Last week, the Financial Stability Board (FSB – global, G-20 related financial consulting body) published recommendations concerning blockchain “stablecoins”. The addressees of recommendations are central banks and financial regulators; its subject, stablecoins, are cryptocurrencies following the value of some traditional asset, usually US dollar, in contrast to the volatile traditional cryptos such as bitcoin or ether. The paper has received some negative responses from crypto finance community: their read is that the document is effectively a call to ban stablecoins altogether.

Łukasz Jonak, Analityk DELab UW

The general gist of the recommendation can be summarized in the following way: “stablecoins (“SCs”) could pose a number of risks to the stability of the wider financial system, therefore they need to be thoroughly regulated, and regulatory authorities around the globe should make sure they are prepared to do that”. The FSB backs its position in two ways: by showing a number of scenarios in which stablecoins could destabilize traditional financial system by simply interacting with it, an by pointing at various potential vulnerabilities within the machinery of stablecoins.

The vulnerabilities of financial systems

Let’s start with the second argument. The consultation document describes a number of areas in which stablecoin might prove unreliable and become a source of systemic risk to financial stability. One is the financial engineering of stablecoins, specifically, the mechanism of their stabilization. Most SCs are backed by a reserve of traditional, “fiat” currencies. FSB worries that this reserve might be not liquid enough, especially if for some reason there is a massive move to convert stablecoins back into traditional currency.

Another vulnerability has to do with the infrastructure and governance of the GSC. FSB points out that stablecoins need to be “antifragile” in areas of key decision making, resilience against internal and external attacks and general capacity of the network. Similarly, the tools on the user side, the wallets and exchanges they use, could be vulnerable in a number of ways.

It is worth to mention that all the above risk factors are common to any advanced and complex enough economic system; stablecoins share these risks with many traditional financial mechanisms constituting the “wider financial system” FSB guards stability of. The community of cryptoeconomy and blockchain entrepreneurs, researchers, developers and users is well aware of them (more often than not this knowledge is learned in a hard way); the ecosystem they are shaping is equipped with mechanisms that promote the mitigation of these risks as stablecoins and “decentralized finance” grow in popularity and accumulate value.

Stablecoins as disruptors

Apparently, FSB expects that the internal risk of “stablecoins” can and will be mitigated. Otherwise it wouldn’t be expecting some cryptocurrencies to become so widespread as to gain the status of “Global Stable Coins” of “systemic importance”; it is difficult to imagine that insecure, unstable, unreliable project could ever reach the status of a “GSC”. The second line of argumentation offered by FSB reveals the object of the real worry of the Board: not poorly designed and governed cryptocurrencies, but those reliable enough to become actual influence on the traditional financial system.

Couple of scenarios included in the document say as much. For example, Global Stable Coin could generate too much financial traffic for the “wider financial system” to handle, thus causing the latter to destabilize. The FSB warns against the scenario in which participants of some local traditional economy going through crisis could en masse move their assets to the more efficient and safer blockchain based economy, exacerbating the crisis. There is also a worry that the value of user’s funds denominated in GCSs” might fluctuate with the changes of the prices of the stablecoin (I assume due to the fluctuation of underlying traditional asset). This would though equal to saying that stablecoin user is exposed to the volatility of, say, the USD.

It is worth pointing out that in the above scenarios the problems seem to stem from the traditional financial systems, presumably their inadequate governance, economic design or technical infrastructure.

One thing that the FSB consultation document makes clear is that cryptocurrencies, crypto economy, is no longer considered a suspicious, obscure and ultimately irrelevant hubris of utopian technophiles. FSB calls for regulation not because of the unreliability of stable cryptocurrencies, but because it expects them to propose enough security and economic utility to become a global instrument.

Stablecoins of the giants and of distributed nobodies

Presumably what made the global regulatory authorities take cryptocurrencies and specifically stablecoins seriously was the announcement of Facebook’s Libra stablecoin. The wording of a number of statements and recomendations issued since then by various global financial organization suggests that what needs to be regulated and ultimately kept in check is a global digital currency created and controlled by a new to the world of finance, but already powerful (in terms of money, marked reach, data collected) corporate, commercial entity such as Facebook, Amazon of Apple. However the recent FSB document adds another threat profile – decentralized currencies. The behemoths, like Facebook, are powerful, but still a convenient subject of regulations. Decentralized stablecoins though are a threat to the very ability of being regulated, because of their vague governance structure, the ambiguity about what is the entity responsible for its operations. Therefore, in the FSB consultation document, the word “prohibition” pops up here and there in the context of extensively distributed stablecoins.

Regulations between guidance and control

It is difficult to blame cryptocurrency community for sharp response to the FSB’s consultation. The part of the evolution of cryptocurrency and blockchain community is the emergence of a native process of ensuring that the ecosystem of products it generates is reliable and useful. In the context of this process it is possible to perceive the external regulatory pressure in a conciliatory and pragmatic way — as a source of guidelines and best practices to be utilized as the community and products mature. However, the FSB recommendations might make it difficult to continue this kind of interpretation. The increase of popularity of stablecoins is considered by the regulator not as a sign of maturation of the system, but a threat signature. The internal standards developed and enforced by the community, validated by wide adoption of products and services, seem to mean little if they don’t match closely the “wider” regulatory framework. The very inability to be scrutinized due to decentralization, no matter how waterproof the system, is a major red flag for regulation community. It is easy to see this stance not as a provision of guidance, but as a form of control. The reality is, the latter is the mandate of the regulation.

The cryptoeconomy and blockchain world doesn’t exactly aspire to be encompassed by “wider financial system”. It doesn’t consider itself just a provider of innovative technologies to improve the world of traditional banks and stock exchanges. Apparently it has its own ideas about how certain public goods — consensus, the system of creation, transmission, storage of value, management of reputation, provisions for systemic security, and many others — should be created and governed. The Financial Stability Board recommendations seem to seriously threaten this identity.

Autor projektu: Łukasz Jonak

Projekt finansowane ze środków programu “Dialog” MNiSW