Today IOSCO, the international association of securities regulators, and the BIS published a report on systemic stablecoins. Apart from reiterating that ‘same risks, same rules’ needs to apply, it provides guidance on identifying whether a stablecoin is systemic. And the bar is pretty high.
The paper also addresses some specific issues. Our reading of the governance guidance is it makes permissioned blockchains preferable, but we’re not clear whether public blockchains are impossible.
Systemic stablecoins must comply with the Principles of Financial Market Infrastructures (PFMI), a list of rules the largest financial institutions adhere to. And today’s guidance suggests how these might be applied stablecoins.
One of the most challenging issues is governance. And this is where you can see why the now-abandoned Libra / Diem initiative switched to a permissioned blockchain.
The guidance says there has to be human accountability, so the stablecoin arrangement must be owned and operated by one or more identifiable legal entities.
For any systemic stablecoin arrangement, it needs to be possible to have timely human intervention in a crisis. Consider that today the substantial stablecoins are operated through smart contracts on public blockchains. The IOSCO guidance considers immutable smart contracts too inflexible in a crisis because it’s simply impossible to address every eventuality code. They have a point. However, there are a few caveats.
The challenge is how you address this. The paper says that the algorithm should be capable of being adjusted when needed. It doesn’t go into detail, raising the question of whether it’s viable on public blockchains.
On a permissioned blockchain, it’s simple. You contact the operators of the nodes and tell them to upgrade. Again, shades of Diem.
But actually, you CAN change a smart contract on a public blockchain. The concept of upgradeable smart contracts came about to address these sorts of issues. Not so much in an emergency, but simply to upgrade them. If you’re curious, there are some tech details here and here.
Whether you’d want to change a smart contract on a public blockchain at short notice is an entirely different issue. We hear on a daily basis how hackers uncover bugs in smart contract code that let them steal money. The fact that smart contracts are updated only occasionally on public blockchains is a good thing. Because they really need to be battle-tested and audited. If you’re talking about a systemic stablecoin, then even more so.
But the other issue relates to governance. The paper states that the stablecoin’s governance must allow for timely human intervention. In other words, there’s no time to consult some decentralized governance mechanism. Management needs to make quick decisions. That of course is the antithesis of public blockchain. However, let’s face it, all fiat-backed stablecoins are entirely centralized.
An even trickier issue is the IOSCO guidance observes that in today’s stablecoins, some aspects are out of control of the stablecoin issuer. Like the operation of the blockchain. This is where it’s unclear if they are ruling out public blockchains in the paragraph below:
“The SA’s (stablecoin arrangements) ownership structure and operation allow the SA to observe Principle 2 (governance) and the other relevant principles of the PFMI irrespective of the governance arrangements of other interdependent functions.”
Novel stablecoin features
There’s a lot more to analyze, but moving on. The BIS/IOSCO paper compares stablecoins to other financial market infrastructures (FMIs) and finds stablecoins to have four novel features. Settlement is neither through central bank nor commercial bank money. There are greater interdependencies between different stablecoin functions. In fact, some of those functions, such as issuance, redemption and stabilization are novel in themselves. Governance and operations might be decentralized. And stablecoins use emerging technologies such as blockchain or DLT.
No systemic stablecoins yet
In a speech yesterday, Sir Jon Cunliffe observed that no current stablecoins comply with the PFMI. Cunliffe is the Chair of the BIS Committee on Payments and Market Infrastructures (CPMI) and Deputy Bank of England Governor.
Based on today’s paper, we’d also conclude that no current stablecoin would be considered systemic.
“Recent developments in the cryptoasset market have again brought urgency for authorities to address the potential risks posed by cryptoassets, including stablecoins more broadly,” Cunliffe said today. “They underline the speed with which confidence can be eroded and how
volatile cryptoassets can be. Such events could become systemic in the future.” And he highlighted growing linkages with traditional finance.