An introduction and regulatory assessment of Stablecoins like Libra, Tether and others.
The news of the week in the world of Blockchain and Cryptocurrencies was probably the change of plans (of kinds) by Facebook regarding its virtual currency Libra (with the mysterious case of a hacker stealing $25m in cryptocurrencies only to return the funds two days later). There are plenty of questions about Libra’s new plans, but more importantly what is means with a view to the framework of Stablecoin regulation. Let’s get to it one question at a time.
Who is the Libra Association?
Ok, that’s probably known to most people in the community, but for those who have not heard about Facebook’s Libra project, it’s an initiative the people behind Facebook came up with and introduced last year to the world. Rumours that Facebook was thinking of launching a cryptocurrency had been circulating for a few years, but it wasn’t confirmed until May 2019 and formally announced as Libra on 18 June. To do this, Facebook established the Libra Association based on the common model of a Swiss foundation, which is headquartered in Geneva, Switzerland. Facebook has no intention of going it all alone and the list of its founding members certainly was impressive: payments giants Visa, Mastercard and Paypal, telecom multinational Vodafone, Fintechs like Stripe and tech unicorns Uber and Lyft joined the project together with eBay and Booking and some of the most important VC firms. Asking for a minimum investment of $10 million and adding further names to the list, the foundation was well endowed for this ambitious project.
What went wrong at the Libra Association?
Right after the formal introduction, Libra was hit by a tsunami of criticism and concerns from regulators, lawmakers and industry observers. Financial watchdogs, central banks and legislators responded with long list of questions about its structure and regulatory compliance to outright stating that it would not be allowed in their jurisdiction as stablecoin regulation did not seem to play a prominent role on the agenda of the developers.
In a meeting with Facebook chief executive Mark Zuckerberg and other senior management tried to disperse these concerns on several occasions, but faced regulatory scrutiny across the board. In a meeting with top Senate Democrats in September 2019, he said that his company’s controversial digital currency would not be launched anywhere in the world until it receives the backing of regulators in the United States. This was followed by a grilling at a U.S. Senate testimony in October of the same year, but while he sought to convince the legislators that the company’s foray into cryptocurrency is a good idea, most lawmaker who spoke at the hearing took Zuckerberg to task over the company’s past failures, calling on him and Facebook to make efforts to regain their trust before moving forward with the Libra project.
Elsewhere, trust in the project eroded, too, as several founding members like Paypal, eBay, Mastercard, Stripe, Visa and Booking leaving the association within the first few months, though others like e-commerce site Shopify have since joined.
What has Libra decided?
As a result of the ongoing criticism and concerns, the Libra Association has taken a step back and reconsidered its model. In an update published on 16 April 2020, Michael Engle told the world on behalf of the Libra Association of changes to the initial approach. According to the announcement these are threefold:
- Offering single-currency stablecoins in addition to the multi-currency coin.
- Phasing the rollout of the Libra network.
- Marrying blockchain technology with accepted regulatory frameworks.
We already mentioned the move to more underlying currencies and getting more information about the rollout – in particular that at the beginning the network will only be accessible to Designated Dealers and Regulated VASPs. It is the third point though that is the especially interesting: under pressure from central banks and lawmakers, the focus is now compliance with accepted regulatory frameworks, but the big question not only Facebook and the Libra Association has been scratching their heads about is what the framework for stablecoin regulation actually looks like.
What is the framework for stablecoin regulation?
One of the key issues during the rise and fall of initial coin offerings, the craze that made cryptocurrencies famous, was the legal and regulatory categorisation of such activities. Regulators were slow to respond, but eventually they did. From the initial perception of
operating in a legal no-man’s land to denying the prominent securities question, cryptocurrencies finally found their categorization under existing and amended laws – obviously depending the respective token model and the difference between utility, security and payment tokens.
The next question is what this in respect of stablecoin regulation. A stablecoin is basically a cryptocurrency pegged to a more stable asset than the many volatile token produced in the heyday of ICOs. The underlying asset could be anything like fiat currencies like the Dollar (e.g. USD Tether), commodities like precious metals such as silver or gold or even other cryptocurrencies. The idea is that the holder can redeem the coin at the current exchange rate of the pegged asset creating an element of stability though that does not have to be the case if you take the current volatility in traditional markets.
It is similar or overlaps in that sense with Security Token Offerings (STOs) that need to be supported by something tangible like equities, bonds, or promissory notes. Since it could basically be any kind of financial instrument, STOs are more like traditional securities and could hence be applied in a similar way and in accordance with securities regulations.
The same could hold true for stablecoins as a recent IOSCO study indicated. However, the paper quickly draws attention to the fact that it is very broad term
encompasses a variety of different types of assets, including assets that may be considered securities in certain jurisdictions. That in tun renders the whole categorization a little bit less clear. In fact, as the report points out “a stablecoin’s features or the way it is used could mean that it falls under several categories at any one time or at different points in its lifecycle. Stablecoins can exhibit a wide range of different features. This means that stablecoins can, depending on their structure, fall within or outside a variety of different regulatory frameworks for financial instruments or services. Similarly, despite their label, many so-called stablecoins are neither “stable” nor “coins” in the true sense of either word. So, whilst stablecoin is a marketing term that has been widely adopted by industry, more neutral terms, may be more accurate starting points for regulatory analysis in many instances.“
What’s the bottom line?
As a result, we find ourselves in a similar dilemma as with accustomed cryptocurrencies regarding a framework for stablecoin regulation and the approach therefore ought to be the same: each case requires to be determined based on its respective features, possibly on a “substance over form” approach as developed by the ESMA. As a result the material components rather than the formal name of a financial instrument are always the decisive factors to establish the regulatory framework a stablecoin has to comply with and Libra will be no different.