As the prominence and popularity of the stablecoin looms, so do regulations and increasing federal and other global regulations. Stablecoins present the first viable option for using cryptocurrency in regular transactions. Other than straight investment and mining purposes, like Bitcoin and Ethereum, stablecoins show potential as being used in day-to-day life transactions.
A recent interpretive letter issued by the Office of the Comptroller opens up the doors for banks to get involved with stablecoins (either in its creation, facilitation, or management), which suggests that the stablecoin does show some potential as a digital currency. Unfortunately, there is still a lot of unknowns around its uses and its regulation.
Stablecoins, which may be backed by a valued asset, are more stable than other cryptocurrencies. So while this stability exists, there are still grey regulatory areas where stablecoins do not fit, including customer due diligence or Know Your Customer (KYC) and in following anti-money laundering (AML) laws, among others.
The regulations for stablecoin could be revolutionary, but they might also handcuff stablecoin issuers to banks, therefore reducing the positive impact of stablecoin as a decentralized and privatized digital currency.
How Do Stablecoins Work?
Stablecoins are a relatively recent creation. Stablecoins emerged as a digital currency to improve upon the viability and use of cryptocurrencies like Bitcoin. Cryptocurrencies, while inherently valuable, are extremely volatile. This volatility makes it unmanageable as an everyday currency. If the value of a given cryptocurrency was fluctuating by more than one or two points (or dollars) every hour, then you would never be able to use that cryptocurrency with a merchant. The merchant and customer relationships would be fraught with discord and negotiations.
Therefore, stablecoins were created as an efficient way of managing cryptocurrency volatility. Stablecoins are created on the same blockchain ledger technology like cryptocurrency, but stablecoin issuers provide an added asset to back and support that stablecoin issuance. Therefore, if you purchase a stablecoin, you get access to the digital ledger technology with tangible assets that could be liquefied if need be.
As of now, stablecoins are backed or collateralized by three main ‘assets’: a commodity like gold, a fiat currency, and cryptocurrencies (using a smart contract algorithm that modifies the crypto amounts to maintain balance). Commodity-backed, fiat-backed, and cryptocurrency-backed are all ways that a stablecoin issuer can almost guarantee that the owner of that stablecoin owns a given value of an asset.
Why the Need for Federal Oversight?
Stablecoin issuers may seek to place their reserve funds in a deposit account with a national bank, which is authorized to receive deposits. For these reasons, then, the national bank that accepts the reserve amounts would still need to abide by laws and regulations around deposit insurance coverage, deposit limits, deposit pass-throughs to a depositor, and the proper disclosures around these deposits.
Therefore, unless stablecoin issuers have the ability to create their own financial institutions, then the National Bank or Federal Savings Association (FSA) are already participating in the facilitation of cryptocurrencies by acting as a constituent reserve. Because central banks under federal regulations need to abide by federal securities laws, they need to be able to obtain certain information about the money and account holder depositing the backing assets.
Therefore, regulated banks need to provide disclosures around deposit insurance coverage, comply with anti-money laundering laws, proper monitoring for Bank Secrecy Act (BSA) compliance and customer due diligence (CDD or KYC), and customer identification set under the requirements of section 326 of the USA PATRIOT Act.
Customer account identification and verification have been one of the biggest roadblocks to cryptocurrency acceptance, especially since anonymity is what makes the blockchain ledger so profoundly successful. Therefore, banks might rely on the verification procedures of stablecoin issuers in order to perform CDD or KYC. The stablecoin issuer would need to be the beneficial owner of the legal entity on behalf of the customers opening accounts.
Potential Federal Regulatory Needs
Considering the unique role of federal banks in managing stablecoin assets, stablecoin issuers may need to enter into contractual agreements with the National Bank and FSA. Primarily, banks need to be prepared to liquefy assets and manage liquidity risk, a heavy risk that comes with stablecoins. Banks will also have to create new, feasible, and compliant business relationships with third-party stablecoin issuers, including stablecoin managers and responsible parties.
Banks must be prepared to audit these third-party programs, and this would require third parties and banks the ability to share confidential yet verifiable information about stablecoin customers. These agreements would need to set in place processes of each responsible party, verification methods, liquidity processes, and outlining all of the interagency guidelines that are needed.
Unfortunately, considering the level of risk, banks may need to provide additional oversight and this might change how stablecoins can be issued and used. Luckily, the introduction of regulation or legislation means that stablecoins are being accepted in federal financial circles and proves that their uses will continue to grow.
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