Coins on seesaw

New guidance indicates that the stablecoin market could be maturing, but there are still unanswered questions, putting that diagnosis in doubt. James King reports.

In July 2022, the Committee on Payments and Market Infrastructures (CPMI), a constituent body of the Bank for International Settlements, together with the International Organisation of Securities Commissions (Iosco) published guidance on the regulatory principles for systemically important stablecoins.

In particular, the two standard-setting bodies clarified the ways in which the Principles for Financial Market Infrastructures (PFMI), a key international regulatory standard, should apply to stablecoin arrangements. 

The new guidance advises that stablecoin arrangements – defined by the Financial Stability Board as instruments that combine different functions and that “purport to be used as a means of payment and/or store of value” – are akin to existing financial market infrastructures (FMI) in light of their core transfer function. As such, PFMI guidance will be applied to stablecoin arrangements, covering areas such as governance, risk-management frameworks, settlement finality and money settlements, mirroring the regulatory guidance for other FMIs including payment systems and central securities depositories.

As Iosco notes: “[The new] guidance is a major step forward in applying ‘same risk, same regulation’ to stablecoins, and extending the international standards for payment, clearing and settlement systems to cover systemically important stablecoin arrangements.”

A mark of maturity

It also represents an important but early milestone in the maturation of the stablecoin market. The guidance is published in the wake of a period of extreme turbulence for the wider digital asset sector. The collapse of TerraUSD in May 2022, in which the algorithmic stablecoin lost its US dollar peg, led to billions of dollars worth of investor losses and formed part of a wider meltdown in crypto assets – $1tn of value was wiped from the market over May and June. This turmoil has crystallised the need for regulation of the sector, particularly as links between the crypto ecosystem and traditional finance deepen over time. 

Yet, the CPMI/Iosco guidance applies to stablecoins exclusively in the context of their transfer function, meaning wider issues, including the ways in which reserve assets are handled by a stablecoin issuer, sit beyond the standard-setters’ remit. “The only [stablecoin function] directly within CPMI’s remit is the transfer function. But the point is you need to be sure that what is being transferred is actually worth something,” says Wendy Saunders, legal director and head of financial services regulatory, at law firm Lewis Silkin.

This underscores one of the key challenges facing regulators as they grapple with a swiftly maturing stablecoin market: how can the sufficiency of a stablecoin’s reserve assets be guaranteed? If a stablecoin is meant to be pegged to an external reference, such as the US dollar, it implicitly comes with the expectation that the coin can be redeemed at the value of the underlying asset on request. 

Risky reserve assets

As research from the US Treasury indicates, no standards exist in relation to the makeup of stablecoin assets. “Stablecoins differ in the riskiness of their reserve assets, with some stablecoin arrangements reportedly holding virtually all reserve assets in deposits at insured depository institutions or in US Treasury bills, and others reportedly holding riskier reserve assets, including commercial paper, corporate and municipal bonds, and other digital assets,” states the report.

The detail, in terms of the sufficiency of the reserve assets, isn’t spelt out anywhere

Wendy Saunders

Securing regulatory clarity on this issue will be vital. In the CPMI/Iosco guidance, it is noted that a systemically important stablecoin arrangement must present “little or no credit or liquidity risk”; yet reaching this determination requires rules that govern the status of reserve assets. Ultimately, this is likely to fall to national or regional regulators in the first instance, although neither the EU’s Markets in Crypto Assets proposal or the UK’s Financial Services and Markets Bill, for instance, tackle the issue in detail. 

“The crux of the problem hinges on the stabilisation mechanism and the reserve assets, and how you deal with the regulation and management of that. The detail, in terms of the sufficiency of the reserve assets, isn’t spelt out anywhere,” says Ms Saunders. 

Beyond this, enhanced regulatory frameworks must also be developed for the issuers and custodians of reserve assets, according to Ms Saunders, underlining the type of second order considerations that need to be addressed moving forward. “We’re still at an early stage because we don’t know how reserve assets and respective activities are going to be treated from a regulatory perspective,” she says.

This means that, even as global and national regulators are taking early steps to develop rules around the use of stablecoins, there is a long way to go before regulatory and market maturity will be achieved. 


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