4 Insights on the State of Stablecoin Regulation Right Now

4 Insights on the State of Stablecoin Regulation Right Now

The last year has seen seismic shifts in how law-makers are approaching crypto regulation.

Thousands of pages of potential legislation have been drafted. Hundreds of hours of hearings, meetings, and briefings. Where does this leave us moving forward?

In this piece, we’ll dive into four high level insights on the state of stablecoin regulation (particularly in the United States).

#1// The crypto IQ of individual law-makers seems as distant as the east is from the west

At the polar extremes, there are members who say that crypto is fraudulent, a ponzi, and scourge on society. There are members who see this new frontier of technology and want to encourage responsible innovation. Then there are members who showcase so little understanding, it kind of makes one wonder if they care at all..

The biggest buzzword in drafted legislation and in-person hearings is “investor protection”. Depending on who is asked about this, you will hear a variety of answers as to what precisely this means.

#2// The primary concern of regulators with stablecoins is reserve attestation

A report from the President's Working Group on Stablecoins (2021) describes the primary dangers of stablecoins:

  • Risk of bank runs (where users are unable to redeem the stable)
  • Doing bad things in DeFi (irresponsible leverage, fraud, market manipulation)
  • Payments risk (credit risk, liquidity risk, operational risk, settlement risk, improper system governance)
  • Systemic risk and concentration of economic power (widely adopted stables that fail could cause distress and instability in the “real” economy)

The one attribute of stablecoins that offers massive protection against each of these dangers is fairly straight-forward: fully collateralized backing.

Proposed legislation like Stablecoin Transparency Act (and many others) require a stablecoin issuer to hold all reserves associated with each fiat currency-backed stablecoin they issue in (1) certain government securities; (2) fully collateralized security repurchase agreements, or (3) U.S. dollars or other non-digital currency.

Additionally, each stablecoin issuer must give a public (on their website) monthly report on their reserves. This must be confirmed by a third party audit.

#3// It appears that basket-pegged stablecoins will not endure the same regulatory scrutiny as single-fiat pegged stables

The reason for this is simple: fiat derivatives create a level of risk.

Right now there are over 200 stablecoins with a total market capitalization of ~$140B with a vast majority being pegged to the USD. This is roughly the same MC as Ethereum with a current market dominance of 16-18%.

If we truly seek widespread crypto adoption, it would be willfully ignorant to say there’s no risk in stablecoins pegged to the USD. The Fed is weighing their options right now to decide how to manage the risk associated with hundreds of billions of dollars of USD derivatives, and stablecoins pegged to the USD will have to adapt to regulatory changes resulting from the Fed’s upcoming decisions.

But what about a decentralized stablecoin not pegged to a dollar, but instead to a basket of assets, currencies, and commodities? The clear picture we’re getting on the state of regulation is that such a stablecoin would be subject to far less scrutiny.

This is good news for SILK’s positioning and adoption.

#4// A US Central Bank Digital Currency seems ready to appear any time

Any decisions here will have massive repercussions on the future of stablecoin regulation in the United States.

The vision of FedNow is low-fee, instantaneous payments. But FedNow is more than that. It is the payment infrastructure for a CBDC. The railroad track has been laid down. We shouldn’t be surprised to see a train running on it soon.

Some estimates suggest that a CBDC is 4-5 years away. Policymakers in-tune with crypto believe that many of the problems CBDCs are purported to solve will already be resolved by current stablecoins at that point. Namely, low fees, ease of transact-ability, and widespread access to all citizens.

The CBDC conversation is the ultimate litmus test for the United States’ mindset on stables. But it is a polarizing conversation within US legislative bodies. Stay tuned.

Government regulation can never provide as much accountability as the shared ownership of decentralized governance.

By all means, we need US lawmakers to deliver reasonable parameters that facilitate responsible financial innovation. But regulators must account for the critical distinctions between centralized and decentralized organizations, custodial exchanges versus protocol owned liquidity.

Legislation like the proposed “Digital Asset Anti-Money Laundering Act” miss this nuance when they seek KYC for everyone with a wallet. It’s an aggressive move to surveille self-custody.

On the DeFi front, right now we have 17,000 protocols. Who will police the integrity and safety of these protocols most effectively: A regulatory body or the community of users and builders who share ownership of that protocol?

Given the regulatory climate, the demand for compliant privacy, and the panicked exodus from centralized finance to decentralized finance and self-custodianship, Shade Protocol and Silk are positioned to succeed in the rapidly changing regulatory and economic environments. The future is bright.

Information provided in this post is for general informational purposes only and does not constitute formal investment advice. Please read the full disclaimer at shadeprotocol.io/disclaimer before relying on any information herein.