Date: 07 September, 2023

In a significant move, global securities regulators have unveiled a blueprint aimed at holding participants in “decentralized finance” (DeFi) accountable for their actions and ensuring market stability. DeFi platforms, leveraging blockchain technology, enable users to engage in activities like lending, borrowing, and saving in digital assets, circumventing traditional financial gatekeepers such as banks and exchanges.

The collapse of the FTX crypto exchange and the Terra USD stablecoin in 2022 demonstrated how shocks in one part of the crypto market could trigger substantial outflows from DeFi applications, leading to a reduction in DeFi from approximately $180 billion in late 2021 to about $40 billion presently. Additionally, the sector has been linked to money laundering concerns.

IOSCO, the global umbrella body for securities regulators, highlighted a common misconception that DeFi is entirely decentralized, emphasizing that responsible individuals can be identified regardless of the operating model. Stakeholders and their roles in DeFi often mirror those in traditional finance.

IOSCO acknowledged the challenge of limited standardized data on DeFi, exacerbated by participants using multiple pseudonymous addresses to obscure their activities. To address these issues, the watchdog has proposed a framework for regulators across its 130-member jurisdictions. The framework aims to ensure investor protection, maintain stable markets in the DeFi space, identify and manage risks, promote clear disclosures, and encourage cross-border cooperation to enforce applicable laws.

Key Points:

• Global securities regulators have introduced a blueprint to hold participants in decentralized finance (DeFi) accountable and ensure market stability.
• DeFi platforms utilize blockchain technology, allowing users to engage in various financial activities without relying on traditional gatekeepers like banks and exchanges.
• The 2022 collapse of the FTX crypto exchange and Terra USD stablecoin revealed how shocks in the crypto market could lead to substantial outflows from DeFi, reducing its value from $180 billion in late 2021 to around $40 billion.
• DeFi has been associated with money laundering concerns, prompting the need for regulatory intervention.
• IOSCO, the global umbrella body for securities regulators, dispels the misconception that DeFi is entirely decentralized, emphasizing the identification of responsible individuals regardless of the operating model.
• Stakeholders and roles in DeFi often mirror those in traditional finance, challenging the notion of complete decentralization.
• Limited standardized data on DeFi poses a challenge, exacerbated by participants using multiple pseudonymous addresses to obscure activities.
• IOSCO proposes a framework for regulators in its 130-member jurisdictions, focusing on investor protection, stable DeFi markets, risk management, clear disclosures, and cross-border cooperation to enforce applicable laws.

References:

https://www.reuters.com/technology/global-regulators-seek-crack-down-decentralised-finance-2023-09-07/

https://money.usnews.com/investing/news/articles/2023-09-07/global-regulators-seek-to-crack-down-on-decentralised-finance

Date: 17 April, 2023

In a statement on Monday, Bank of England Deputy Governor Jon Cunliffe suggested the necessity of imposing initial limitations on the use of major stablecoins for payments. He emphasized the importance of such stablecoins being backed by high-quality and liquid assets to safeguard consumers. The UK is in the process of adopting regulations for stablecoins, a type of cryptocurrency backed by assets or fiat currency, enabling consumers to make digital payments.

Cunliffe, speaking at a conference organized by Innovate Finance, highlighted that systemic stablecoins must be supported by high-quality and liquid assets. Possible options include deposits at the Bank of England or highly liquid securities, or a combination of both, with the central bank considering the most appropriate approach.

He acknowledged that initially, protecting stablecoin deposits in the event of a failure wouldn’t be feasible using the industry-funded scheme that safeguards sterling bank deposits up to £85,000. This underscores the importance of ensuring that the backing assets maintain sufficient value to meet redemption requests, potentially involving capital requirements.

While the Bank of England believes that over time, risks to financial stability from stablecoins can be manageable, Cunliffe expressed uncertainty about the extent and speed of stablecoin adoption. Consequently, he suggested the potential need for limits, at least initially, to prevent disruptive changes that could threaten financial stability.

Key Points:

• Bank of England Deputy Governor Jon Cunliffe advocates for initial limitations on major stablecoins’ use for payments.
• Emphasis on the importance of stablecoins being backed by high-quality and liquid assets to ensure consumer protection.
• The UK is in the process of establishing regulations for stablecoins, a type of cryptocurrency backed by assets or fiat currency, facilitating digital payments.
• Systemic stablecoins should be supported by high-quality and liquid assets, including options like deposits at the Bank of England or highly liquid securities, with the central bank exploring the most appropriate approach.
• Initial protection of stablecoin deposits in case of failure may not be possible using the industry-funded scheme safeguarding sterling bank deposits up to £85,000, highlighting the need for backing assets to maintain sufficient value for redemption, potentially involving capital requirements.
• Bank of England anticipates that, over time, risks to financial stability from stablecoins can be manageable but expresses uncertainty about the extent and speed of stablecoin adoption.
• Cunliffe suggests the potential need for limits, at least initially, to prevent disruptive changes that could pose a threat to financial stability.

References:

https://www.reuters.com/business/finance/bank-england-says-may-need-limits-using-stablecoins-payments-2023-04-17/

https://www.bloomberg.com/news/articles/2023-04-17/bank-of-england-official-says-stablecoin-use-may-need-limits

Date: 08 November, 2023

On November 8, the European Union’s banking watchdog introduced proposals mandating that issuers of stablecoins backed by currencies must possess adequate funds for complete investor redemption starting from June. As part of the world’s first comprehensive set of rules for cryptocurrency and stablecoin markets, the European Banking Authority (EBA) outlined minimum capital and liquidity requirements for stablecoin issuers and other forms of digitized tokens. The EBA initiated public consultations specifically on liquidity requirements for the reserve of assets supporting a stablecoin, emphasizing the use of eligible high-quality assets.

The objective is to ensure that these assets can be swiftly liquidated, even in stressed markets, to generate cash for meeting redemption obligations, thereby preventing runs and contagion during a crisis. The EBA stipulates that issuers of stablecoins backed by a currency must be capable of offering full redemptions to investors at par. In contrast, stablecoins backed by assets such as gold are only required to offer redemptions at the prevailing market price for the asset at the time of redemption.

Post-application of the guidelines, supervisors may enhance liquidity requirements for relevant issuers based on the results of liquidity stress testing, as outlined in a statement by the EBA. Notably, the proposed liquidity rules consider potential exemptions for banks in specific cases, acknowledging their existing liquidity buffers under EU bank capital and liquidity regulations. This approach ensures that stablecoin issuers, even if non-bank entities, adhere to equivalent safeguards, preventing any unfair advantages in capital or liquidity compared to banks.

Key Points:

• European Union’s banking watchdog proposes regulations for stablecoin issuers, requiring sufficient funds for full investor redemption starting from June.
• European Banking Authority (EBA) outlines minimum capital and liquidity requirements as part of the world’s first comprehensive rules for cryptocurrency and stablecoin markets.
• Public consultations initiated by EBA focus on liquidity requirements for the reserve of assets supporting stablecoins, emphasizing eligible high-quality assets.
• Objective is to enable swift liquidation of assets, even in stressed markets, to generate cash for meeting redemption obligations and preventing runs and contagion during crises.
• Issuers of stablecoins backed by currency must offer full redemptions at par to investors, while those backed by assets like gold only need to offer redemptions at the prevailing market price.
• Supervisors may enhance liquidity requirements for issuers based on liquidity stress testing results after the guidelines’ application.
• Proposed liquidity rules consider potential exemptions for banks, recognizing existing liquidity buffers under EU bank capital and liquidity regulations.
• Ensuring that stablecoin issuers, even if non-bank entities, adhere to equivalent safeguards, preventing unfair advantages in capital or liquidity compared to banks.

References:

https://www.reuters.com/markets/europe/eu-watchdog-sets-out-capital-liquidity-rules-stablecoin-issuers-2023-11-08/

Date: 07 December, 2023

On December 7, global banking regulators announced plans to initiate consultations regarding potential revisions to the capital adequacy requirements for banks covering risks associated with stablecoins. The Basel Committee expressed its intention to address “unacceptable behaviours” exhibited by certain global banks. This development follows the committee’s review of standards established a year ago on how banks should handle exposures to crypto assets.

Stablecoins, typically backed by a traditional currency, currently receive less stringent capital treatment under Basel’s rules compared to unbacked crypto assets like bitcoin. However, some stablecoins have proven to be less stable than initially claimed. In response, the Basel Committee will conduct consultations later this month to explore potential revisions to the criteria for “Group 1b” stablecoins, particularly those claiming to possess a stabilization mechanism.

Last year, Basel indicated a need for further examination to identify reliable tests for low-risk stablecoins, potentially influencing the criteria for inclusion in Group 1b. The forthcoming consultations will also address technical amendments to enhance a consistent understanding of the standard.

The committee affirmed that crypto assets using permission less blockchains present inherent risks that current mitigation measures cannot sufficiently address. Consequently, the existing treatment for such assets will be maintained.

In addition to stablecoins, the committee reviewed the risks associated with banks providing custody services for crypto assets. Ongoing monitoring will determine if additional measures are required.

Looking ahead, the committee plans consultations in the coming year to explore policy options aimed at preventing “window dressing” by globally systemic banks. This refers to a form of “regulatory arbitrage behaviour” intended to temporarily reduce perceived risk profiles during specific reporting periods.

Key Points:

• Global banking regulators, led by the Basel Committee, plan to revise capital adequacy requirements for banks in response to the risks associated with stablecoins, initiating consultations.
• The Basel Committee aims to tackle “unacceptable behaviours” observed in certain global banks, following a review of standards established a year ago on handling exposures to crypto assets.
• Despite receiving less stringent capital treatment, some stablecoins backed by traditional currencies have proven less stable than claimed, prompting the Basel Committee to consider potential revisions and consultations.
• The committee acknowledges inherent risks in crypto assets using permission less blockchains, maintaining existing treatment due to insufficient mitigation measures.
• The committee plans future consultations to explore policy options preventing “window dressing” by globally systemic banks—a regulatory arbitrage behaviour aiming to temporarily reduce perceived risk profiles during specific reporting periods.

References:

https://www.reuters.com/business/finance/global-regulators-review-bank-capital-rules-stablecoin-exposure-2023-12-07/