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Stablecoins are a relatively new form of cryptocurrency and are often regarded as a solution to the instability of other cryptocurrencies such as Bitcoin. Stablecoins such as Tether, TrueUSD, Basis, and Saga are backed by fiat currency like the dollar, euro, and others.
Stabelcoins have their critics, but they were essentially born to solve some of the problems faced by cryptocurrencies – stability and usability are the major issues that stablecoins attempt to solve. Even though cryptocurrencies are becoming more and more popular, there still hasn’t been much movement on using cryptocurrencies for everyday spending. Some companies have experimented with allowing Bitcoin payments, but unfortunately it’s not widespread and doesn’t always last.
In 2014 travel company Expedia started accepting Bitcoin payments but stopped in 2018 due to support problems with the cryptocurrency exchange Coinbase, since then they have been quiet on whether they will restart crypto payments. Computer hardware retailers started accepting Bitcoin payments in 2014, but only for US customers. KFC Canada also launched a ‘Bitcoin Bucket’, but it’s only available in Canada. The usability of cryptocurrencies is linked to the stability issue.
Your landlord would be unlikely to accept rent in Bitcoin and write this in your contract since it would be too much hassle to determine the amount of Bitcoin needed to pay each month since it’s value fluctuates wildly and can be difficult to predict. So, if many cryptocurrencies are unstable in nature, then how can make them more usable and more widespread? How do we adopt cryptocurrency into society at large?
Some think stablecoins are the answer. They solve the instability problem by having the digital asset backed by traditional currency, and if the virtual coin is stable, then it should also be predictable and hence it can translate easier into the real world.
Tether (USDT) is linked to the dollar so that 1 Tether coin equals 1 USD and is a very popular stablecoin; this means that the virtual coin is stable and can work in a similar way to traditional currency and it also means that there isn’t a reserve of virtual coins that will run out, as is usually the case with cryptocurrency. However, that isn’t to say that stablecoins don’t have their own problems and issues, they do. They are often fully controlled by the company which created them, meaning they are more centralized and there’s also no way to prove the reserves exist or that the coin is really backed at a 1:1 ratio unless the companies conduct a third-party audit. These are problems that USTD has run into and been criticized for in the past.
Coins backed by existing currency are called fiat-collaterlized stablecoins, and stablecoins backed by other cryptos are called crypto-collateralized coins. Crypto-collateralized stablecoins are backed by more than one cryptocurrency in order to keep the system decentralized and not vulnerable to a single point of failure. These virtual coins still have the stability issue, even if to a lesser extent than a single cryptocurrency; however, decentralization is a major selling point of crypto which makes this approach attractive to many. Non-collateralized stablecoins also exist, but they aren’t backed by any real-world assets at all, but rather their value is determined by using algorithms.
Whatever type they are, stablecoins are on the rise. JPMorgan recently announced the launch of their stablecoin, JPM Coin; blockchain startup Paxos announced its stablecoin in autumn last year, and cryptocurrency finance company Circle launched its own around the same time. When cryptocurrency has seen booms in popularity and investment, what follows is the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) taking a closer look at the industry and more whispering of regulation.
So how do we determine the legal status of stablecoins? Where will they fit into our economies and legislation? Up until now, the SEC has largely focused its attention on initial coin offerings in the crypto space; however, as stablecoins continue to grow, they are likely to turn their sights on whether these digital assets are compliant.
The stablecoin Basis is an example of a non-collateralized stablecoin which is stabilized through on-chain supply management. In April 2018 Basis hit headlines when it raised $133 million in funding from venture capitalist firms. Eight months after this, Basis closed and had to return any remaining capital back to the investors. Basis CEO Nader Al-Naji stated:
“We met with the SEC to clarify a lot of our thinking [and] got the impression that we would not be able to avoid securities classification.”
If we consider US Federal Law, it’s likely that stablecoins will be considered “demand notes”; this is because stablecoins are purchased with a stablecoin issuer and in return, the issuer will give them the equivalent amount worth of stablecoin. Demand notes are considered to be securities under US law unless a specific exception applies. This exception may be if stablecoins become defined as “swaps”. According to Investopedia, a swap is defined as:
“an agreement between two parties to exchange sequences of cash flows for a set period of time. Usually, at the time the contract is initiated, at least one of these series of cash flows is determined by a random or uncertain variable, such as an interest rate, foreign exchange rate, equity price or commodity price. Conceptually, one may view a swap as either a portfolio of forward contracts or as a long position in one bond coupled with a short position in another bond.“
If stablecoins are considered swaps or securities then the industry can expect to be hit with a whole lot more regulation; yet, individual providers may be able to argue that their stablecoin doesn’t fit into this definition and as such they should be excluded.
The “State of Stablecoins 2019 Report” was released in February this year and found that 36.8% of stablecoin issuers view the industry regulations as favorable. Blockchain Analyst George Samman authored the report and said:
“Money systems are broken in many parts of the world. many governments have lost control of their monetary policy and it has destabilized countries and reduced their wealth… inflation and hyperinflation are more common than people think and having a stable and transparent money option can solve a lot of problems for those afflicted by bad monetary policy.”
Some of these 36.8% believe that stablecoins will be viewed more favorably by regulators than other cryptocurrencies. However, 13.2% have an unfavorable view of regulation in the stablecoin space at present. It’s fair to say there is relatively little regulation at present so we can only expect this percentage to rise as more regulation comes in. The report highlights the wider conflict between the regulators and the crypto industry, the two often don’t agree with each other and this is something that will only get worse as time goes on. Overall, though, George Samman remains positive about the future of stablecoins and cryptocurrency, and their role in a revised finance system. He said:
“Personally, I feel these projects and the ones that aren’t tied to traditional financial institutions hold the most promise.”
Time will tell how the US’s regulatory bodies choose to tackle the issue of stablecoins, but the current boom in stablecoins is likely to speed up this process and encourage the SEC and others to act sooner than they otherwise would have.