Many financial institutions and companies are weighing the pros and cons of issuing their own stablecoins. New regulations in Europe have been announced that will provide both the clarity needed for issuers and the confidence necessary for users. The use cases of stablecoins continue to proliferate with ongoing advances in Web3, while rising interest rates make reserve management a profitable proposition for their issuers.
In this exclusive interview with Daniel Lee, Head of Web3 at Banking Circle, we discuss what issuers need to consider: the type of stablecoin, governance structure, use cases and how stablecoins can thrive in the face of competition from CBDCs.
What are the decisions that financial institutions need to make when deciding whether to explore the issuance of their own stablecoins?
The first thing is to decide between the three types of stable coins. The first is backed by fiat or cash equivalent assets. The second is backed by fiat plus other collateral such as bonds. The third is algorithmic or crypto-asset based.
After what happened to Luna, there's a lot of concern about crypto asset-backed stable coins or algorithmic-backed stablecoins. What is important about this is that now you need to have regulated institutions to back the issuance of the coin. That is something where we as a bank can play a role, not only just holding on to the fiat and managing the reserves but also to provide overall evidence on the coin.
What are the most important considerations? Are they around digital custody?
The most important thing is overall governance. Digital custody does not play a role if you're not doing crypto assets. If you are doing a fiat-backed stablecoin, then you are only dealing with short-term money market-type instruments. Custody becomes important if a coin is going to be backed by crypto assets or if it involves a bankruptcy-remote structure.
We are looking to help our clients issue the highest possible quality of stablecoin. The whole purpose of a stablecoin is that it must represent the underlying assets very accurately and shouldn't deviate. To do that, it must have a very good governance structure and transparency for the users where information on audited reserves is made available.
And what does a good governance structure look like?
A good governance structure is one that is transparent. It would have very clear, quick and periodic reports on what is happening to the reserve. And that has to be available to all users of the stablecoin. You also need to detail the ways in which the structure you’re setting up is bankruptcy-remote. Bankruptcy remoteness is important if you are going to set up a stablecoin where you give the users the highest level of confidence in the issuance. This would be similar to a fully replicated ETF structure, where even when an ETF issuer or manager collapses, the collateral in the fund is safe and can be returned to the holders of the ETF.
Similarly in a bankruptcy-remote structure, even if the issuer collapses, the funds can be returned to each of the holders of the stablecoins. A good governance structure will ensure that the collateral is really there, and if not fiat or fiat equivalents, it’s properly marked-to-market. This would ensure the utmost trust in the stablecoin.
What are the main concerns that you are seeing at companies that wish to set up a stablecoin?
They must determine the use case of issuing their own stablecoin and how this would be different from those that have already been issued. There are a lot of crypto firms that have a large enough user base that they can issue their own stable coins.
But there are some concerns after what has happened to certain stablecoins: How secure is the stable coin? How well are the reserves being managed? Where are the reserves being managed?
Those are the kinds of issues where we can add value when we partner with companies that want to issue stablecoins. We add credibility to the issuance by being a bank and therefore being able to provide a strict governance structure to the issue.
How are the new regulations that are coming up going to help clarify some of these issues and will they help set new standards?
What is happening with MiCA [Markets in Crypto Assets EU regulatory framework] is very clear in terms of what we can and cannot do with the reserves. It’s very important. Even though MiCA is not yet live, we can follow what it prescribes and issue a coin based on those requirements. We can voluntarily comply with those regulations for good governance. That's the whole purpose. We can show the governance structure to the users of the coin, so they have confidence.
What are your predictions for how the market for stablecoins might develop over the next three years?
A lot of stablecoins today are denominated in U.S. dollars. Not many have been created using euros and other currencies. This is partially due to the previous negative interest rate environment, as it’s hard to generate the yield on the reserve.
But going forward, euro stablecoins makes a lot of sense, as there is a huge European market of crypto traders, investors and users and whenever they trade on different exchanges or DAOs or protocols, they expose themselves to some sort of forex risk, when trading in U.S. dollars.
How do you think the CBDC market is going to develop?
It’s difficult to know at this stage how CBDCs might actually take shape. In most of the experiments that are underway, the CBDC always ends up being issued on a very centralized model, or it’s being issued on some sort of permissioned blockchain. If that's the case, then it defeats the whole purpose of the decentralization of money.
CBDCs will be issued from a centralized source and be controlled from a centralized source. What then is the use case of the CBDC? It's just digital money. A CBDC’s success really depends on how it's executed, how decentralized it gets and whether it could be used as an investment product, not just a remittance product used to pay somebody.
A CDBC’s value is simply the trust one places in the issuer – in this case a central bank. If a stablecoin is issued in a bankruptcy-remote structure with good governance, it could provide the same kind of trust. It’s also likely that when CBDCs are initially issued, they will have many restrictions on use and may initially be just tools for remittance.
Stablecoins on the other hand can be freely used as M1-M3 in various ecosystems including decentralized ones. Furthermore, stablecoins can also be issued on a few chains, while in most CBDC experiments only one chain is chosen. Technically, though, they can also be issued on a few chains, but due to the conservative nature of most central banks, the process of issuance on other chains may take much longer.
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