Stablecoins classification and regulatory issues

10 April 2020

Stablecoins emerged over the past year as a revolutionary innovation not only within the virtual currency market; they could become a new mechanism for global commerce.

The idea behind the stablecoins is quite simple: provide people with benefits of convertible virtual currency, without the worry for volatility.

Stablecoin classification

The list of stablecoin projects is expected to grow. Even if it is hard to count all the live and pre-launched stablecoins available for investors, such coins are now more than 200 (for comparison purposes, today there are 180 currencies across the world recognised by the United Nations).

While new technologies are rapidly emerging, the eco-system has already identified several stablecoin types.

Fiat stablecoin

They are pegged against or collateralised by fiat currencies such as the US dollar or Euro in a fixed ratio (1 stablecoin = 1 euro). Examples of fiat stablecoins are TrueUSD, USD Tether, and USD Coin.

Crypto stablecoin

They are pegged against or collateralised by other virtual currencies. Amongst the others, MakerDAO and Bitshares fall within this category.

Commodity stablecoin

They are pegged against or collateralised by a commodity. The commodity can be metal, energy, livestock, or agricultural. Digix Global and HelloGold are some of the few examples of live commodity stablecoins.

Algorithmic stablecoin

They are not backed by any asset and utilise an algorithmically governed approach to expanding and contracting their supply (just like how a central bank prints or destroys money) with the primary objective to get the coin’s price as close as possible to USD 1. Examples of algorithmic stablecoins are Basis, Fragments, and Carbon.

Hybrid stablecoin

Hybrid stablecoins are generally pegged or collateralised by fiat first and then basket of assets later using an off-chain tokenised collateral. Reserve, Saga, and Aurora-Boreal are examples of this category.

Derivative-Backed stablecoin

They are on-chain or off-chain financial instruments used to protect investors and other members of the eco-system from price fluctuations, interest rate risk (inflation) and transfer risk through futures, forwards, swaps, or options.

Sovereign stablecoin

They are a quite controversial category of stablecoins, due to they be backed by and approved by a central bank or regulatory authority. In some cases (such as in countries like Cuba, Russia, China, Iran, North Korea, Venezuela) they an be used to fight inflation, combat trade wars, bypass economic embargos or sanctions. Further, it is well known that some national banks are looking at developing their own stablecoins to cut transaction costs.

Regulatory issues

It is a foregone statement to say that a robust regulatory framework is crucial for public trust and, conversely, the mass adoption of cryptocurrency in general and stablecoins in particular.

What are the facts and circumstances around the stablecoin issuance? What are the rights and obligations or parties involved in a transaction? Is stablecoin an advanced payment or a deposit, bailment, or a national principal contract, an opion or a warrant, a note or equity investment, or is it a multi-layered financial instrument? Stablecoin issuers and those who want to invest in stablecoins need to answer these questions.

The first issue usually addressed in many jurisdictions is whether stablecoins comply with securities and money service laws. Under the rules of some countries, fiat stablecoins do not meet the definition of a security, since their owners do not expect profit from them. Different arguments should be made about some algorithmic stablecoins, which may be better considered securities, given that someone who buys them might be expecting a profit. Similarly, commodity stablecoins may also be deemed an investment and therefore qualify as a security.

Within the EU, fiat stableoins may likely fall under the Electronic Money Directive, which defines electronic money as electronically, including magnetically, stored monetary value as represented by a claim on the issuer which is issued on receipt of funds for the purpose of making payment transactions […], and which is accepted by a natural or legal person other than the electronic money issuer.

Standard money transmission laws may also apply to stablecoins, which in the US and EU would entail abidance with anti-money laundering (AML) laws and licensing.

Furthermore, various consumer protection laws may also be relevant. Hence the importance of seeking the help of lawyers, accountants, advisors, and regulators before a stablecoin is launched (or even before considerable investments are made on it).

It is interesting to note that, in July 2018, Mr. Agustin Carstend, General Manager of the Bank of International Settlements (BIS), published a statement saying: My message to young people: stop trying to create money.

Many economists and central bankers for some time now have been highly critical of cryptocurrencies like Bitcoin, in large part due to its volatility, with some going so far as to jettison the term cryptocurrency from official speeches in favour of the term crypto-asset.

While volatile cryptourrencies are not viewed by many central bankers as a pressing competitive threat to their own national currencies, stablecoins of sufficient size and use may be deemed to pose greater direct competition to fiat currencies than Bitcoin and may, therefore, spark a competitive response or regulatory backlash from watchdogs, which in many jurisdictions have largely remained on the sidelines of cryptocurrency regulation to date.

At this stage, to look at where stablecoins are currently legally domiciled could be essential to identify friendly (or at least not adverse) jurisditions that could be home to new stablecoin projects.

For the time being, the leading legal domicile for stablecoins is the uS, followed by Switzerland, Australia, Cayman, and Jersey are legal homes for more than one project. The UK, Belgium, Estonia, Serbia, and Malta must be mentioned as potentially interesting jurisdictions in Europe.

Final thoughts

Cryptocurrencies are still in their infancy, and this is even more true with stablecoins.

Although their quantity and quality are rapidly improving, stablecoins as a new form of digital currency are still taking shape, and their maturity seems to be a still long term goal.

It is impossible to predict what the future holds for stablecoins, the world of Blockchain is moving at a fast pace and making predictions about it is the natural territory of visionaries and pioneers, not of technicians. In any case, it appears to be safe to assume that stablecoins will help bring cryptocurrencies as a whole to the mainstream.

As with all things, even within the financial space, each form of stableoin comes with its unique set of benefits and weaknesses, and to find the perfect one would be a wasted effort. But despite this, stablecoins are more than capable of being disruptive, both to businesses and individuals globally.

The many emerging stablecoins will have to experiment with these new paradigms to see what works and what doesn’t.

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