Stablecoins – What Are They?

Stablecoins are blockchain-based digital assets, or cryptocurrencies, that are designed to maintain a stable value relative to a national currency (“Reference Fiat”) and sometimes to other assets such as precious metals like gold or silver, or in some cases, other digital assets (“Reference Asset”). For instance, USD Tether (or USDT) is a stablecoin that is ‘pegged’ against the US dollar and is intended to have a 1:1 exchange ratio with USD (1 USDT = $1 USD).

Issuers typically attempt to achieve price stability for fiat-based stablecoins by maintaining a certain amount of the Reference Fiat or Reference Asset in reserve for stablecoins issued (e.g. $1 USD held in reserve for every 1 stablecoin issued), allowing users the right to redeem their stablecoin for the Reference Fiat in accordance with the peg (i.e. users can exchange 1 USDT for $1 USD).

Stablecoins utilize the strengths of blockchain technology – allowing for faster, cheaper, and more secure transactions than their fiat alternatives – while also offering the stability of their Reference Fiat or Reference Asset to an otherwise volatile cryptocurrency market.

According to the Report, the use of stablecoins has increased by nearly 500% over the last 12 months. The market capitalization of the largest stablecoin issuers exceeded $127 billion as of October 2021. The Report notes that stablecoins are predominantly used in the US to facilitate the trading, lending, and borrowing of other digital assets and allow market participants to engage in speculative digital asset trading.

Risks Posed by Stablecoins

The Report identifies several risks that stablecoins and their issuers pose to capital markets. These risks include:

• User Protection and Run Risk: The stability of stablecoins depends on the public’s confidence that they can, at any point, redeem their stablecoin for its Reference Fiat or  Reference Asset. The mere prospect of a stablecoin not performing as expected could result in a “run” on that stablecoin, causing an escalating drop in the value of the stablecoin as holders scramble to sell their coins. Runs could spread contagiously from one stablecoin to another, or to other types of financial institutions, which could in turn pose systemic risk to the broader economy.  
• Payment System Risk: Much like their fiat counterparts, stablecoins are also subject to operational risk (i.e. risk that deficiencies in information systems or internal functions or external events may result in a disruption of service), settlement risk (i.e. risk that settlement will not occur as expected), and liquidity risk (i.e. risk that there would be temporary shortages in the reference asset’s supply).
• Systemic Risk and Concentration of Economic Power: The possibility of a single stablecoin issuer rapidly scaling up may pose anti-competitive risks (i.e. risk that an issuer of a widely adopted stablecoin disincentivizes the use of other payment systems), excessive concentration of economic power risk (i..e. risk that a stablecoin issuer or wallet provider combines with a commercial firm), and systemic risk (i.e. risk that failures of that entity may adversely affect broader financial markets).

Stablecoins in the United States are not currently subject to a consistent set of regulations that address the above risks.  

Recommendations

The Report recommended some of the following areas for legislation in response to the risks posed by stablecoins:

• User Protection and Run Risk: Legislation should require stablecoin issuers to be insured depository institutions, which are subject to appropriate supervision and regulation, at the depository institution and the holding company level.1
• Payment System Risk: Legislation should require custodial wallet providers to be subject to appropriate federal oversight. In addition, Congress should provide the federal supervisor of a stablecoin issuer with authority to require any entity that performs activities critical to the functioning of the stablecoin arrangement to meet appropriate risk-management standards.
• Systemic Risk and Concentration of Economic Power: Congress should enact regulations that limit a stablecoin issuer or custodial wallet provider’s affiliation with commercial entities. In addition, federal supervisors should have the ability to implement standards to promote interoperability among stablecoins and regulate other anti-competitive activities of widely adopted stablecoin issuers.  

It is important to keep in mind that some of the activities of stablecoin issuers, custodial wallets, and other entities involved in facilitating stablecoin transactions may also fall within the purview of financial regulators such as the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC). The recommendations made in the Report are meant to supplement and not replace or override the involvement of such regulators.

What This Means

To the extent that Congress follows the general spirit of the Report, market participants can expect a much more tightly regulated stablecoin space – where stablecoin issuers are treated like quasi-banks subject to significant government oversight. This may slow innovation and increase costs but also provide stability and certainty to a burgeoning section of our current financial markets.  

Canadian Context

Canadian regulators have remained largely silent on how stablecoins may be treated.  

There is some indication that securities regulators, at least in Ontario, feel negatively towards the most popular stablecoin, Tether (USDT). As a condition to the temporary exemptive relief granted to crypto asset trading platforms Wealthsimple and Coinberry, the Ontario Securities Commission prohibited the trading of USDT.  

Although the OSC’s decision may have been driven by Tether’s ongoing dispute with the SEC, this nonetheless indicates the SEC’s influence over Canadian securities regulators and signals that Canadian regulators may be looking to focus their attention on stablecoins in the near future.

We expect that the Report and any ensuing US legislative change may provide a roadmap of how Canadian lawmakers may regulate the stablecoin space.

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