Facebook’s entrance into the stablecoin game with Libra was in many ways a wake-up call to regulatory bodies and entrenched financial institutions worldwide. Previously slumbering bears were officially awakened when they realized the potential reach between Facebook’s three-legged horse of Messenger, Instagram, and WhatsApp. This, in part, is a big reason why Libra still hasn’t launched yet — and may not fully do so in the way it originally planned as it bears down against governing bodies both abroad and in the United States. Facebook, and specifically Libra, now renamed Diem, were the specific targets of a recently released report conducted by the Bank for International Settlements, or BIS for short. While this was designed as an introductory paper for non-stablecoin holders with outlines about its history, usage, and current trading volume, much of the paper was focused on the specific case study of Libra and the regulatory policies around it.
Within the 31-page report released by BIS, there were certainly multiple points worth highlighting. However, there seems to be an aura of inevitability, bundled with a feeling of excitement as if dawn is about to break in the financial world. COVID-19 accelerated the shift to digital payments and stablecoin growth like never before. The report acknowledged that this rare blend of variables is creating the environment for stablecoins to thrive. Naturally, as with all major reports released in the finance sector, risk and risk aversion were central themes, as BIS highlighted fall-outs ranging from the Mexican Revolution, the collapse of the Bank of Amsterdam in the 1780s, and Tether’s more recent issue with Bitfinex. That being said, the overall report retained a fairly bullish tone throughout, as it undoubtedly recognizes both the reality the stablecoins are here to stay, in addition to its potential areas of growth. But don’t worry, we’ve read through the entire 31 pages, so you don’t have to. Below are the key takeaways from it.
Virus Driven Responses
When it comes to regulatory bodies as large as the BIS, one has to wonder why a prominent institution of their caliber would act all of a sudden, rather than resting on their laurels, as they have for the last decade or so as cryptocurrencies have grown? One of the reasons highlighted is virus related — this applies not just to COVID-19, but rather a broader change to people’s mindset and future viral outbreaks. Cash, specifically, is seen as a major loser in this mindset shift as more people are going to be averse to the idea of constantly passing cash back and forth, and the germs along with it. This is a key driver for banks, especially banks involved in remittance like BIS, to think forward about how to adapt in the digital age.
Difference between Financial Regulation and Supervision
To the BIS at least, there is a clear difference between regulation and supervision. As stated, regulations should be clearly and firmly written out. Whereas supervision should be much more flexible, and open-minded to change. Therefore, regulation minimizes these risks and ensures stability, while supervision allows the continued innovation and progress.
Private Stablecoins vs. Centrally Backed Digital Currencies (CBDC)
Okay, BIS may have a bit of an implied bias here since much of their work revolves around central banks and governing bodies. That being said, a significant part of the report was given to the identification of different stablecoins (more on that below). But they did raise the question around stability involving private stablecoins such as Tether, versus a centrally backed digital currency which can perform all the tasks of USDT without any of the risks or incentives to maximize profits since it is a governing body.
Global vs. Private Stablecoins
Another key differentiation the BIS report made was the impact of private stablecoins like Tether (USDT) have on the global financial market versus truly global stablecoins like the proposed Libra. In short, global stablecoins pose much more risk to regulatory bodies and can cause some serious market fluctuations — which means that the policies involved for global stablecoins need to be much stricter and more thought out compared to private ones like Tether.
A Diverse set of Collaterals
Despite global stablecoins like Libra potentially posing more risks to global financial infrastructure, generating market volatility in the process, the BIS believes that these diversified stablecoins are actually inherently safer compared to single backed stablecoins like USDT. The reason for this is the same as many financial instruments, diversification guards against singular black swan events. If global stablecoins are to be created, whether that’s by private organizations or through central governing bodies, the BIS highly recommends the set of collaterals be diversified not just amongst fiat currencies, but also to include assets like gold, metals, or even oil.
Arguably the biggest takeaway from this report is the idea of embedded supervision, something that we’ve already seen being done on Chinese payment platforms like Alipay and WeChat pay. As we’ve stated above already, there is an implied difference between supervision and regulation. In terms of supervision, BIS put forth a framework centered around embedded supervision, something that is much more simply done through the blockchain ledger than it would be done through a central bank where audits need to be conducted manually. In this proposed framework, we’d see a significant reduction in the costs of compliance — leading to a level playing field for smaller players. Furthermore, embedded supervision would ensure compliance legally in terms of payments settled, something that is a little different from the economic or contractual settlements involved. With an open-source suite of monitoring tools provided by the blockchain technology, such a framework would allow large governing bodies to have oversight over transactions, in turn lowering risk while providing transparency.
While stablecoins have caught fire in 2020, the regulating bodies globally are much slower in adapting and adjusting to this sudden growth. It is in their best interest to not fall behind too much, as demand for stablecoins will only increase with time. This is evidenced with JP Morgan officially launching their own stablecoin earlier this year, and PayPal vaulting themselves into the crypto space as well. The Bank for International Settlements has put forth a rather interesting framework in terms of how stablecoins could be regulated, as well as supervised through the blockchain ledger while also identifying the potential risks and differentiations between private stablecoins and global stablecoins. As this market continues to grow and mature, further segmentation of stablecoins is bound to happen. It is therefore rather important to have reports like these be thoroughly analyzed and debated so regulating bodies are able to put forth proper regulations, while allowing the market to flourish. We applaud the efforts put forth by the BIS, but also recognize that this isn’t the be-all end-all solution either. Rather, it is the first of many steps required to properly identify the risks involved for both private users, and traditional financial institutions.
To learn more about the benefits of using stablecoins and how they can improve your business operations as well as position you as a pioneer in the adoption of disruptive technology, reach out to us here. We will gladly walk your organization through the steps of building a stablecoin with our all-in-one solution. Whether it is the code, compliance, distribution, or marketing, we’ve got you covered.
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