April 15, 2021
In 2009, Satoshi Nakamoto released Bitcoin into the world with the promise of delivering a peer-to-peer electronic cash system that “would allow online payments to be sent directly from one party to another without going through a financial institution.”
Since its debut, Bitcoin’s value has continued to increase as interest in cryptocurrency as an investment has grown. However, while Bitcoin is now priced at approximately $59,000, it often experiences spectacular fluctuations in value that limit its ability to serve as an effective monetary and payment system.
It begs the question, why would you pay for a cup of coffee with Bitcoin if you believe its value will climb to new heights tomorrow? Conversely, why would a business with its cost structure in U.S. dollars want to accept a cryptocurrency that may plummet in value in a matter of hours, if not minutes?
This challenge is not unique to Bitcoin. Other cryptocurrencies, such as Litecoin or Dogecoin, also experience price volatility.
While some accept the risks that come with such swings in value, others are working to blend the potential benefits of cryptocurrency with enhanced stability mechanisms to create digital currencies that can effectively function as stores of value, means of exchange, and units of account. These digital currencies are collectively known as stablecoins.
What exactly is a stablecoin?
A stablecoin is broadly defined as a “crypto-asset that aims to maintain a stable value relative to a specified asset, or a pool or basket of assets.” Therefore, the value of the underlying assets affects the value of the stablecoin. However, descriptions may vary because there is no commonly accepted definition across jurisdictions and regulatory bodies.
Despite the use of the word “stable,” these digital currencies can experience volatility. In fact, the Financial Action Task Force (FATF), an intergovernmental group that develops guidance and recommendations to deter terrorist financing and money laundering, refers to them as “so-called stablecoins” to underscore concerns about volatility.
Although there are many different types of stablecoins available today, they can be broadly classified into two categories according to their stability mechanism.
What’s happening with stablecoins?
Policymakers and regulators around the world remain watchful of stablecoins due to concerns about their potential to disrupt monetary policy, introduce new risks for consumers, and affect existing financial systems and infrastructures.
Financial Action Task Force (FATF) recently released an updated draft of its guidance for virtual assets and virtual asset service providers. Its revisions call for analyzing money-laundering and terrorist-financing risks and mitigating those risks prior to the launch of a stablecoin, especially if it may achieve wide-scale adoption. Moreover, the organization advises that stablecoins “should never be outside the scope” of anti-money-laundering and counter-terrorist-financing laws and regulations. FATF is accepting public feedback on the revised guidance until April 20.
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Domestically, stablecoins are also receiving attention from regulators. Since last summer, the Office of the Comptroller of the Currency (OCC) has issued two interpretive letters related to stablecoins.
Published last September, Interpretive Letter #1172 authorized banks to hold reserves for stablecoin issuers that create stablecoins backed 1:1 by a fiat currency. In January, the OCC issued Interpretive Letter #1174, which allows national banks and federal savings associations to use distributed ledger systems and stablecoins for payment activities.
It is still too early to assess the impact of this guidance because many banks are still learning about digital currencies, assessing risks, and evaluating how they may fit into their overall business strategies or address customer needs.
What comes next?
Stablecoins will continue to be a hot topic in the payments industry this year. The Facebook-backed Diem Association—formerly known as the Libra Association—is working to address regulatory concerns in anticipation of the launch of its stablecoin. Visa also made headlines recently with its announcement that it settled a transaction in USDC, thereby marking the first time it conducted settlement without using fiat currency.
The future of cryptocurrency is constantly in flux as new technologies become available, regulators adapt to keep pace with innovation in financial services, and customer payment preferences evolve. Just know that ICBA remains committed to helping community bankers navigate the changing payments landscape by keeping our industry informed about new developments in this space.
The next blog in the Crypto Chronicles series will discuss the evolution of Bitcoin.
Brian Laverdure, AAP, is ICBA vice president of payments and technology policy.