoins.
First, it defines “asset-referenced tokens” as crypto
assets that “purport to maintain a stable value by referring
to the value of […] one or several commodities.” Second,
MiCA separately defines “e-money tokens” as crypto assets
primarily used as a means of payment, and which maintain a stable
value by specifically referencing itself to the value of a currency
(as opposed to “asset-referenced tokens,” which can
reference any kind of asset). Regulating these two instruments is a
key focus of MiCA.
MiCA establishes a number of regulations regarding Crypto Asset
Service Providers (CASPs), including solvability/capital
requirements for various kinds of CASPs (Article 55), imposing a
duty to act honestly and professionally (Article 59), and
standardizing the rules for exchanging crypto assets for fiat
currencies (Article 69). MiCA’s scope is expansive, aiming to
cover not only stablecoins (i.e.,
“asset-referenced” and “e-money” tokens), but
also “utility” tokens, which are issued to provide the
holder with access to a given DeFi application, service or
resources, and even specific rules governing the acquisition of
The President’s Working Group on Financial Markets (PWG),
composed of representatives from the Treasury, the Federal Reserve,
the Securities and Exchange Commission, and the Commodify Futures
Trading Commission, published its Report on Stablecoins on Nov. 1,
The PWG report offers little in the way of concrete proposals,
but bears some similarities to the HKMA’s proposal in that it
prioritizes creating a framework to regulate payment-based
stablecoins, and adjusts that framework as necessary to respond to
future developments in the stablecoin market.
The report also sets out priority objectives for any eventual
stablecoin regulation, including:
- Limiting stablecoin issuance to entities that are insured
depositories under U.S. law (such as banks and savings
associations, whose deposits are insured by the federal
- Promoting interoperability between stablecoins; and
- Imposing risk management standards for the entities charged
with the functioning of stablecoin settlement/payment
Stablecoin regulation in the U.S. faces a number of impending
roadblocks. In addition to the partisan deadlock, there is
uncertainty within the federal government as to the appropriate
entity to take the lead on stablecoin regulation between the
Treasury, the Securities and Exchange Commission and the Federal
In our next and final installment, we explore the status of CBDC
development around the world.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.