## Regulating the Crypto Ecosystem: The Case of Stablecoins and Arrangements ## Source details **Canonical URL:** [Regulating the Crypto Ecosystem: The Case of Stablecoins and Arrangements](https://www.imf.org/-/media/files/publications/ftn063/2022/english/ftnea2022008.pdf) ## Other formats - [Markdown version](/-/media/files/publications/ftn063/2022/english/ftnea2022008.pdf.md) - [Structured JSON version](/-/media/files/publications/ftn063/2022/english/ftnea2022008.pdf.json) --- ### Definition, scope, and focus - Stablecoins are crypto assets that aim to maintain a stable value relative to a specified asset or a pool or basket of assets. - Focus of this note: - Stablecoins with a face value denominated in a monetary unit of account (for example, the US dollar) and backed by financial assets (for example, high-quality bonds). - Algorithmic stablecoins may have no backing assets. - Key functional uses if nominal stability is ensured: - Means of payment (including cross-border). - Store of value. - Competition with bank deposits, cash, or central bank digital currency (CBDC). ### Recent developments and systemic linkages - Market and DeFi size and dynamics: - Market capitalization quadrupled in 2021. - Market capitalization reached a peak of over $175 billion in December 2021 before falling to less than $160 billion by mid-2022. - DeFi grew to around $100 billion by December 2021 before falling significantly in 2022. - Usage patterns and risks: - Dollar-denominated stablecoins are growing in popularity in emerging market and developing economies as a potential store of value and hedge, raising risks of dollarization and cryptoization. - Higher volatility correlation observed between stablecoins and stock markets, especially during recent market stress periods. - Involvement of large financial institutions in reserve management, custody, and issuance can rapidly generate new risks and increase contagion between traditional finance and the crypto ecosystem. ### Key regulatory principles and global coordination - Need for standards: - Comprehensive, consistent, and coordinated global standards required for effective crypto regulation and supervision, especially for stablecoins and their ecosystem. - The Financial Stability Board (FSB) is identified as well placed to coordinate and establish global standards, taking into account sector-specific standards by other standard setters. - Design principles for any global regulatory framework: - Comprehensive, risk-based, and flexible. - Designed to provide a level playing field. - Adequately cover all entities carrying out core functions, including issuers and crypto asset service providers (for example, wallets, exchanges, and reserve managers). - Regulatory approach: - Focus on structural features and economic functions rather than terminology or marketing. - Apply “same activity, same risk, same regulation” where components perform economic functions equivalent to traditional financial instruments and intermediaries. ### Risk-based tailoring of regulation (examples) - Payment-style stablecoins (face value in a monetary unit and redeemable on demand): - Should be fully backed in perfectly safe and liquid assets; regulation might take cues from e-money frameworks. - Where widely used, requirements might be similar to those in bank regulation. - Stablecoins redeemable within an elapsed time: - May be backed by safe but less liquid assets. - Stablecoins redeemable at going market value (or in kind): - May hold riskier assets; regulation may draw on money market fund (MMF) frameworks, including constant net asset value considerations. - Issuers and intermediaries should clearly disclose and explain structural features to end users. ### Core functions and regulatory coverage across the ecosystem - Three key functions to consider: 1. Issuance, redemption, and stabilizing mechanisms (issuers, reserve assets, custodians, market makers, governance). 2. Transfer (network, network validators, operators). 3. Access (wallets and exchanges). - Regulatory objectives and risks to address: - Financial stability (run/liquidity risk; interlink with wider financial sector and DeFi; currency substitution and bank disintermediation). - Consumer protection (misleading disclosures; inappropriate use of client assets; conflicts of interest; use of leverage). - Credit, market, and liquidity risks. - Operational and cyber-resiliency risks. - Market integrity and concentration risks. - Coverage should be proportionate to arrangement structure and country circumstances. ### Domestic implementation considerations - Practical domestic responses depend on resources, existing legal/regulatory structures, and timeframe. - Essential domestic choices: - Consider efficiency and effectiveness given country circumstances; narrowing issuers to already regulated entities may be expedient but requires attention to interconnectedness, spillovers, and competition. - If unregulated/underregulated entities perform ecosystem functions, bespoke regulation or revised frameworks must ensure licensing/authorization, clear criteria, designated responsible authorities, and coordination mechanisms. - Apply “same risk, same activity, same regulation” and proportional supervision; novel technology may require same regulatory outcomes rather than identical rules. - If issuers become systemically important, apply requirements comparable to those for systemically important banks (more intensive supervision, safety and soundness, stress testing, recovery, and resolvability), considering differences in business models. - Consider access to the financial safety net when stablecoins reach systemic scale or when commercial banks issue tokenized deposits, subject to safeguards. ### Cross-border and monetary implications - Stablecoins are inherently cross-border and can be denominated in one currency but used where a different unit of account prevails. - Issuers headquartered in one jurisdiction may market services globally, affecting capital flows and monetary independence. - Dollar-denominated stablecoins held in emerging markets and developing economies can accelerate dollarization or cryptoization, affecting monetary policy transmission. ### Interim measures and enforcement considerations - Where risks are growing quickly, authorities should take immediate action using existing powers, guided by international standards, focusing on vulnerabilities such as wallets, exchanges, and financial institutions’ exposures. - Where stablecoins generate systemic risk, applicable regulatory requirements should reflect their main risks and economic functions, aligned with rules for similar products. - Broad restrictions or bans may be attractive short term but can be disproportionate and difficult to enforce and should not be seen as permanent. - Authorities should address drivers of stablecoin use, such as weak macroeconomic conditions or unmet digital payment needs. ### Table of regulatory recommendations (summary highlights) - Financial Stability - Most Salient Risks: Run/liquidity risk; interlink with wider financial sector and DeFi; currency substitution and bank disintermediation. - Regulatory Consideration: Prudential requirements to address mismatches; concentration limits; cross-border cooperation; compliance with PFMI (for designated and global stablecoin arrangements). - Consumer and Investor Protection - Most Salient Risks: Misleading disclosures; inappropriate use of client assets; conflicts of interest; use of leverage. - Regulatory Consideration: Disclosure and audit requirements; segregation of the reserve assets and restriction of the reuse of reserve assets; implementation of IOSCO recommendations on crypto trading platforms; limits or restrictions on the use of leverage. - Operational and Cyber-Resiliency - Most Salient Risks: Operational failures; cyberattacks. - Regulatory Consideration: Requirements for robustness, resiliency, and integrity of operating systems; segregation of clients’ private keys in cold wallets; compliance with the PFMI where applicable. - Financial Integrity - Most Salient Risks: AML/CFT. - Regulatory Consideration: Adopt Financial Action Task Force standards. - Embracing Potential While Managing Risks - Most Salient Risks: Lack of sufficient powers or scope of regulatory authorities; lack of regulatory resource and expertise. - Regulatory Consideration: Legislative change to empower regulators; authorities to determine legal classification of stablecoins. ### Introduction — scope and rationale (selected facts) - The FSB defines stablecoins as crypto assets that aim to maintain a stable value relative to a specified asset or a pool or basket of assets. - Stability hinges on effectiveness of stabilization mechanisms and issuer’s means to honor redemption. - Market facts: - Stablecoin trading volumes outpaced those of all other crypto assets during the rapid growth phase in 2021. - Stablecoins are the “currency” of DeFi and enable other services. - DeFi appears largely used by a small number of institutional entities (anecdotal evidence points to market makers and hedge funds). ### The stablecoin ecosystem: components and risks - Core components by function: - Issuance: stablecoin issuers, reserve assets, custodians, market makers, governance bodies. - Transfer: network, network operators, validators. - Access: wallets and exchanges. - Exchanges can act as underwriters, distributors, redemption gates, and market makers; they perform off-chain transfers and often host wallets. - Key risks: - Issuance: liquidity mismatch and run risk; legal uncertainty; governance weaknesses; consumer protection; concentration of economic power. - Transfer: governance, operational resilience, cyber-resilience, safety and integrity. - Access: financial integrity, consumer protection, data privacy, cybersecurity. ### Stability/run risks, issuance, and reserves (selected requirements and empirical details) - Legislative and regulatory recommendations: - Require stablecoin issuers to be insured depository institutions subject to supervision and regulation (including capital, liquidity, and resolution requirements) and eligible for Federal Reserve emergency liquidity (where applicable by jurisdictional policy choices). - Require federal oversight over stablecoin issuers and custodial wallet providers to address payment system risk. - Require entities performing critical functions to meet appropriate risk-management standards. - Introduce restrictions and interoperability standards to address concentration of economic power. - Consider FSOC designation of certain activities as systemically important if Congress does not act. - Reserve risks and disclosures: - Reserve composition risks where assets are insufficient, risky, illiquid, opaque, or concentrated. - Some issuers hold risky assets including commercial paper; incentives to invest in higher-risk assets can arise from search for yield or conflicts of interest. - Many major issuers (including Tether, Circle, and Binance) are yet to release audit reports regularly by independent auditors. - Concentration of reserves in a few commercial banks is common. - Empirical details on Tether (issuer examples and supervisory findings): - Tether has reached a market capitalization of over $60 billion. - The issuing entity is domiciled in the British Virgin Islands and is largely unregulated; Tether is not available to US households and firms. - The Commodity Futures Trading Commission identified that Tether held sufficient fiat reserves for only 27.6 percent of the days in a 26-month sample period from 2016 through 2018 and imposed civil monetary penalties in October 2021. - Recent disclosures (end of March 2022) show only 6 percent of Tether is backed by cash. - Exposures to commercial paper and MMF are high at 28 percent and 10 percent, respectively. - The issuer increased their liquidity by holding US treasury bills which account for 56 percent. - Liquidity and contagion risks: - Greater use of stablecoins could trigger fire sales of collateral assets in stress, impacting banks and bond markets. - Collapse in price or trust could trigger redemptions and pressure on short-term credit markets. ### Failures of algorithmic stablecoins — TerraUSD (UST) case study (key facts and timeline) - UST was the third largest stablecoin and the largest algorithmic stablecoin (market cap at $18 billion before the crash). - Key events: - Initial stress event: a $2.5 billion UST withdrawal from Anchor on May 8. - On May 8, $150 million in UST liquidity was removed from Curve3Pool ahead of testing an upgrade to Curve4Pool. - Large swaps to other stablecoins occurred (largest swap $85 million), leaving the liquidity pool unbalanced. - Stabilization protocol maintained peg within 200 basis points for one day but panic selling outran the stabilization mechanism. - UST depegged on May 9 and entered a death spiral; supply of LUNA increased exponentially attempting to repeg UST, increasing selling pressure on LUNA. - By May 16: - UST price dropped to $0.16. - LUNA price fell from over $80 to $0.0002. - Luna Foundation Guards (LFG) sold $2 billion worth of bitcoin in defense; bitcoin price sharply fell by $2,000 right before UST first materially depegged. - Tether also dropped below its peg on secondary markets during the turmoil. - Vulnerabilities and design lessons: - Algorithmic designs depend heavily on market confidence and market-making; reliance on DEX liquidity made UST particularly vulnerable. - Governance opacity and unclear reserve deployment worsened crisis response. - Redemption designs reliant on third parties can amplify run risks; examples of limited direct redemption: - Tether allows direct redemptions only for requests larger than $100,000. - USD Coin (USDC) limits redemption rights to institutional investors. - Regulatory considerations include segregation of end-user assets in supervised regulated entities, reserve adequacy and transparency, legal clarity, audits, custodian independence, and recovery/resolution planning. ### Lessons from MMF and e-money frameworks - MMF-style rules applicable where stablecoins do not pledge redemption at par and on demand: - Disclosure, audit, governance, investment limits (credit quality), maturity limits, diversification, and redemption restrictions. - Liquidity management tools (redemption gates, in-kind redemptions) can address first-mover advantage but may not suit retail payment use-cases. - E-money frameworks applicable for immediate redeemability: - Segregation and ring-fencing of reserve assets; deposit into commercial bank trust/escrow or central bank; insurance or guarantee where segregation not required; certainty of end-user claims. - E-money–style minimum and ongoing capital charges and investment limits may be relevant. - Tailoring required given pseudonymity of holders and novel technology. ### Deposit insurance considerations (summary) - International standard setters have yet to issue guidance on whether asset-backed stablecoins should be covered by deposit insurance. - PWG (US) recommended payment stablecoins backed by fiat be subject to prudential framework requiring issuers to be “insured depository institutions.” - Preconditions for DIS coverage: - DIS members must be well regulated and supervised. - Extending deposit insurance to unregulated stablecoins backed by illiquid reserves could create moral hazard. - Operational challenges exist for applying DIS to DLT-based arrangements (for example, identifying users to reimburse). - Preliminary conclusions: - Stablecoins with less-liquid reserve assets or used mainly for investment should not be insured. - Tokenized deposits issued by commercial banks that meet prudential requirements could be covered. - Nonbank-issued stablecoins used primarily for payment purposes may not warrant deposit insurance unless systemic. ### Application of PFMI to stablecoin arrangements (selected guidance) - CPMI-IOSCO guidance applies to systemically important stablecoin arrangements (SAs) considered as FMIs; systemically important payment SAs should observe relevant PFMI principles. - Selected PFMI principles and implications: - Governance (Principle 2): appropriate governance, clear lines of responsibility, timely human intervention. - Comprehensive risk management (Principle 3): regular review of material risks across functions and appropriate mitigants. - Settlement finality (Principle 8): clear and certain final settlement; define point of irrevocability; legal basis supporting finality. - Money settlements (Principle 9): stablecoins used for money settlements should have little or no credit or liquidity risk; clarity of legal claims; sufficiency and liquidity of reserve assets; timely convertibility into other liquid assets. - Challenges highlighted: - Governance complexity due to software automation. - Settlement finality uncertainty from probabilistic settlement on DLT. - Counterparty and asset risks if settlement uses privately issued money. - Interdependent functions and concentration risks; interoperability issues. - Regulatory considerations: - Authorization/licensing with robust conditions (governance, safeguarding user funds, incident procedures, security, business continuity, AML/CFT compliance). - Risk-management frameworks including legal, credit, liquidity, operational resilience, third-party risk, and AML/CFT risks. - Legal alignment on finality and enforceability across jurisdictions. - Proportionate application for nonsystemic arrangements and standards to promote interoperability. ### Cybersecurity, access, and wallets - Cyber- and operational risks permeate all functions and components of the ecosystem. - Wallets and exchanges provide user interfaces and are vulnerable to custodial, operational, and concentration risks. - If wallets are used for payment purposes, they may be subject to additional regulations applicable to electronic payment instruments. - Oversight frameworks (for example, Eurosystem’s PISA) provide models for proportional oversight based on importance and potential risks. ### Conclusion — role, risks, and policy architecture - Potential benefits if regulated: - Reduce costs of cross-border remittances. - Complement and improve payments infrastructure. - Provide competition in the payments space. - Generate efficiencies for wholesale/back-end functions among large, regulated entities. - Risks without robust regulation: - Significant consumer, market, and financial-stability risks. - Heightened where reserve compositions are complex, less liquid, or opaque and where key participants (wallets, exchanges) are underregulated. - Recommended regulatory architecture: - Intense monitoring and a targeted approach across all actors (issuers, wallets, exchanges, network providers, governance bodies, reserve managers). - Combination of conduct, payment, and prudential regulation drawing cues from commercial banking, e-money, FMIs, and MMFs. - Follow "same risk, same regulation" by focusing on functions and risks to ensure licensing and authorization. - Consider unique technology-related risks and apply proportionate supervisory approaches where necessary. - Cross-border coordination and standards: - Data availability and extraterritorial oversight are common challenges; international coordination is essential to prevent a race to the bottom. - The FSB should take a leading role in coordinating across sectoral standard-setting bodies. - Home authorities need to coordinate with other relevant authorities where users are located. - IMF staff are actively contributing to SSB activities to facilitate development and implementation of robust international standards. *International Monetary Fund — Fintech Notes: Regulating the Crypto Ecosystem: The Case of Stablecoins and Arrangements (ftnea2022008).* ### Executive Summary ...................................................................................................... ### Executive Summary ### Definition, scope, and focus - Stablecoins are crypto assets that aim to maintain a stable value relative to a specified asset or a pool or basket of assets. - To achieve stability, assets backing stablecoins are usually held. - This paper focuses on stablecoins with a face value denominated in a monetary unit of account, such as the US dollar, and backed by financial assets, such as high-quality bonds. - In the case of algorithmic stablecoins there may be no backing assets. ### Recent developments and systemic linkages - Stablecoins have experienced periods of rapid growth, which also accelerated links between traditional finance and the crypto ecosystem. - In 2021, the market value of stablecoins quadrupled in conjunction with the rise of decentralized finance (DeFi), although it has since fallen in line with the broader crypto market. - Dollar-denominated stablecoins are growing in popularity in emerging market and developing economies as a potential store of value and hedge against inflation and exchange rate volatility, raising risks of dollarization and cryptoization. - Higher volatility correlation has been observed between stablecoins and stock markets, especially during recent market stress periods. - The involvement of large financial institutions in reserve management, custody, and issuance can rapidly generate new risks. - Without proper regulation, contagion risks between traditional finance and the crypto ecosystem will increase. ### Key regulatory principles and the need for global coordination - Comprehensive, consistent, and coordinated global standards are required to achieve effective crypto regulation and supervision, especially for stablecoins and their broader ecosystem. - The Financial Stability Board (FSB) is identified as well placed to take the lead in coordinating and establishing global standards to support national regulation of crypto assets, including stablecoins, and their ecosystem (or “arrangements”), taking into account sector-specific standards developed by other standard setters. - Any global regulatory framework for stablecoins should be: - Comprehensive, risk-based, and flexible. - Designed to provide a level playing field. - Adequately covering all entities carrying out core functions, including issuers and crypto asset service providers (for example, wallets, exchanges, and reserve managers). - Regulation should look beyond terminology and marketing to structural features and economic functions, noting that a stablecoin’s intended issuance purpose may differ from its primary use across jurisdictions. ### Risk-based tailoring of regulation (examples) - Stablecoins denominated in a monetary unit of account and offering redemption into cash on demand—likely to be used for payments—should be fully backed in perfectly safe and liquid assets; regulation might take its cue from e-money frameworks. Where a stablecoin becomes widely used, requirements might be similar to those in bank regulation. - Stablecoins offering redeemability within an elapsed time may be backed with safe but less liquid assets. - Stablecoins offering redemption at the going market value of the underlying assets (or in kind) may hold riskier assets (for example, a tokenized bond). In these cases, regulation may draw on that for money market funds (MMFs), including from constant net asset value funds. - Issuers and intermediaries should clearly disclose and explain the structural features of their offering to end users. ### Core functions and regulatory coverage across the ecosystem - The stablecoin ecosystem should be considered across three key functions: 1. Issuance, redemption, and stabilizing mechanisms (issuers, reserve assets, custodians, market makers, governance). 2. Transfer (network, network validators, operators). 3. Access (wallets and exchanges). - Key elements of the regulatory framework should address: - Financial stability. - Consumer protection. - Credit, market, and liquidity risks. - Operational and financial risks. - Market integrity and concentration risks. - Depending on arrangement structure and country circumstances, necessary regulatory adjustments will differ. ### Domestic implementation considerations - The note is not prescriptive on legal denominations or design but provides key elements that should feature in any regulatory arrangement. - Global standard setting bodies (SSBs) recognize that components of stablecoin arrangements may perform economic functions equivalent to traditional financial instruments and intermediaries; application of “same activity, same risk, same regulation” is relevant. - Practical domestic responses will depend on available resources, existing legal and regulatory structures, and timeframe; novel technology may require same regulatory outcomes rather than identical rules. - Essential domestic choices include: - Authorities should consider the most efficient and effective approach given the country’s circumstances; narrowing issuers to already regulated entities may be expedient but requires attention to interconnectedness, spillovers, and competition issues. - Where unregulated/underregulated entities are allowed to perform ecosystem functions, bespoke regulation or revised frameworks must ensure licensing or authorization, clearly articulated criteria, designated responsible authorities, and well-defined coordination mechanisms. - Regulation, supervision, and oversight should be proportional to risks and adhere to “same risk, same activity, same regulation,” while considering novel technology risks. - If issuers become systemically important, apply requirements comparable to those for systemically important banks (more intensive supervision, safety and soundness, stress testing, recovery, and resolvability), considering differences in business models, especially where stablecoins do not offer maturity transformation. - Access to the financial safety net could be considered when stablecoins reach systemic scale and when commercial banks issue their own stablecoins or tokenize their deposits, subject to safeguards. ### Cross-border and monetary implications - Authorities must coordinate domestically and globally to address risks, as stablecoins are inherently cross-border and may be denominated in one currency but used in markets with a different unit of account. - Issuers headquartered in one jurisdiction may market services globally, leading to capital flow and monetary independence issues. - Dollar-denominated stablecoins held in emerging markets and developing economies can accelerate dollarization or cryptoization. ### Interim measures and enforcement considerations - In markets where risks are growing quickly, authorities should take immediate action using existing powers, guided by international standards, focusing on vulnerabilities such as wallets, exchanges, and financial institutions’ exposures. - Where stablecoins generate systemic risk, applicable regulatory requirements should reflect their main risks and economic functions, with rules aligned to those of similar products. - The alternative of restricting certain uses of stablecoins or imposing complete bans may be attractive short term but can be disproportionate and difficult to enforce; such measures should not be seen as permanent because of incentives and technological alternatives for circumvention. - Authorities should address drivers of stablecoin use, such as weak macroeconomic conditions or unmet digital payment needs. ### Table of regulatory recommendations (summary of policy objectives, risks, and regulatory considerations) - Financial Stability - Most Salient Risks: Run/liquidity risk; Interlink with wider financial sector and DeFi; Currency substitution and bank disintermediation. - Regulatory Consideration: Prudential requirements to address mismatches; Concentration limits; Cross-border cooperation; Compliance with PFMI (for designated and global stablecoin arrangements). - Consumer and Investor Protection - Most Salient Risks: Misleading disclosures; Inappropriate use of client assets; Conflicts of interest; Use of leverage. - Regulatory Consideration: Disclosure and audit requirements; Segregation of the reserve assets and restriction of the reuse of reserve assets; Implementation of IOSCO recommendations on crypto trading platforms; Limits or restrictions on the use of leverage. - Operational and Cyber-Resiliency - Most Salient Risks: Operational failures; Cyberattacks. - Regulatory Consideration: Requirements for the robustness, resiliency, and integrity of operating system; Segregation of the client’s private keys in cold wallets; Compliance with the PFMI where applicable. - Financial Integrity - Most Salient Risks: AML/CFT. - Regulatory Consideration: Adopt Financial Action Task Force standards. - Embracing the Potential of Stablecoins While Managing Risks - Most Salient Risks: Lack of sufficient powers or scope of regulatory authorities; Lack of regulatory resource and expertise. - Regulatory Consideration: Legislative change to empower regulators; Authorities to determine legal classification of stablecoins. *International Monetary Fund — Fintech Notes: Regulating the Crypto Ecosystem: The Case of Stablecoins and Arrangements (Executive Summary).* ### Introduction ### Introduction ### Scope - The FSB defines stablecoins as crypto assets that aim to maintain a stable value relative to a specified asset or to a pool or basket of assets. - Stablecoins could be backed by: - a monetary unit of account such as the dollar or euro, - a commodity such as gold, - or a currency basket. - Stability implication: - "The value of a stablecoin, as expressed against the asset to which it is pegged, would need to be stable if it is to be redeemed at par, in cash immediately, and at all times." - "Much hinges on how effective the stabilization mechanisms are and whether a stablecoin issuer has the means to honor a redemption request." - "Some stablecoins may be far from stable." - Focus of this note: - Stablecoins with a face value linked to a commonly used monetary unit of account and backed by financial instruments (for example, dollar-backed stablecoins). - These are used primarily in crypto asset markets to access other crypto assets across different exchanges and are growing especially rapidly as a means of generating yield in DeFi applications. - Potential uses if nominal stability ensured: - Means of payment, including across borders. - Store of value. - Competition with bank deposits, cash, or central bank digital currency (CBDC). - Foreign currency stablecoins could lead to currency substitution if used as a store of value and means of payment in countries with weak currencies. - Purpose: - Help regulators and supervisors identify key challenges and risks, providing high level guidance for designing regulatory and supervisory approaches. - Relationship to other IMF work: - Builds on Regulation of Crypto Assets (Cuervo and others 2020) and is a companion to Regulating the Crypto Ecosystem: The Case of Unbacked Crypto Assets (Bains and others 2022). - Part of a broader set of IMF publications focused on crypto assets and digital money. ### Why Stablecoin Regulation Matters - Market growth and scale: - Market capitalization quadrupled in 2021. - Market capitalization reached a peak of over $175 billion in December 2021 before falling to less than $160 billion by mid-2022. - DeFi grew to around $100 billion by December 2021 before falling significantly in 2022. - Role in crypto markets: - Stablecoin trading volumes outpaced those of all other crypto assets during the rapid growth phase in 2021, primarily because they are usable for settlement of spot and derivative trades across crypto asset platforms without converting to fiat currencies. - Stablecoins are the "currency" of DeFi and enable other services. - DeFi characteristics and centralization: - DeFi aims to provide financial services without centralized financial entities, although centralization exists to varying degrees (admin key and governance token holders provide an avenue of centralization). - DeFi operates on permissionless blockchains using programmed smart contracts for automatic execution of transactions. - GFSR observation: DeFi seems largely used by a small number of institutional entities (anecdotal evidence points to market makers and hedge funds; many protocol developers funded by venture capitalists, especially in advanced economies). - Potential systemic and cross-border implications: - Stablecoins supported by high-quality and liquid reserves could become a stable store of value and a credible means of payments. - Absent robust regulatory frameworks, prudential, conduct, and payment system–related risks will increase across the stablecoin ecosystem, potentially leading to instability. - Stablecoins could be used as a hedge against inflation and weak currencies in emerging markets and developing economies and exacerbate currency substitution. - Involvement of BigTech could lead some stablecoins to be systemic at launch or quickly scale, leveraging large consumer bases and network effects in payment and remittance services. - Standard-setting and regulatory coordination: - Existing cross-sectoral standards include FATF standards for AML/CFT (limited to financial integrity). - FSB issued 10 high-level recommendations for global stablecoins; CPMI and IOSCO published guidance relevant to systemic stablecoin arrangements; Basel Committee issued consultation papers on prudential treatment of bank exposures to crypto assets (June 2021 and June 2022). - More coordination is required among standard setters to develop comprehensive international standards, especially for nonsystemic stablecoins. - Nonglobal or nonsystemic stablecoins tend to share many risks with global stablecoins; similar but proportionate rules are necessary. ### I. The Stablecoin Ecosystem: Components and Risks - Core functions and components: - Issuance (creation/destruction and stability mechanisms): - Stablecoin issuers (may hold tokenized customer funds as liabilities). - Reserve assets. - Custodians holding reserves, market makers, governance entities. - Transfer: - Network, network operators, validators. - Access: - Wallets and exchanges used by end users. - Organizational arrangements: - Functions may be carried out by the same or different entities; multiple firms can provide the same function (e.g., several technology vendors or custodians). - Role of crypto exchanges: - Act as underwriters and distributors at issuance. - Many stablecoin issuers rely on crypto exchanges as redemption gates. - Some crypto exchanges act as market makers performing stabilization functions. - Exchanges perform off-chain transfers among their own wallets and often provide hosted wallet services. - Key risks by function: - Issuance-related risks: - Liquidity mismatch and run risk. - Legal certainty. - Sound governance. - Consumer/investor protection. - Concentration of economic power to key service providers. - Other risks across functions: - Operational resiliency. - Cybersecurity. - Data protection. - Transfer-related concerns: - Sound governance. - Operational resilience. - Cyber-resilience. - Safety and integrity. - Access-related vulnerabilities: - Financial integrity. - Consumer protection. - Data privacy. - Cybersecurity. - Regulatory focus on functions: - Some recent initiatives identify risks by the issuance, transfer, and access functions (for example, the US president’s Executive Order and related Working Group report focused on payment stablecoins and the risks tied to those three functions). ### Box 1 — US President’s Working Group on Financial Markets and Executive Order on Ensuring Responsible Development of Digital Assets - November 2021 report (US President’s Working Group) key points: - Focused on the potential for increased use of stablecoins as payments. - Concluded the current regulatory framework does not adequately manage risks of payment stablecoins and called for urgent legislative action to impose federal prudential regulation to overcome gaps. - New federal legislation would "complement existing authorities with respect to market integrity, investor protection, and illicit finance," and would address three broad areas. *Source: ftnea2022008 - Introduction (IMF Fintech Note)* ### 1. Stability/run risks: To address risks to stablecoin users and guard against stablecoin runs, ### ftnea2022008 - 1. Stability/run risks: To address risks to stablecoin users and guard against stablecoin runs, ### Regulatory requirements to address stability/run, transfer, and concentration risks - Stability/run risks: - Legislation should require stablecoin issuers (institutions or holding companies) to be insured by depository institutions subject to supervision and regulation (including capital, liquidity, and resolution requirements) and eligible for Federal Reserve emergency liquidity. - Transfer risks: - Legislation should require federal oversight over stablecoin issuers and custodial wallet providers to address payment system risk. - Any entity that performs critical functions for stablecoin arrangements should be required to meet appropriate risk-management standards. - Concentration risks: - Stablecoin issuers and wallet providers should have restrictions that limit affiliation with commercial entities to address systemic risk and concentration of economic power. - Standards to promote interoperability among issuers should be introduced to address concentration of economic power. - Other standards for custodial wallet providers, such as on accessing users’ transaction data, should be considered. - Interim measure if Congress does not act: - Certain activities of stablecoin arrangements should be considered systemically important by the Financial Stability Oversight Council (FSOC), triggering relevant risk-management standards and examination and enforcement frameworks. ### Executive Order on ensuring responsible development of digital assets (March 2022) — assigned objectives and next steps - Objectives directed by the executive order: - Protect US consumers, investors, and businesses by directing the Department of the Treasury and other agency partners to assess and develop policy recommendations to address implications of the growing digital asset sector and changes in financial markets for consumers, investors, businesses, and equitable economic growth; the order also encourages regulators to ensure sufficient oversight and safeguard against any systemic financial risks posed by digital assets. - Protect US and global financial stability and mitigate systemic risk by encouraging the FSOC to identify and mitigate economy-wide (i.e., systemic) financial risks posed by digital assets and to develop appropriate policy recommendations to address any regulatory gaps. - Promote US leadership in technology and economic competitiveness by directing the Department of Commerce to work across the US government in establishing a framework to drive competitiveness and leadership in and leveraging of digital asset technologies; this framework will serve as a foundation for agencies and integrate this as a priority into their policy, research and development, and operational approaches to digital assets. - Support technological advances and ensure responsible development and use of digital assets by directing the US government to take concrete steps to study and support technological advances in the responsible development, design, and implementation of digital asset systems while prioritizing privacy, security, combating illicit exploitation, and reducing negative climate impacts. - Next steps and timelines: - Within 210 days of the date of the order, the Secretary of the Treasury should convene the FSOC and produce a report outlining the specific financial stability risks and regulatory gaps posed by various types of digital assets and provide recommendations to address such risks. ### Issuance, redemption, and stabilization: functions, governance, and reserve management - Issuers and governance: - Stablecoins backed by financial instruments usually have an identifiable issuer and are more likely to be issued by a single issuer or a small number of known issuers (such as a consortium) in a closed network. - Issuers could be banks, nonbank financial entities, and large technology conglomerates known as BigTech. - Decisions for stablecoin arrangements are usually taken by a governance body; governance rights may be distributed broadly or concentrated in a few known entities and may include decisions on reserve asset types and collateral ratio. - Stabilization mechanism: - The stabilization mechanism aims at reducing volatility and underpins holders’ expectation that stablecoins will be redeemed at par, on demand, and in any state of the world. - For most stablecoins covered in this note, the stabilization mechanism is a peg to a fiat currency, sustained by reserves. - The ability to meet redemption requests hinges on the safety and liquidity of assets held as reserves; reserve management is specified by the governing body and reserves are typically held in custody by a third party such as a financial institution. - Banks, tokenization, and permissioning: - Banks may issue stablecoins via special-purpose vehicles or subsidiaries; some banks are considering tokenizing deposits to create tokenized deposits that represent a claim on the depositor’s commercial bank. - Permissioned networks and stricter policies around unhosted wallets are preferred by banks to address settlement finality and AML/CFT risks. - Tokenized deposits would operate in a closed network and only among existing bank account holders but raise complex operational and legal/regulatory issues, including the need for instant settlement and interchangeability across banks. ### Key challenges and risks from issuance functions and reserves - Reserve composition, allocation, and management risks: - Risks stem from reserves being insufficient, risky, illiquid, opaque, or concentrated. - Some stablecoins are backed by risky and illiquid assets, including commercial paper, which may render reserves non-redeemable at par. - Incentives for investing in less liquid, higher-risk assets can arise from search for yield or conflicts of interest between issuers and related parties (such as crypto exchanges). - Reserve composition and allocation opacity elevates risks of conflicts of interest between issuers and custodians and of misappropriation of reserve assets. - Many major issuers (including Tether, Circle, and Binance) are yet to release audit reports regularly by independent auditors. - Concentration of reserves in a few commercial banks is common due to banks’ regulatory uncertainty and financial integrity concerns, raising systemic implications. - Liquidity and contagion risks: - Greater use of stablecoins could trigger fire sales of collateral assets in stress, posing risks to the broader financial sector. - If large issuers face trouble, widespread redemptions could negatively impact token holders and broader markets such as banks and bond markets. - Any collapse in the price or trust of stablecoins could trigger further redemptions and add pressure on short-term credit markets. ### Boxed examples and empirical details - Use-case example: - Novi, a Meta-owned subsidiary, launched a pilot remittance program (now closed) partnering with Coinbase that involved users in the United States and Guatemala with a maximum value of $1,000 per wallet; Novi used a stablecoin (Pax Dollar) for transfers. - Box 2 — Stablecoins issued by a commercial bank and deposit tokenization: - Tokenized deposits would represent a claim on the depositor’s commercial bank, just as a regular deposit does. - For tokenized deposits to work as intended, the DLT network would need to ensure instant settlement and tokenized deposits would need to be interchangeable across banks. - Box 3 — Tether and its reserves (recent disclosures and supervisory findings): - Tether has reached a market capitalization of over $60 billion. - The issuing entity is domiciled in the British Virgin Islands and is largely unregulated; Tether is not available to US households and firms. - The Commodity Futures Trading Commission identified that Tether held sufficient fiat reserves for only 27.6 percent of the days in a 26-month sample period from 2016 through 2018 and imposed civil monetary penalties in October 2021. - Recent disclosures (end of March 2022) show only 6 percent of Tether is backed by cash, indicating liquidity mismatches given direct and “immediate” redemption at face value through Bitfinex (with small fees and issuer’s right to delay redemptions or redeem in kind). - Exposures to commercial paper and MMF are high at 28 percent and 10 percent, respectively. - The issuer increased their liquidity by holding US treasury bills which account for 56 percent. - Enforcement and transparency actions: - The office of the New York attorney general identified that a significant amount of Tether’s reserve assets had been provided to its related crypto exchange (Bitfinex) without proper disclosure; Bitfinex and Tether agreed in February 2021 to pay a fine, cease services to New York residents and entities, and start providing quarterly transparency reports. *International Monetary Fund — Fintech Notes: Regulating the Crypto Ecosystem: The Case of Stablecoins and Arrangements* ### Box 4. Failures of Algorithmic Stablecoins ### Box 4. Failures of Algorithmic Stablecoins ### Collapse of TerraUSD (UST) — key events and impacts - UST was the third largest stablecoin and the largest algorithmic stablecoin (market cap at $18 billion before the crash). - Initial stress event: a $2.5 billion UST withdrawal from Anchor on May 8. - On May 8, $150 million in UST liquidity was removed from UST’s primary DEX, Curve3Pool, in preparation to test an upgrade to Curve4Pool (UST, FRAX, USDT, USDC), leaving the liquidity pool balanced but much smaller. - Within hours, large unforeseen swaps to other stablecoins occurred (the largest swap at $85 million), leaving the liquidity pool extremely unbalanced and vulnerable to smaller transactions. - The stabilization protocol maintained the peg within 200 basis points for one day, but panic selling continued and outran the stabilization mechanism. - Large depositors disproportionately withdrew, exacerbating pressure and leaving smaller depositors more exposed. - UST depegged on May 9 and entered a death spiral: supply of LUNA exponentially increased in attempts to repeg UST, increasing selling pressure on LUNA’s price. - By May 16: - UST price dropped to $0.16. - LUNA price fell from over $80 to $0.0002. - Luna Foundation Guards (LFG) attempted to defend the peg by selling $2 billion worth of bitcoin; bitcoin price sharply fell by $2,000 right before UST first materially depegged. - Tether (largest stablecoin) also dropped below its peg on secondary markets during the turmoil. - Trading on centralized exchanges experienced rapid liquidity disappearance and trading halts for UST/LUNA, disproportionately preventing retail investors from exiting UST. ### How algorithmic stablecoins function and vulnerabilities - Algorithmic stablecoins rely on a smart contract-based algorithm that regulates between a stablecoin and a balance token (model details vary). - Arbitrage stabilization mechanism described: - When stablecoin > $1: burn $1 of balance token and mint one stablecoin. - When stablecoin < $1: burn stablecoin and mint the balance token until peg returns. - Vulnerability: the balance token (e.g., LUNA) issuance and value depend on market confidence in the issuing entity (Terraform Labs for UST/LUNA). - Stability depends heavily on market confidence and market-making by exchanges; reliance on DEX liquidity made UST particularly vulnerable when DEX liquidity was drained. - Governance opacity and unclear allocation of responsibilities between Terraform Labs and LFG worsened crisis response; LFG chose bitcoin as the backstop without public clarity on how and when reserves would be deployed. ### Liquidity, custody, and redemption design risks - Third parties involved in custody and redemption can amplify run risks by delaying redemptions and adding costs. - Examples of limited direct redemption: - Tether allows direct redemptions only for requests larger than $100,000. - USD Coin (USDC) limits redemption rights to institutional investors. - Majority of retail holders must rely on crypto exchanges to convert stablecoins to fiat. - On Anchor, only small depositors (original wallet size under $10K) increased positions from May 6 to 9. - Where redemption depends on third parties, governance must have clear plans to ensure redeemability if those third parties fail; operational and liquidity arrangements should ensure immediate and near-par redemption during stress. ### Regulatory considerations and recommended safeguards - General regulatory aim: ensure assets of end users are segregated from issuer’s assets and held in supervised regulated entities (typically commercial banks) to ensure robust accounting, safekeeping, internal controls, and prompt access. - Reserve adequacy and redeemability: - Set requirements on reserve asset allocation, custody, and transparency (credit quality, maturities, diversification). - Requirements should reflect the issuer’s redemption pledge and underlying risks (capital and liquidity requirements similar to prudential requirements for banks, adjusted where appropriate). - Legal classification and certainty: - Stablecoins may be classified under private law as intangible property, a claim, or sui generis asset—affecting transfer, lending, pledging, and insolvency rights. - Under financial law, classification may be as deposit, security, e-money, or commodity; classification informs issuer regulation (depository institution, money transmitter, securities issuer, e-money provider, or trust). - Jurisdictional differences and DLT use raise questions: applicable law across borders, settlement finality, whether digital data are representations or separate assets, private key knowledge equating to possession, and applicability of innocent acquirer protections. - Transparency and disclosure: - Require timely and public disclosures on reserve holdings (detailed explanation of reserve holdings preferably no more than a predefined number of business days after the end of each month). - Mandatory publication of a white paper with issuer and governance information, reserve asset description and investment policy, nature and enforceability of redemption rights, and technology-related risks. - Audits, custodianship, and independence: - Introduce requirements for independent audits of reserve holdings (frequency and detail tailored to reserve size and systemic risk). - Regulate and require independence for custodians; consider limiting custodians to regulated financial institutions (commercial banks and/or trust companies licensed by financial authorities). - Intermediaries and marketing: - Subject intermediaries to robust regulation to ensure marketing is unbiased and structural features and redemption limits are clearly disclosed to end users. - Conflicts of interest and lending: - Where issuers engage in lending services, manage conflicts via arms-length operations or prohibit lending if governance cannot ensure proper control. - Systemic and cross-border coordination: - If stablecoin arrangements become domestically systemic, impose additional requirements similar to those for systemically important institutions (more intensive supervision, stress testing, recovery and resolvability). - Coordinate with authorities of referenced foreign currencies where stablecoins are linked to foreign currencies or baskets to mitigate currency substitution and monetary transmission risks. - Consider deposit insurance for systemic stablecoin issuers only with strict safeguards and robust prudential regulation. - Data, supervision, and recovery planning: - Require robust systems for collecting, storing, and safeguarding data to enable monitoring of evolving risks, business models, interconnectedness, and risk concentrations. - Enhance regulatory data collection, analytical capabilities, and cross-border and cross-sectoral information exchange. - Require issuers to prepare recovery and resolution plans; apply more intensive supervision, including liquidity stress testing. ### Lessons from MMF and e-money frameworks (applicability to stablecoins) - Where stablecoins do not pledge redemption at par and on demand, MMF-style rules may guide reserve investments into less liquid assets with higher returns; MMF requirements include disclosure, audit, governance, investment limits (credit quality), maturity limits, diversification, and redemption restrictions to address first-mover advantage. - Liquidity management tools used by MMFs (redemption gates and in-kind redemptions) can help but may not suit stablecoins used for day-to-day payments because such tools can prevent immediate redemption. - For stablecoins with immediate redemption pledges, e-money regulation provides useful guidance: - Requirements include segregation and ring-fencing of reserve assets, deposit into a commercial bank trust/escrow or central bank, insurance or guarantee where segregation is not required, and certainty of end-user claims. - E-money–style minimum and ongoing capital charges (as a share of the float) and investment limits may be relevant. - Tailoring and complementarity: - Application of MMF and e-money regulation must be tailored to stablecoins’ specificities; some risks (pseudonymity of holders) make certain MMF tools (e.g., in-kind redemptions) difficult to implement. - Banklike liquidity tools (liquidity coverage ratio, net stable funding ratio) and reporting, supervision, and stress testing may be needed to address liquidity transformation risks. *International Monetary Fund — Box 4. Failures of Algorithmic Stablecoins (excerpt).* ### Box 7. Stablecoins and Deposit Insurance ### Box 7. Stablecoins and Deposit Insurance ### Overview - A deposit insurance system (DIS) protects depositors against the loss of insured deposits at supervised deposit takers. - International standard setters have yet to issue guidance on whether asset-backed stablecoins, such as those backed by bank deposits, should also be covered by deposit insurance. - The Financial Stability Board (FSB) stressed the need for recovery and resolution planning for global stablecoins but did not address extending deposit insurance, viewing it as outside of its scope (FSB 2020). - The International Association of Deposit Insurers established a Fintech Technical Committee to consider the issues. - In advance of international consensus, authorities are considering national approaches: - The President’s Working Group (PWG) in the United States recommended that payment stablecoins backed by fiat currency be subject to a prudential framework, which would require stablecoin issuers to be “insured depository institutions” (meaning members of the US DIS, the Federal Deposit Insurance Corporation [FDIC], and thereby subject to the regulations of the FDIC) resolution regime (PWG Report on Stablecoins, November 2021). - The Bank of England expects that stablecoins issued as tokenized deposits by banks subject to the bank regulatory regime would be covered by the DIS, while a modified insolvency regime would suffice for systemic nonbank stablecoins. ### Preconditions and key risks for DIS coverage - A precondition for deposit insurance is that DIS members be well regulated and supervised. - Extending deposit insurance to unregulated stablecoins backed by illiquid reserve assets could create moral hazard and burden regulated banks with the costs of failed, volatile stablecoins. - Operational complexity of stablecoin arrangements, including distributed ledger technology, may raise challenges when operationalizing deposit insurance (for example, which entity would retain the user information needed by the DIS to identify and reimburse insured users). ### Preliminary conclusions on deposit insurance coverage for stablecoins - A prudent regulatory framework for stablecoins and legal certainty (Box 5) should be prior conditions for deposit insurance coverage. - Stablecoins that have less-liquid reserve assets (such as commodities, crypto assets) and are mainly used for investment purposes or are not redeemable at par should not be insured. - From their purpose and risk profile, these coins are more comparable to securities investments (such as money market funds or other securities funds), to which deposit insurance is not extended. - Where commercial banks, which are already members of a DIS, issue tokenized insured deposits or their own stablecoins backed by insured bank deposits that can be redeemed on a one-to-one basis for fiat currency, deposit insurance coverage could apply. - Issuers would already fully meet the requirements, including for regulation and supervision. - If stablecoins are issued by nonbank entities and are used primarily for payment purposes, then deposit insurance coverage may not be warranted. - Similar to e-money and in the absence of being systemic, regulatory arrangements to safeguard users may be sufficient. - As with e-money, this should include regulation that addresses redeemability, reserve assets management (including a matching requirement, ensuring high liquidity of the reserve assets, and addressing concentration risks), and strict customer asset segregation and ringfencing. - Consideration could be given to extending deposit insurance to nonbank-issued stablecoins if they became systemic (that is, presented similar financial stability risks and consumer protection issues to—and were regulated like—bank deposits). ### Bank-issued stablecoins and prudential regulation - Stablecoins issued by commercial banks should be subject to adjusted bank regulation. - Some risks arising from issuing stablecoins could be addressed by existing prudential and conduct regulations at the entity and group levels; other risks (especially those arising from public blockchains and unhosted wallets) may not be fully addressed by the existing banking regulatory framework. - Banking regulators should specify under what conditions and technologies commercial banks are allowed to issue their own stablecoins. - The Basel Committee on Banking Supervision’s second consultation paper (June 2022) on prudential treatment of crypto asset exposures clarifies some prudential treatments (such as liquidity charges for issuing a stablecoin) in case bank-issued stablecoins. - Additional risk management and prudential requirements for banks may be applied. - Careful analysis is needed if an issuing entity is established independently from the prudentially regulated financial institutions. - When appropriate, the issuing entity should be consolidated into the banking/financial group and should be subject to existing prudential regulation, such as liquidity coverage ratio and net stable funding ratio requirements. - If the issuing entity is truly independent and there are sufficient safeguards or firewalls between the stablecoin issuing entity and banking group, it may be acceptable not to include the issuing entity as part of the banking group. - While banks may not be legally obliged to meet redemption requests to the issuing entity, they may face strong pressure to step in and provide liquidity if this could cause reputational damage to the group. - Financial institutions are expected to manage operational risk (arising from the platform operation of cross-border payment services) and conduct risk (for example, when issuing structured bonds). ### Cross-border considerations and cooperation - Effective cross-border cooperation between home and host supervisors is necessary to address various risks arising from stablecoin arrangements. - Prudential regulation on issuers is typically imposed by the home supervisor where issuers are domiciled. - The home supervisor would need to consider different economic functions and business models globally and tailor the regulations accordingly, considering the risks arising from these functions and business models. - Effective cross-border cooperation mechanisms are critical for achieving consensus among home and host supervisors on the regulation that captures globally active stablecoin issuers. *Source: Box 7. Stablecoins and Deposit Insurance, ftnea2022008.* ### Box 8. Guidance on the Application of the Principles for Financial Market ### Box 8. Guidance on the Application of the Principles for Financial Market Infrastructures to Stablecoin Arrangements ### Scope and approach - CPMI-IOSCO guidance on the application of the principles for financial market infrastructures (PFMI) to stablecoin arrangements (SAs) applies to SAs considered as systemically important financial market infrastructures (FMIs), including the entities integral to such arrangements. - The guidance is provided on only a subset of principles; however, a systemically important SA used primarily for making payments is expected to observe all the relevant principles. - Depending on the design of an SA, types of entities, and functions involved, the principles that apply to payment systems will apply to SAs used primarily for making payments based on a functional approach (“same business, same risks or risk profile, same rules”). - When an SA provides functions that more closely resemble those provided by other types of FMIs (such as securities settlement system or trade repository), the SA should observe the respective principles. ### Principle guidance (selected PFMI principles) - Governance (Principle 2) - A systemically important SA should have appropriate governance arrangements. - A systemically important SA should consider how: - the SA’s ownership structure and operation allow for clear and direct lines of responsibility and accountability, for instance, it is owned and operated by one or more identifiable and responsible legal entities that are ultimately controlled by natural persons. - the SA’s governance allows for timely human intervention, as and when needed. - the SA’s ownership structure and operation allow the SA to observe Principle 2 and the other relevant principles of the PFMI irrespective of the governance arrangements of other interdependent functions. - Comprehensive management of risks (Principle 3) - A systemically important SA should regularly review the material risks that the FMI function bears from and poses to other SA functions and the entities (such as other FMIs, settlement banks, liquidity providers, validating node operators and other node operators, or service providers) which perform other SA functions or on which the SA relies for its transfer function. - A systemically important SA should develop appropriate risk-management frameworks and tools to address these risks. In particular, it should identify and implement appropriate mitigations, taking an integrated and comprehensive view of its risks. - Settlement finality (Principle 8) - A systemically important SA should provide clear and certain final settlement, at a minimum by the end of the value date, regardless of the operational settlement method used. Where necessary or preferable, such settlement should be provided on an intraday or real-time basis. - A systemically important SA should: - clearly define the point at which a transfer of a stablecoin through the operational method used becomes irrevocable and unconditional. - ensure that there is a clear legal basis that acknowledges and supports finality of a transfer. - have robust mechanism(s) for preventing any misalignment between the state of the ledger and legal finality and ensure that legal finality of a transfer, once it has occurred, is maintained regardless of competing state(s) of the ledger. - Money settlements (Principle 9) - A stablecoin used by a systemically important SA for money settlements should have little or no credit or liquidity risk. - The SA should consider whether the stablecoin provides its holders with a direct legal claim on the issuer and/or claim on, title to or interest in the underlying reserve assets for timely (as soon as possible, at a minimum by the end of the day and ideally intraday) convertibility at par into other liquid assets such as claims on a central bank, and a clear and robust process for fulfilling holders’ claims in both normal and stressed times. - A systemically important SA should determine whether the credit and liquidity risks of the stablecoin that it uses for money settlements are minimized and strictly controlled and the stablecoin is an acceptable alternative to the use of central bank money. Relevant factors may include but are not limited to: - The clarity and enforceability of the legal claims, titles, interests and other rights and protections accorded to holders of the stablecoin and SA participants in relation to the issuer of a stablecoin and reserve assets backing it, including their treatment (e.g. seniority) in the event of insolvency of the issuer, its reserve manager or a custodian of the reserve assets and/or other protections such as thirdparty guarantees. - The nature and sufficiency of the SA’s reserve assets to support and stabilize the value of the outstanding stock of issued stablecoins, and the degree to which the SA’s reserve assets could be liquidated at or close to prevailing market prices. - The clarity, robustness, and timeliness of the process for converting the stablecoin into other liquid assets such as claims on a central bank in both normal and stressed circumstances. The stablecoin should be convertible into other liquid assets, as soon as possible, at a minimum by the end of the day and ideally intraday. - The creditworthiness, capitalization, access to liquidity, and operational reliability of the issuer of the stablecoin, provider of the settlement accounts, and custodian(s) of the reserve assets. Reserve assets held or placed in custody should be protected against claims of a custodian’s creditors. Any chosen custodians should have robust accounting practices, safekeeping procedures, and internal controls to protect the assets as well as a sound legal basis supporting its activities, including the segregation of assets. - The sufficiency of the regulatory and supervisory framework that applies to the issuer, reserve manager(s), and/or custodian(s) of the reserve assets. - The existence of risk controls that could, where needed, reduce credit and/or liquidity risks. Possible examples include collateral pools supporting committed lines of credit, third-party guarantees and procedures for allocating losses arising from a default by the issuer, or a decrease in value of the stablecoin. ### Challenges and risks - Governance complexity and accountability - Clarity and transparency of the governance of the transfer or exchange function of stablecoins may be clouded by software automation. Decision functions may be performed solely by software (smart contracts), diminishing the ability to hold an entity clearly accountable. - Governance risks may be exacerbated during times of crisis. - Settlement finality uncertainty - Emerging technologies such as DLT may impact how an FMI observes certain PFMI principles, for example, in terms of finality of transfers. - Unlike centralized FMIs where settlement is final and irrevocable once a book entry is made, SAs may use consensus mechanisms to achieve settlement, lowering certainty about when settlement finality is reached. - “Probabilistic settlement” can be caused by a misalignment between the state of the ledger and when legal finality may occur. Without a responsible legal entity, enforcing legal finality or the resulting legal claim could be challenging. (See CPMI-IOSCO 2022, 16.) - Counterparty and asset risks - Settlement in privately issued money can expose users to counterparty risks. The PFMI expects money settlement to be conducted in central bank money where practical and available. - Depending on the model, participants may be subject to credit and liquidity risk from the issuer, settlement account provider, and reserve assets’ custodian. - Interdependent functions and concentration risks - Interdependent functions (issuance, redemption, stabilization, transfer) may be governed or performed by single or multiple entities, exacerbating legal, operational, and other risks and affecting PFMI observance. - Closed ecosystems, permissioned blockchains, or siloed operations can increase concentration and frictions in payments through lack of interoperability. - Lack of interoperability among blockchains and stablecoins may lead to market fragmentation and excessive concentration. Stablecoins available on multiple blockchains may not be directly fungible across chains, requiring strong market-maker support to ensure price stability. - Potential interoperability issues among private stablecoins, commercial bank money, and central bank money should be considered if stablecoins are used more broadly for payments. ### Considerations for regulatory responses - Governance and accountability - Stablecoin arrangements should have identifiable decision-making structures that are transparent and promote safety and efficiency. - Lines of responsibility and accountability and the decision-making process, including any conflict of interest, should be clearly defined and documented. - The risk-management framework should be established and documented. - The governance arrangements of other interdependent functions should not hinder observation of the relevant PFMI principles. - Authorization, licensing, and supervision - An adequate registration or licensing regime should apply to the entities involved in the transfer function of stablecoins to collect information necessary for supervision and oversight while protecting individual user privacy. - Such approaches should include a set of strict and comprehensive conditions and prudential requirements (such as initial capital and own-funds requirements) proportionate to the operational and financial risks faced by such entities. - Authorization/licensing conditions (examples) - The entity applying for authorization or licensing should comply with key requirements and conditions, such as having: 1. robust governance arrangements, including a clear organizational structure with well-defined lines of responsibility, effective procedures to manage risks, and adequate internal control mechanisms proportionate to the nature, scale, and complexity of the payment services provided; 2. measures to safeguard payment service users’ funds; 3. procedures to monitor, handle, report, and follow up on security incidents; 4. processes to file, monitor, track, and restrict access to sensitive payment data; 5. business continuity arrangements, including identification of critical functions and contingency plans; 6. security policy and risk-management framework for payment services comprising security controls and mitigation measures; 7. internal control mechanisms to comply with AML/CFT obligations. - Risk management - A robust risk-management strategy and review process must be in place for stablecoin arrangements. - A systemically important stablecoin arrangement should develop appropriate risk-management frameworks and tools by taking an integrated and comprehensive view of its risks (CPMI-IOSCO 2022). - Risk-control policies and practices should include legal, credit, liquidity, general business, and operational resilience (including outsourcing, fraud and cyber risk, risk of loss of data; and various nonfinancial risks, such as data integrity; operational resilience; third-party risk management and AML/CFT related risks). - Settlement finality and legal alignment - There should be certainty on how finality and irrevocability is achieved: - Stablecoin arrangements should be transparent about the settlement methods in use. If settlement is probabilistic, the exact moment when finality and irrevocability is reached should be defined. - The settlement method should be supported by an enforceable legal framework. - There should be defined risk-management processes to prevent misalignment between the operational and legal settlement processes. - Given cross-jurisdictional spans, there should be legal consistency regarding settlement finality across jurisdictions. - Assessment of acceptability as alternative to central bank money - Stablecoin arrangements should determine whether credit and liquidity risks are minimized and strictly controlled. Factors listed in CPMI-IOSCO guidance (clarity and enforceability of legal claims; sufficiency of reserve assets; clarity and robustness of conversion process; etc.) should inform whether a stablecoin is an acceptable alternative to central bank money. - Proportionate application for nonsystemic arrangements - While PFMI guidance is applicable to systemically important SAs, nonsystemic arrangements are encouraged to comply with key PFMI requirements in a proportionate manner (governance, finality of transfer, safeguarding users’ funds, risk-management frameworks, authorization/licensing or information provision). - Interoperability and concentration - Authorities should consider appropriate policy and regulatory responses where SAs lead to additional friction and concentration, particularly where there are closed ecosystems or a lack of interoperability. - Standards to promote interoperability should be introduced to limit concentration risk and supplier lock-in to particular technologies. ### Cybersecurity and operational risk - Cyber- and operational risks permeate all functions and components of the stablecoin ecosystem. - While DLT may be more resilient to certain threats than traditional payment systems, cyber- and operational risks can still materialize across network operations, exchanges, wallets, and other components. - To strengthen cyber- and operational resilience, stablecoin arrangements must ensure appropriate policies and controls are in place: - Entities involved in stablecoin services should have robust operational risk-management frameworks with appropriate policies, procedures, and controls. - Systems should be designed for a high degree of security and operational reliability, including sufficient capacity. - Business continuity procedures should be in place for timely recovery of operations. - Operational interdependencies between actors (such as technical service providers) should be identified and risks properly managed. - Entities should observe other relevant international standards on operational and cyber-risks, such as International Organization for Standardization (ISO) standards for information security management or US National Institute for Standards and Technology standards, guidelines, and best practices for cybersecurity-related risks. ### Access and wallets - An access point (user interface) is needed to connect users to the stablecoin ecosystem; wallets and exchanges provide such interfaces and additional services (storage of cryptographic keys, transaction initiation). - Wallets and exchanges are vulnerable to custodial, operational, and concentration risks. - If a wallet is used to store and transfer stablecoins for payment purposes, it could be subject to additional regulations applicable to electronic payment instruments and further operating requirements. - The Eurosystem’s Payment Instruments, Schemes and Arrangements (PISA) framework is an example of oversight based on PFMI principles; oversight activities should be proportionate to the importance and potential risks of the arrangement. - Where the payment system becomes systemic, authorities might consider implications of the failure of a wallet provider, including the merit and scope of user protection; some jurisdictions have implemented user protection schemes for e-money and may adopt similar approaches for crypto asset wallets if they become systemic. - Additional operating rules and requirements may be needed for stablecoin wallet providers and/or merchants because they access existing payment systems. *Source: Box 8. Guidance on the Application of the Principles for Financial Market Infrastructures to Stablecoin Arrangements, ftnea2022008* ### Conclusion ### Conclusion ### Role and potential benefits of stablecoins - Stablecoins may play a role in the future of finance. - If developed and implemented under appropriate regulation, stablecoins have the potential to: - reduce costs of cross-border remittances; - complement and improve existing payments’ infrastructure; - provide competition in the payment space; - generate efficiencies when used for more wholesale or back-end functions involving large, regulated entities. ### Risks and vulnerabilities without robust regulation - Absent robust regulatory frameworks, stablecoins will introduce significant risks. - Stablecoin issuers and arrangements could generate risks to consumers, markets, and—where systemic—financial stability. - Risks are heightened where: - reserve compositions are complex, less liquid, or opaque; - key participants in stablecoin arrangements—such as wallets and exchanges—are not appropriately regulated and there is little recourse for consumers in the event of operational failures, cyberattacks, or frauds and scams. - Decentralized nature of stablecoin arrangements increases attention needed on legal certainty, governance, settlement finality, and operational risk. ### Regulatory framework design and supervisory focus - Developing a robust and comprehensive regulatory framework will involve intense monitoring and a targeted approach focusing on all actors. - An appropriate and consistent framework should provide a level playing field along the activity and risk spectrum. - Regulation should aim at key participants of the stablecoin ecosystem, including issuers, wallets, exchanges, network providers, governance bodies, and reserve managers. - A combination of conduct, payment, and prudential regulation that takes cues from similar products and activities in the market (commercial banking, e-money, FMIs, and MMFs) might be a sensible approach. - The framework should follow a "same risk, same regulation" approach by focusing on key components, their functions, and risks to ensure those entities are licensed and authorized. - Authorities should consider unique risks from underlying technology, volatility, market awareness, and product knowledge/understanding, and how stablecoins are being used. - While a technology-neutral approach might be considered, supervisory approaches should consider the unique risks of different methods of delivery and operation. - Cross-sectoral issues may need bespoke responses. ### Applicability of existing payments and FMI standards - Regulatory, supervisory, and oversight approaches used for existing payments could apply, to some extent, to stablecoins intended as means of payment and enabling transfer between users. - Existing e-money regulation might not be fit for purpose for all aspects of stablecoin arrangements, but adjusted frameworks taking cues from such regulation could cover some risks. - Existing regulatory approaches for payment service providers and payment institutions could be relevant for certain services provided by stablecoin arrangements. - The transfer function of systemic stablecoins must adhere to the PFMIs, especially if they integrate with existing payment systems. - CPMI-IOSCO guidance establishes that the PFMI and additional guidance on specific principles apply to systemically important stablecoin arrangements. - PFMI-related risks and mitigation measures could also be relevant for nonsystemically important stablecoins, applied in a proportionate manner. ### Cross-border dimension, coordination, and short-term policy actions - Data availability and extra territorial oversight are common challenges across the crypto asset ecosystem, including stablecoins. - The cross-sector and cross-border dimensions of stablecoins make domestic and international coordination and cooperation key. - Consistent regulatory approaches can prevent a race to the bottom and address regulatory arbitrage. - In jurisdictions where stablecoins are systemic, immediate policy action may be warranted, although broad-based restrictions are unlikely to be a long-term solution. - In some emerging markets and developing economies where crypto assets such as stablecoins already generate risks to financial stability, waiting for global regulatory standards might not be an option; authorities should use existing regulatory powers to manage risks and buy time to develop comprehensive regulations. - Where users move to stablecoins to hedge against inflation or currency devaluation risk, stronger domestic macroeconomic policies—such as strengthening monetary policy credibility, safeguarding the independence of central banks, and maintaining a sound fiscal position—may dampen incentives. - Restricting the use of crypto assets for certain activities—such as restricting derivatives linked to or payments in crypto assets—could be a short-term solution to dampen crypto asset growth. - Broadly banning the use of crypto assets would likely stifle innovation, could trigger stronger incentives for regulatory arbitrage and circumvention, and enforcing broad bans would be extremely difficult. ### International standards and coordination role - Robust international standards are indispensable to ensuring effective and efficient cross-sectoral and cross-border cooperation. - Relevant SSBs are undertaking significant effort to develop standards according to their mandates. - The economic functions of stablecoins are likely to change over time, changing the suitability of sector-specific regulations. - The FSB should take a leading role in coordinating efforts across sectoral SSBs and in establishing global standards for the regulation of stablecoins, taking into account sector-specific standards developed by other SSBs. - Home authorities where an entity carrying out core functions for stablecoins is domiciled need to coordinate with other relevant authorities where the users of the stablecoins are located. - IMF staff are actively contributing to SSBs’ activities to facilitate development and implementation of robust international standards. *International Monetary Fund — Regulating the Crypto Ecosystem: The Case of Stablecoins and Arrangements — Conclusion* --- _Source: https://www.imf.org/-/media/files/publications/ftn063/2022/english/ftnea2022008.pdf_