The FSB is wary that stablecoins may be better than fiat currencies and want central banks to maintain power.

On Tuesday, the Financial Stability Board (FSB) released a document (PDF download) that outlined the risks posed by stablecoins and provided 10 high-level recommendations that central banks should consider to regulate and, in some cases, prohibit them. 

We’ve reviewed and analyzed the nearly 70-page document to understand the FSB’s position and how their recommendations may impact the stablecoin economy. We’ve broken this analysis down into the following sections:

Let’s go!

Who is the FSB and why are they doing this now?

The Financial Stability Board is an international entity that monitors and makes recommendations about the global financial system. Its members include representatives of central banks and ministries of finance from G20 member states, as well as global financial institutions such as the World Bank, European Commission, and many others. 

While the FSB has no formal legal power, its recommendations are quite influential for global financial authorities.

In February, the members of the FSB tasked the organization with analyzing the impact stablecoins may have on the global financial system. 

Why now, though? 

Stablecoins have become significant enough to garner the attention of central banks and global authorities and are on the cusp of having an outsized impact on the global economy.

The market cap of stablecoins has grown significantly over the past two years, and trading volume continues to increase as well. 

Growth in stablecoin market cap. Courtesy of Stablecoinindex.com

And global authorities are wary that stablecoins may have a detrimental impact on the use of their fiat currencies. 

Summary of the FSB’s position

In this section, we summarize the supposed risks that stablecoins pose to the global financial system and the FSB’s recommendations on how to regulate stablecoins. 

The supposed risks that stablecoins present

The FSB highlighted a few primary risks that stablecoins pose. We’ll simply state them here, and analyze them further in the section titled “Our analysis of the FSB’s position”.

First, they identified that if a stablecoin were to be used as a store of value, a moderate change in the stablecoin’s value might cause fluctuations in users’ wealth, which may impact spending decisions and users’ economic activity. 

Next, the FSB said that if a stablecoin were widely used for payments, any disruption to the operations and management of the stablecoin may significantly impact economic activity and proper functioning of the financial system. Additionally, large scale flows of funds into or out of stablecoins could test the ability of the supporting infrastructure to handle high transaction volumes and thus potentially negatively impact the wider financial system.

Want to learn everything you need to know about stablecoins? Click here to download our 31-page Stablecoin handbook. You'll be an expert in no time!

Third, stablecoins may cause market, credit, and operational risk to financial institutions, especially those who play multiple roles with respect to managing stablecoins, such as resellers, wallet providers, or custodians of reserve assets. 

The FSB also claims that widespread use of stablecoins might magnify confidence effects on the economy, in both positive and negative ways. 

First, consumer confidence might impact the extent of use of stablecoins as a store of value or medium exchange. 

Additionally, if financial institutions who play a role in managing stablecoins come under financial distress, this may detrimentally impact these stablecoins. And vice versa - if a stablecoin faces problems, this might expose the financial institutions to adverse confidence effects. 

Also, these problems may interact with each other. For example, if stablecoin payments channels are disrupted, consumer confidence may tank, which may induce mass redemptions, thus causing a decline in the stablecoin’s price, which will further decrease confidence. 

Finally, the FSB states that stablecoins may cause macroeconomic effects. If people use stablecoins as a store of value over fiat currencies during tough economic times, this can have destabilizing effects on capital flows, exchange rates, and domestic bank funding. 

Summary of risks that stablecoins present, according to the FSB.

FSB’s recommendations

In light of these potential risks, the FSB laid out 10 high-level recommendations on how central banks should regulate and oversee stablecoins. In short, the FSB recommends that authorities should:

  1. Have and use the necessary tools and resources to comprehensively enforce regulation of and, if necessary, prohibit stablecoins. 
  2. Apply regulations proportionate to the level of risks stablecoins present. 
  3. Ensure proper regulation across borders, both domestic and international. 
  4. Ensure that stablecoin entities have a comprehensive governance framework.
  5. Ensure that stablecoin entities have effective risk management policies, specifically pertaining to reserve management, operational resiliency, cybersecurity, anti-money laundering, and countering financing of terrorism.
  6. Ensure that stablecoin entities have robust systems for collecting, storing, and managing data.
  7. Ensure that stablecoin entities have appropriate recovery and resolution plans. 
  8. Ensure that stablecoin entities provide users and relevant parties with comprehensive and transparent information on how their stablecoins work and maintain their peg. 
  9. Ensure that stablecoin entities provide legal clarity on users’ redemption rights and the process for redemption. 
  10. Ensure that stablecoins meet all applicable regulations in a particular jurisdiction before operating there. 

Our analysis of the FSB’s position

We believe that many of the FSB's conclusions are unfounded, the goal of these recommendations are to help central banks maintain centralized authority, and that the risks they identify are no riskier than any that exist today.

By writing this document, we believe that the FSB recognizes that stablecoins can be very useful and are superior to fiat currencies in many ways. Thus, they present a true threat to citizens’ use of fiat currencies over the long term.

Let’s assess the risks that the FSB identified and debunk them. 

Risks of stablecoin use as a store of value

The first potential risk that the FSB identified was that if stablecoins were used as a store of value, and its value varied a bit, this might cause significant fluctuations in users’ wealth. These fluctuations might impact spending decisions and economic activity.  

First, if a GSC were used as a common store of value, even a moderate variation in its value might cause significant fluctuations in users’ wealth. Such wealth effects may be sizeable enough to affect spending decisions and economic activity. 

What about variations in the value of the fiat currencies that central banks manage? 

One of the key applications of stablecoins, and a major reason why they and other cryptocurrencies like bitcoin exist, is for protection against fiat inflation. And this is because many countries’ central banks have mismanaged their fiat currency to the point where their value has significantly diminished. 

Venezuela is a prime example of this. Their economy has been so mismanaged by their government that their inflation rate has reached 500,000%, which makes their fiat currency, the Bolivar, basically worthless. 

Venezuela's insane inflation. Courtesy of Statista.

With the declining purchasing power of the Bolivar, Venezuelan citizens can’t even afford to buy essentials like food and water. I’d say this has an impact on “spending decisions and economic activity,” wouldn’t you? 

Risks of disruptions to stablecoin operations

The FSB also highlighted that disruptions to the operational processes of stablecoins might have a significant impact on economic activity. 

Second, if widely used for payments, any operational disruption in the GSC arrangement might have significant impacts on economic activity and financial system functioning. If users relied upon a stablecoin to make regular payments, significant operational disruptions could quickly affect real economic activity, e.g. by blocking remittances and other payments. 

While this may be true, traditional financial institutions are not immune to operational disruptions that impact economic activities. Case in point - recently, the websites and apps of major banks like Chase, Capital One, and PNC are buckling under the load of people checking whether they’ve received their stimulus payments. Don’t you think this is impacting economic activity right now?

The FSB also stated that large volume of funds going into or out of the stablecoin could strain supporting infrastructure in handling of high transaction volumes, potentially negatively impacting the wider financial system.

Large-scale flows of funds into or out of the GSC could test the ability of the supporting infrastructure to handle high transaction volumes and the financing conditions of the wider financial system. 

This is absolute trash. The global financial system executes over $6 trillion worth of foreign exchange transactions per day and continues to grow. And these financial rails are working just fine. 

Want to learn everything you need to know about stablecoins? Click here to download our 31-page Stablecoin handbook. You'll be an expert in no time!

Risk of stablecoins to financial institutions

The FSB also believes that stablecoins may cause market, credit, and operational risk to financial institutions, especially those who play multiple roles with respect to managing stablecoins, such as resellers, wallet providers, or custodians of reserve assets. 

Third, exposures of financial institutions might increase in scale and change in nature – particularly if financial institutions played multiple roles within a GSC arrangement (for example as resellers, wallet providers, managers or custodians/trustees of reserve assets). This may be a source of market, credit and operational risks to those institutions. 

Financial institutions take on a large amount of risk each and every day. They are faced with credit, operational, market, and liquidity risk and thus are required to have appropriate risk management strategies in place.

The fact of the matter is that stablecoins pose no more risk to financial institutions than any other financial asset. 

Rather, central banks are facing a real risk of becoming obsolete if stablecoins replace weak fiat currencies and improve the global financial system. And these central banks just can’t fathom that. 

The stablecoins that are well-equipped to deal with these recommendations

We believe that certain types of stablecoins are better prepared to deal with FSB’s recommendations, should they be implemented by central banks. 

There are many stablecoins on the market, each holding its position on the spectrum of decentralization. 

Some stablecoins' position on the decentralization spectrum

On one end, there are centralized, fiat-collateralized stablecoins like Tether and USDC. 

Because these depend on the current financial system to operate, they must be highly regulated and closely monitored by authorities. And under the FSB’s recommendations, they will continue to be. So it’s likely that they will be able to operate in a similar manner than they do today. But they will still be very risky because:

  1. There is still a chance that central banks will decide to outright ban fiat-collateralized stablecoins. If this is the case, these stablecoins will go bye-bye.
  2. You still have to trust and have confidence in a central party to properly manage the monetary policy of the stablecoin, making them not that different from fiat currencies. 

On the other end of the spectrum are fully-decentralized stablecoins, like Meter. Central banks may try to regulate these stablecoins but the more decentralized they are, the more difficult it is to enforce regulations. 

A fully-decentralized currency is run by its community and lacks a centralized entity for authorities to fine, sue, or disband. 

Additionally, the Meter stablecoin MTR doesn’t rely on collateral, whether it’s fiat, commodity, or crypto, to be created and hold value. Thus, authorities can’t try to seize or establish control over this collateral to affect the value of MTR. Rather, MTR naturally holds value in itself due to its unique consensus mechanism. 

So while regulators can try to ban the use of fully-decentralized stablecoins like Meter, their power to do so is greatly diminished. 

The stablecoins that lie in the middle of the spectrum that will face major problems. 

They are not centralized enough to succeed in a highly-regulated environment, nor are they decentralized enough to be able to withstand bans by the government. 

If the FSB’s recommendations see widespread enactment, these stablecoins will cease to exist. 

Conclusion

Cryptocurrencies and stablecoins were created in large part due to the failures of central banks to properly manage their economies and fiat currencies. 

Stablecoins are much more efficient and provide many benefits as a store of value and medium of exchange compared to fiat currencies. And now that their usage has grown significantly, authorities are reacting in a totally expected way - with fear, anxiety, and a fervor to maintain centralized power. 

And some stablecoins are better suited to dealing with the FSB’s recommendations than others. 

This is certainly a significant story that we’ll be tracking closely, but here at Meter, we're not worried. 

What are your thoughts on the FSB’s recommendations? Which stablecoins do you think are best equipped to deal with them? We’d love to hear from you!

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