Today the Financial Stability Board (FSB) published a 67-page document analyzing global stablecoins – such as Facebook’s Libra – and inviting a response to its consultation until July 15.
Last year the G20 asked the FSB to explore regulatory issues re stablecoins. Additionally, the IMF is assessing macroeconomic issues for IMF member countries, and the Financial Action Task Force (FATF) is investigating compliance with anti money laundering and counter terrorism financing (AML/CTF).
Per the G20 brief, the FSB paper doesn’t address issues of monetary policy, monetary sovereignty, currency substitution, data privacy, competition and taxation.
However, it does explore the potential vulnerabilities of stablecoins and the risks to financial stability.
Risks to financial stability
Concerning risks, emerging markets and developing economies (EMDE) are of particular concern. That may, in part, be because it is these jurisdictions that have an appetite for any form of digital currency. The FSB states that in EMDEs there is a higher likelihood of a global stablecoin becoming a mainstream store of value.
If a stablecoin is not sufficiently stable, it could affect spending decisions in EMDE’s and operational disruptions could impact economic activity. In the case where financial institutions play a role within a global stablecoin, this could be a source of risk to those institutions.
In times of distress, there could be a flight from a local EMDE currency to a global stablecoin, which might impact exchange rates and domestic bank funding.
The extent of the risk depends on the stablecoin’s functions, how widely it’s adopted, and the degree of connectedness with the banking system.
Apart from financial stability, the stablecoins themselves have aspects that make them fragile.
Because of their link to underlying assets, stablecoins are vulnerable to financial risks: market, liquidity and credit risks. If there was a mass redemption, could the underlying asset be redeemed close to market prices, or is there a risk of a fire sale? Also, if there’s a change in the makeup of the reserves, might this impact the wider markets given the potential large scale?
There are also risks if market makers or resellers withdraw from providing liquidity for stablecoin trading. This could have a knock-on effect on user confidence and trigger more redemptions.
The second group of vulnerabilities relates to the governance, operation, and design of the stablecoin. There could be a technical or design defect in the ledger, a cyber incident, or an issue with a custodian.
Any ambiguity about coin holder rights could magnify a loss of confidence.
And the third group of vulnerabilities relates to wallets used to store private keys and exchanges used to trade coins. If one of them has an incident, the impact on users will depend on the market share of the wallet or exchange and their operational resilience.
The FSB made ten recommendations, summarized below. In relation to global stablecoins they:
- should be comprehensively regulated and supervised
- should be regulated in proportion to the risks
- should be regulated internationally through jurisdiction coordination to prevent gaps in oversight
- have governance frameworks which are comprehensive and identify accountability
- have effective risk management for reserves, operational resiliency, cybersecurity, AML/CFT
- have robust systems for safeguarding, managing, storing data
- have recovery plans
- provide transparent information about functions including any stabilization mechanism
- provide legal clarity on the enforceability of redemption rights
- meet all regulatory, supervisory and oversight requirements of any jurisdiction before operating
While the paper did not explore other issues, yesterday we wrote about potential antitrust issues with Libra. An interesting issue is the role of regulators and their impartiality, given they, in some respects, are regulating the competition.