US regulators catch stablecoin jitters

The opacity of the crypto markets means financial regulators don’t have a clear idea of what that might mean for the regulated parts of the system and therefore for financial stability.

This year, however, while the total crypto market grew 150 per cent, the value of stablecoins exploded, rising 350 per cent from a starting point of only about $US29 billion as the coins became more central to the trading of other digital assets.

While the dominant crypto asset, Bitcoin, isn’t seen as a useful medium of exchange because of its volatility and therefore isn’t a threat to fiat currencies, stablecoins do have the potential to be widely used because of their promised stability. Their liabilities are supposed to be matched by assets like traditional currencies (usually the US dollar) or commodities.

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Around the world regulators and legislators are trying to grapple with the longer-term implications of the increasing mainstreaming of digital assets for financial stability and their control of their financial systems.

Some want to bring them into the regulatory nets but with “light touch” regulation so as not to stifle the innovation and potential efficiencies that digital assets proffer. Others, like China and, more recently, the Reserve Bank of India, want to prohibit all crypto activity.

That division between those who see crypto asset as a threat and those who see it as an opportunity has been seen within the US Congress, where some (mainly Democrat) lawmakers want to regulate them as financial institutions and others (mainly Republicans) want a less intrusive approach.

The one certainty is that they will be regulated, whether as depository institutions like banks or as securities, with regulated disclosure requirements, regulatory oversight and inclusion in tax systems.

The near-paranoia some regulators have in regard to crypto assets, and stablecoins in particular, has been fuelled by the extraordinary increase in their acceptance by conventional investors, including institutions, this year.

Despite the wild volatility, or perhaps because of it and the trading opportunities it presents — Bitcoin has been below $US30,000 and almost breached $US70,000 this year before falling back to around $US47,000 – major financial institutions and sophisticated investors are increasingly involved in the market.

The opacity of the crypto markets means financial regulators don’t have a clear idea of what that might mean for the regulated parts of the system and therefore for financial stability.

There’s also an underlying concern that digital assets might undermine the ability of central banks to execute effective monetary policies.

For securities regulators and consumer protection agencies there is the widespread occurrence of fraud, the inadequacy of disclosures and the increased development of derivative trading by crypto asset firms and those trading in the assets, which increases leverage and the magnitude of any losses.

It is instructive that there has been controversy over whether the claimed assets that back some stablecoins actually are stable and fully cover their liabilities.

If they don’t, and don’t have sufficient liquidity, the potential for a “run” on the stablecoin issuer would be real, potentially disastrous for investors and, if the sector continues to grow at exponential rates, could have implications for the wider financial system.

The Securities and Exchange Commission has described the market for crypto assets as the “Wild West” and rife with frauds, scams and abuses. Without regulation there’s little transparency or investor protection.

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The Bank of England and the “central bank for central banks” — the Bank for International Settlements – both want a global framework for regulating crypto assets. For the moment there is no settled framework, although there is a vast amount of discussion and policy development underway at the international and national levels around the globe.

The urgency to devise an approach to regulation that reduces risks to financial systems and individuals without quashing the innovation and competition to traditional institutions the crypto firms could provide will increase as the digital assets markets continue to grow.

This year has been a watershed moment for cryptos, the year they started to become “mainstreamed. With that will come the inevitability of their being brought into the regulatory nets. Whether that’s a good thing, or not, will depend on the credibility and substance of the individual asset and its promoters.

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