Global Stablecoins and Financial Stability

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Last week, the Federal Reserve released its latest Financial Stability Report. In this report, the Federal Reserve warns of the risks that stablecoins may pose. We have translated the relevant parts of the report in full:

A stablecoin is a cryptocurrency whose value is supposed to be pegged to an underlying asset or basket of assets. 1 If properly designed and regulated, innovations that facilitate faster, cheaper and more inclusive payment methods can complement existing payment systems and improve consumer welfare. However, the possibility of a stablecoin payments network rapidly reaching global scale introduces important challenges and risks for financial stability, monetary policy, combating money laundering and terrorist financing, and protecting consumers and investors.

Stablecoins could become a new medium of exchange…

Price volatility is one of the key issues that has limited early cryptocurrencies as payment instruments. For example, Bitcoin’s extreme volatility in value makes it a poor medium of exchange; Bitcoin’s dollar value can double in a matter of hours. Stablecoins attempt to address this volatility by pegging their value to an asset (eg, a national currency) or a basket of assets (eg, a portfolio of sovereign currencies). Stablecoin initiatives, such as Facebook's Libra, built on existing large networks of cross-border customers have the potential to achieve widespread adoption quickly. These schemes are called "global stablecoins".

…however, if poorly designed and unregulated, could negatively impact financial stability

Global stablecoin networks could pose a risk to financial stability if poorly designed and unregulated. Stablecoins not functioning as intended could disrupt other parts of the financial system. For example, the inability to convert stablecoins into national currencies on demand or make payments on time could create credit and liquidity chaos in the economy. Stablecoins could face a loss of confidence if their credit, liquidity, market and operational risks are poorly managed. This loss of confidence could lead to a run, with many holders attempting to liquidate their stablecoins simultaneously. In extreme cases, holders may not be able to do so, which could have serious consequences for domestic or international economic activity, asset prices, or financial stability.

Stablecoins Must Meet Protections Against Money Laundering and Terrorist Financing

The anonymity common in stablecoins can be used to obscure financial transparency and facilitate money laundering, terrorist financing and other financial crimes. Financial institutions must comply with customer due diligence and other anti-money laundering regulations designed to help detect and disrupt illicit activity. Addressing such vulnerabilities is critical for any stablecoin. Regulators in many jurisdictions have made it clear that stablecoin issuers, operators, and intermediaries are responsible for preventing their systems from being used by criminals to conceal their identities, locations, and transactional activities, and ensuring compliance with regulations in their jurisdictions. Anti-money laundering and counter-terrorist financing laws and regulations.

Consumer and investor protection will be critical

As with any financial product, it is vital that consumers and investors understand how it works and understand the associated costs and fees, terms and conditions and risks of the product. Stablecoin issuers, operators, and intermediaries should fully disclose their terms of service. Disclosures should clearly detail consumer and investor rights and protections, including whether stablecoin holders have any rights to the underlying asset. Issuers should be transparent about how stablecoins are linked to the underlying assets. Holders must be protected against errors and fraudulent transactions and have recourse in case of unauthorized use. Furthermore, the data privacy of the holders must be properly maintained.

The Fed is closely monitoring the risks of stablecoins