Stablecoins are a new type of thing
Stablecoins are a new type of thing
New types of things need new types of thinking
tldr
Stablecoins can be payment rails as well as stores of value–and more. However, emerging regulation is mostly focused on treating them like gift cards. Well-run stablecoins will continue to grow regardless, so we can only hope for the emergence of rational, data-driven regulation that focuses on user benefits rather than incumbent profits.
Unlike current bank products, stablecoins can be two things at once to benefit users
In their most elementary form, stablecoins are a type of eurodollar deposit. Someone, somewhere in the world needs to hold dollars and stablecoins offer a way to access those dollars. All stablecoins are a type of ‘narrow-bank’, a simple bank balance sheet structure that does only one thing – hold dollars in sight deposits or checking accounts.
Stablecoins can do better than typical sight deposits with respect to minimizing the risk of not having enough cash on hand for people to redeem their deposits. This is because the behavioral pattern of every stablecoin on a public blockchain can be tracked in real-time. This means the effective maturity of those deposits can be estimated with far more data than banks can, and can give more confidence to the degree of liquidity risk that a stablecoin balance sheet can take.
Given that stablecoins can invest in money market funds or, theoretically, central bank deposits, at low risk to the holders, there is no good reason that the users of a stablecoin couldn’t benefit from sharing in the rewards too. USDM from Mountain Protocol, for example, is a fiat-backed stablecoin fully regulated in Bermuda that offers its (non-US) holders close to the federal funds rate just by holding. Each token maintains its redemptive claim to $1 by rebasing the number of tokens a user holds, rather than its value.
By virtue of trading on a public blockchain, stablecoins can offer clear and instant settlement for transfers anywhere in the world, compared to the antiquated and byzantine ledger clearing exercise banks must regularly do to settle their wires (as in the original wire transfers that were executed over telegraph by Western Union in the 19th century).
To be clear, there are many improvements left to make in the space, but the path is clearly promising to enough people that stablecoins have become a +$100bn market cap category. In aggregate, stablecoins would be one of the world’s top 20 banks – on sight deposits alone! – and represent at least a significant single digit percentage of the US treasury market, even as incumbents whine to the government and push them out of legitimate funding markets.
Thus stablecoins, in combination with public blockchains, offer a distinctive and novel innovation in financial services. They offer services that reward users rather than extract solely for shareholders. Stablecoins are a new type of thing and should be treated as such.
However, regulation is focused on treating them as an old thing instead
Stablecoins are facing a difficult time being understood properly by regulators. This subsector of our industry is unfortunately overshadowed by the fraudulent Terra scheme, whose founder prevaricated on the risks of running an insolvent-by-design stablecoin and wiped out thousands of user deposits.
As ‘narrow-banks’ they do not have a favorable path ahead of them either. The Federal Reserve in the US has been averse to narrow-banks in the past for ‘being too safe’ and ‘threatening monetary policy transmission’. Both statements are obviously false, bewildering and proof that central bank independence is largely a myth (too big to fail → regulatory capture of the executive → lean on central banks to call the safest possible type of bank unsafe).
Most new attempts at legislative enshrinement of fiat-backed stablecoins treat them as payment rails, similar to a prepaid card. MiCA relies explicitly on e-money regulation which was originally devised for early internet payment methods and inherits its prohibition on granting interest to holders. This benefits some fiat-backed stablecoin issuers, such as Circle or Tether, who can reap the gargantuan rewards of risk-free investments for themselves, while artificially manipulating the competitive environment for new players who can otherwise compete by offering users more value. The UK looks like it is going in a similar direction, unless clearer heads prevail.
Rather than try and make a new shape for a peg, regulators the world over are insisting on finding ways to shove a round block into a square hole or exclude it altogether.
Well-run stablecoins will continue to grow so regulation should follow
The interesting thing about stablecoin mobility is that it isn’t really restricted to a specific jurisdiction. Regulators should be mindful of the efforts they put in to try and essentially impose soft capital controls on a system that can’t physically be fully controlled other than by attacking validators for public blockchains. Imagine trying to turn off the internet just so you can censor a tweet (or stop a stablecoin).
Suppose a fiat-backed stablecoin is enshrined in law as the 'Only Correct Choice’, paying no interest to users. They might have more facilities for integrating in a specific country, for e.g. offramps to bank accounts and similar facilities. But experience in dollarized economies such as Lebanon shows that people in conditions of deep institutional mistrust don’t actually hold their dollars in banks – out of a misapprehension about the local banks. They simply transact in US dollar cash with each other for goods and services, off the purview of the central bank and financial regulators in Lebanon. The same may well occur with fiat-backed competitors, who may shy away from greater transparency to prevent regulatory attacks. But if people choose to use them to transact amongst themselves, there is little that a regulator could feasibly do.
The pragmatic approach and the one that solves for the greatest amount of consumer welfare and positive prudential regulatory outcomes, is to recognize what stablecoins look like right now, and frame regulation around that instead. In fairness, lawmakers do seem to know how to get this right in some instances. For example, EU legislators recognize that crypto whitepapers play the role of prospectuses and MiCA recognizes them as such, adding new and arguably positive legal liability elements to explicit claims made in a whitepaper for example.
Decentralized or hybrid crypto/fiat stablecoins such as DAI have a role to play too, offering crypto-native guarantees to collateral backing and a native dollar currency to the burgeoning economy of crypto-native workers. Its inherent flexibility (in theory, DAI could be pegged to any asset, not necessarily USD) and its lack of a central issuer (each DAI is minted permissionlessly by users interacting with a smart contract) evades its classification as a fiat-backed e-money token. Of course, these systems can and must improve over time, but their roadmap to that improvement goes through greater resilience and transparent visibility into the backing.
Where decentralized stablecoins can self-regulate over time into becoming ‘the most transparent form of cash’, fiat-backed stablecoins need rational, data-driven regulation to enforce guarantees to users without wiping away all of the innovative benefits. Regulators opting to lean into old paradigms for regulating new things will find themselves enshrining incumbents at the expense of users, and may well still find themselves governing a small fiefdom as users choose otherwise around them.
Fortunately, some green shoots exist. As new, well-designed, fiat-backed stablecoins continue to emerge and grow, we can only hope that regulation will follow them conscientiously to allow their benefits to accrue to stablecoin users.
nb. Steakhouse Financial is a third-party signer to Mountain Protocol