Stablecoins are electronic money

There is a clear market demand for stablecoins, otherwise they wouldn’t exist. Professor Eswar Prasad, writing in the MIT Technology Review on the future of money, said that “Bitcoin, the cryptocurrency that started it all, may not have much of a role to play in this monetary future” because stablecoins of one form or another might well be more desirable to the average person than volatile tokens for speculators. He also suggests that, rather than leading to a proliferation of public and private currencies that compete on a level playing field, the emergence of digital currency could make economic power more concentrated than ever. If major currencies such as the dollar, the euro and renminbi are available to citizens around the world, they might well displace the currencies of many other nations. Similarly, and in my view just as likely, the digital currencies issued by multi-national corporations might replace weak fiat currencies by exploiting their ecosystems.

So there is clearly a need for proper regulation of stablecoins. Caveat emptor is not a solution. But what might that regulation look like? If you are talking about asset-based stablecoins, then I would argue that a light touch is appropriate. Morgan Ricks, a professor at the Vanderbilt Law School and a former Treasury official, was quoted in the Financial Times as saying that “there’s nothing inherently dodgy about stablecoins. But there is something inherently dodgy about banking, which is why countries build elaborate regulatory regimes to protect deposits”. This is why banking regulations have to be rigorous (and expensive), but stablecoin regulations need not be, because stablecoins issuers do not create money as banks do.

Coming from another direction, the just-published fourth report in the series on The Future of Banking from the IESE Business School identifies payment systems as one of the key challenges for banks moving forwards. It similarly reinforces the need for regulation around stablecoins and highlights the issue of whether fintechs have access to central bank accounts. This is because if a digital currency is to be a substitute for commercial bank deposits, then non-bank issuers must commit to guarantee the one-for-one convertibility with public money. The lack of access to central bank accounts and liquidity facility services complicates such a commitment, which threatens to jeopardise the stability of such alternatives.

Christopher Waller, a member of the Board of Governors of the Federal Reserve System, said earlier this year he was sceptical that a Federal Reserve CBDC “would solve any major problem confronting the U.S. payment system”. I actually agree with the general sentiment here, but I would phrase it in a slightly different way: that there is no “burning platform” for a retail central bank digital currency in the United States. Appropriately-regulated private sector “stablecoins” could be used to satisfy the demands of the decentralised finance (“defi”) sector for money that can be algorithmically-traded for cryptographic assets. Governor Waller also said in a speech last year that “I disagree with the notion that stablecoin issuance can or should only be conducted by banks, simply because of the nature of the liability” and went on to talk about private-sector innovation outside the banking sector that should be given a chance to compete “on a clear and level playing field”.

(It appears that recent proposals from legislators and regulators have shifted attention away from turning stablecoin issuers into insured depository institutions – which was one recommendation made by the President’s Working Group on financial markets in November 2021 – and toward this lighter and more open approach.)

For what it’s worth, I completely agree, with both Professor Ricks and Governor Waller. You do not need to regulate stablecoin issuers as banks (because they will not provide credit) but regulate them something like the existing European electronic money regime. This seems is adequate for fiat stablecoins and, indeed, this is what the UK intends to do.  The definition of “electronic money” under Electronic Money Regulations 2011 (EMRs) will be extended to include fiat-linked stablecoins, with the additional recognition that the holder of a stablecoin may not always have a relationship with the issuer. The holder’s relationship may instead be with a third party (such as an exchange or wallet provider).

I think there is a need for the US, and other jurisdictions, to look at the European example and develop the idea of a regulatory category of Payment Institutions (or whatever they might be called) that can provide services to the public, access core payment systems and issue stablecoins against central bank reserves as an alternative to banks.