Stablecoins: Sailing without a Rudder

Stablecoins are cryptographic (crypto) assets that are widely used in decentralized finance (DeFi) applications and crypto-asset trading strategies. Stablecoins offer the prospect that their “stable value” could potentially increase their use and desirability as a crypto medium of exchange by exploiting the benefits of blockchain technology, such as composability (integrating code from other products and DeFi applications such as lending protocols), interoperability, and instant settlement. That, in turn, offers the prospect of 24/7 availability of funds and the ability to process and settle payments instantaneously and across borders. This suggests, for example, that Canadians will be able to purchase goods and services online or send and receive money to or from friends and family members anywhere in the world instantaneously and with immediate settlement of the transaction in a safe and secure fashion. Recent events, however, have shown that stablecoins are unlikely to reap their potential as payment vehicles unless they are properly regulated. In the absence of proper regulation it is just too tempting for some stablecoin issuers to look for ways to enhance their profits in the short run by underinvesting in needed infrastructure and controls and by backing their stablecoins with risky assets that are not sufficiently safe or liquid to hold their value in good times and bad. In some cases, like algorithmic stablecoins, they are not backed by specific assets but instead rely on computer programs that may not function as intended. For stablecoins to flourish as widely used payment vehicles they require a proper regulatory framework. A good starting point is to adhere to the principle of “same risk, same activity, same regulation.” Another worthwhile principle is to not recreate the wheel. With this in mind, this Commentary offers some suggestions as to how stablecoins and their issuers could be regulated using the existing regulatory frameworks that are applied to retail payments-system providers and deposit-taking institutions. These existing frameworks include the Bank Act, its provincial statutory counterparts, and the relatively recent Retail Payments Activities Act. We paraphrase the Financial Stability Board’s high-level recommendations for global stablecoins – many of which apply in a domestic setting as well – and assign the legislation/recommendations/authority based on the Canadian context. These recommendations include the promotion of the following: A comprehensive governance framework with clear allocation of accountability for activities of the stablecoin; Effective risk management frameworks in place especially with regard to reserve management, operational resilience, cyber security safeguards and AML/CFT measures; A robust system for collecting, storing, and safeguarding data; Appropriate recovery and resolution plans; and Comprehensive and transparent information to help users understand the stabilization mechanism.