Long Baitao: There are still many difficulties when it is ready to come out, the risks and challenges of global stablecoins
Editor's Note: This article comes fromDigital Asset Research Institute CIDA (ID: gh_cbfb4ac358dc)Editor's Note: This article comes from
Digital Asset Research Institute CIDA (ID: gh_cbfb4ac358dc)
Digital Asset Research Institute CIDA (ID: gh_cbfb4ac358dc)
Abstract: Stablecoins pose a range of potential challenges and risks to public policy, oversight, and management. These risks can be partly addressed within the existing regulatory and supervisory framework, but regulatory loopholes may also exist. Regulatory and policy frameworks should be technology-neutral and should not hinder innovation as long as they do not conflict with public policy objectives, including monetary sovereignty."stable currency"Bitcoin, the best-known first-wave crypto asset, has so far failed to provide a reliable and attractive means of payment or store of value. They exhibit extreme price volatility, limited throughput capacity, unpredictable transaction costs, limited or lack of governance, and limited transparency, among others.
At present, emerging stablecoins have many characteristics of traditional encrypted assets, but try to stabilize the "coin" price by linking their value to the value of the asset or asset pool.
stable currency"In fact, it may be unstable and may pose similar risks as other encrypted assets. In October 2019, the G7 Stablecoin Working Group completed the "Global Stablecoin Assessment Report" (hereinafter referred to as the "G7 Report") and submitted it to the G20 meeting. The G7 report focuses on stablecoins that represent some kind of claim, either on a specific issuer, or on an underlying asset or fund, or some other right or interest."Stablecoins present a range of potential challenges and risks to public policy, oversight and management. These risks can be partly addressed within the existing regulatory and supervisory framework, but regulatory loopholes may also exist. Regulatory and policy frameworks should be technology-neutral and should not hinder innovation as long as they do not conflict with public policy objectives, including monetary sovereignty.
Some stablecoins backed by large technology or financial companies have large customer bases and thus have the potential to scale quickly to global operations. these are called
Global Stablecoin
At present, the FSB Stablecoin Working Group has taken over GSC regulatory issues. The FSB will present a first draft consultation report in April 2020, with a final draft in July. The official report of the FSB is a proposal for the detailed rules of the global stablecoin regulatory policy. Therefore, it can be considered that the work of the FSB will clear legal and regulatory obstacles to the development of stablecoins.
Since 2008, although various countries have formulated various legal, regulatory and regulatory frameworks for the encrypted asset industry, countries have basically acted on their own and there are significant regulatory differences. In stark contrast, since Facebook released the Libra white paper on June 18, 2019, the G7 immediately established a G7 working group in July to assess the risks of stablecoins. After March, the G20 countries began to formulate stablecoin risks and regulatory policies. Consensus has been developed on the basis of an emphasis on international communication and collaboration to ensure consistent global mitigation of GSC risks. Global regulatory responses to traditional encrypted assets and stablecoins are very different. The fundamental reason is that they have never considered traditional encrypted assets to be "currency" but have recognized stablecoins as "currency".
After the release of the G7 report, the author translated and proofread the full text of nearly 20,000 words in Chinese, and felt the responsibility to deliver the international work results related to stablecoin regulation to domestic readers in a timely manner. Therefore, this article is an interpretation of the G7 report, and combines Libra, DC/EP, Tether/USDT, and digital currency solutions of large technology companies for case analysis.
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1 The Ecosystem of Stablecoins
1.1 Three stabilization mechanisms
The description in the Libra white paper belongs to the second model, whose value is linked to a basket of legal currency and/or legal currency assets (treasury bonds), but Facebook has changed its tone in order to obtain regulatory approval, and Libra may simplify the design and issue a single legal currency The stablecoin, which is the first stable mechanism. Ant Financial's Yu'e Bao, whose balance represents the share of the underlying money market fund, is a stablecoin that belongs to the second stabilization mechanism (although whether Yu'e Bao is a digital currency is still controversial within a certain range, but since 2017, the People's Bank of China Since then, money market funds held by non-bank financial institutions have been counted as broad money. This should have settled the controversy, but I will not discuss it here). The value of the basket assets may fluctuate, and the issuer may need to increase the assets in the basket or withdraw stablecoins from the market and destroy them to maintain the stability of the stablecoin value. In order to reduce the fluctuation of the value of the basket assets, the issuer may set certain access conditions for the assets in the basket in terms of liquidity, market depth, reputation level and concentration. These operations are very similar to the collateral management framework in the central bank's currency issuance mechanism."retail"1.2 Examples of Stablecoins"Stablecoins can be differentiated at a high level by users and exchange rate policies."retail
The term is used to refer to stablecoins for anyone to use, such as Libra, while
wholesale
Refers to a stablecoin with limited access, usually to a financial institution or to specific clients of a financial institution.
To date, only two classes of stablecoins have been observed: wholesale stablecoins with fixed exchange rates and retail stablecoins with variable exchange rates.
1.3 Stablecoin Ecosystem
A typical stablecoin ecosystem consists of three core functions: issuance, redemption, and value stabilization of stablecoins; transfer between users; and interaction with users (ie, user interface). Issuance and stabilization typically require a central governance entity to manage the stabilization mechanism, with transfers between users typically controlled by a Distributed Ledger Technology (DLT) protocol.
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2 Challenges and risks to public policy, oversight and management
From a public policy, oversight and management perspective, stablecoins pose a range of potential challenges and risks. Some risks – for example, with respect to the security and efficiency of payment systems, money laundering and terrorist financing, consumer/investor protection and data protection – are familiar and can be addressed, at least in part, within existing regulatory and supervisory frameworks. However, given the nature of some stablecoins, their implementation and enforcement may involve additional complexities. Stablecoin arrangements should meet the same standards and be subject to the same stringent requirements as traditional payment systems, payment schemes or payment service providers (i.e. same activities, same risks, same regulations). Furthermore, some of the economic features of stablecoin arrangements resemble traditional activities conducted by payment systems, ETFs, money market funds (MMFs), and banks, which may help in understanding possible risks to stablecoin functionality.
The G7 report identifies nine risks to stablecoins, but implicitly reflects different priorities.
2.1 Financial Integrity - "Three Evils"
Stablecoins and their ecological related entities must meet the requirements of Anti-Money Laundering (AML), Countering the Financing of Terrorism (CFT) and Countering the Financing of the Proliferation (Countering the Financing of the Proliferation). of weapons of mass destruction: CPF) with the highest international standards. The Financial Action Task Force (FATF) is the international standard-setting body for AML / CFT / CPF. FATF provides a robust and comprehensive framework to combat money laundering, terrorist financing, proliferation financing, and other illicit finance by states, financial institutions, and designated non-financial businesses and industries. The G7 report not only supports the FATF framework, but also asks G7 countries to "lead by example to implement the revised FATF standards related to virtual assets quickly and effectively".
On October 24, the president of Crypto Capital, known as the "central bank" in the cryptocurrency field, was arrested by Polish police on suspicion of laundering money for a Colombian drug cartel.
2.2 Data protection
Policy issues around personal and financial data protection and privacy will become increasingly important as more data is collected and used to provide financial services and as machine learning and artificial intelligence technologies develop. Data policies are difficult to harmonize across borders, especially with differing laws and regulations across jurisdictions and different cultural views on data protection and privacy. Japan's G20 presidency in 2019 confirmed the importance of establishing global standards on how data is defined, secured, stored, exchanged and traded.
The data privacy characteristics of stablecoins can significantly affect their acceptance. For example, senior officials of EU countries have blocked Libra from operating in European countries on the grounds of Facebook's bad record in abusing user privacy data. The cultural views of different countries also significantly affect the attitudes of governments and companies on data privacy, and bring about significantly different business outcomes. Negative cases come from Internet companies in China. Baidu CEO Robin Li once publicly stated that "Chinese users are willing to trade privacy for convenience" to defend their business model. Since the EU issued the General Data Protection Regulation (General Data Protection Regulation: GDPR) in June 2018, China's largest social platform WeChat directly out of European operations. Positive cases also come from China. In the past few years, China's big data industry has crazily expanded its business model with the core of crawling, processing, processing and selling Internet user information under the hat of "technical and financial innovation". This frenzy may be stopped by the Chinese government's accelerated rollout of the "Trial Measures for the Protection of Personal Financial Information (Data)" and the large-scale arrest of technology company executives. Considering that the Chinese government is currently launching the central bank’s digital currency DC/EP with a high profile, it will reverse the abuse of data privacy by Chinese companies with thunderous momentum, and rebuild China’s "cultural view" of responsible data privacy protection with the courage to scrape poison and heal wounds. The global promotion of DC/EP to help the internationalization of RMB is an important prerequisite. Otherwise, as long as other countries attack the weakness of user data privacy protection, they can defeat all China's efforts in the central bank's digital currency.
2.3 Legal certainty
A sound, clear and transparent legal basis in all relevant jurisdictions is a prerequisite for any stablecoin arrangement. The underlying technology and contractual arrangements of stablecoins may vary significantly, and the applicable legal regime will largely depend on the particular design and features. Ambiguity in rights and obligations could make stablecoin arrangements vulnerable to a loss of trust (with implications for financial stability). If value stability is dependent on market mechanisms, then the legal obligations of market makers must be defined to ensure that liquidity is always available to all clients.
For example, the stability of the value of most stablecoins relies more on market makers (mainly major crypto asset exchanges), but their white papers do not have any terms and arrangements related to market-making obligations. In addition, the market-making mechanism alone cannot satisfy the price stability of stablecoins under extreme circumstances. When the stablecoin price is seriously below the benchmark, market makers have no incentive to provide liquidity to the market because they lack confidence in the return of the stablecoin price. In this case, stablecoin issuers need additional mechanisms to ensure stablecoin price returns, such as using their own funds (such as historically accumulated undistributed profits) or raising funds through bond issuance to repurchase excess liquidity in the market This is very close to the requirements of banks' overall loss-absorbing capacity as defined by the Basel III Accord. A sound stablecoin design would need to incorporate similar issuer bail-in mechanisms.
Specific issues may arise in cross-jurisdictional situations as there is a need to determine which jurisdiction's law applies to each element of the overall design, and which jurisdiction's courts have the competence to resolve disputes. There is also the potential for conflict of laws to arise, given the differing treatment in different jurisdictions. In some jurisdictions, applicable financial sector laws may not have kept pace with new business models and market activity related to stablecoins.
2.4 Sound Governance
The governance structure of stablecoins must also be clearly defined and communicated to all ecosystem participants. Stablecoins that rely on intermediaries and third parties should be able to review and control the risks they take from other entities and the risks they bring to other entities.
In the case of using DLT in stablecoins, responsibilities and obligations and recovery processes need to be carefully defined. Sound governance can be especially challenging in the case of permissionless DLT systems, as a decentralized system that lacks an accountable entity may not be able to meet regulatory requirements. On the other hand, a highly complex governance structure can hinder decision-making on stablecoin design and technical evolution, or can slow down response to operational issues.
If reserve assets are not segregated from the interests of stablecoin issuers, issuers may abuse investment policies to privatize asset gains while asset losses are socialized to token holders.
2.5 Market Integrity
Market integrity means that stablecoins must ensure fair and transparent pricing in the primary and secondary markets, which is a key basis for protecting investors and consumers as well as competition. In some designs, agents (such as designated market makers) may have significant market power and stablecoin pricing power, with the potential to abuse the market.
In a manner similar to what can happen to some existing crypto asset trading platforms, businesses in the stablecoin ecosystem may face conflicts of interest. For example, they may have an incentive to disclose false information about their activities, such as customer numbers and transaction volumes, for advertising and other purposes. Additionally, stablecoin issuers may knowingly (or not) mislead customers about key functions they perform, such as the way they manage collateralized assets. These types of misinformation can lead to mispricing and market failure. Because a single entity can play multiple roles in the ecosystem, such as market maker, trading platform, and custodian wallet, in ways not seen in other markets, the risk and impact of market misconduct by that entity can be magnified.
Almost all encrypted asset exchanges with a Chinese background are also a single entity that plays the roles of asset trading, custody, market making, and wallets.
2.6 Consumer/Investor Protection
Given the complexity and novelty of stablecoin arrangements, users (especially retail) may not fully understand the risks. Therefore, additional work may be required to ensure that consumers and investors are informed of all material risks and their individual obligations.
If there is an unauthorized payment from a stablecoin account, it should be clear what rights the holder has to claim a chargeback, with clear instructions on how to obtain one. As has been observed in the broader cryptoasset market, the potential for misleading marketing and misselling can exacerbate concerns about information and consumer understanding.
2.7 Security, Efficiency and Integrity of the Payment System
Stablecoin arrangements are expected to meet the same standards and be subject to the same requirements as traditional payment systems, payment schemes and payment service providers (i.e. same activities, same risks, same management).
2.8 Cyber and other operational risk considerations
Public authorities will require that the operational and cyber risks posed by stablecoins be mitigated through the use of appropriate systems, policies, processes and controls. For example, some crypto asset wallets and trading platforms have proven vulnerable to fraud, theft, or other cyber incidents. The structure of the distributed ledger system may also be compromised, potentially disrupting the system. Moreover, new technologies may be subject to as yet unidentified operational risks.
2.9 Tax compliance
Stablecoins, like other cryptoassets, may present two types of challenges to tax administrations. First, there is uncertainty about the legal status of stablecoins, and therefore the tax treatment of transactions using them. Alternatively, a stablecoin can be viewed as a security, with a tax obligation involved when the stablecoin’s backing value fluctuates relative to fiat currencies. In this case, redemption of fiat stablecoins may be subject to taxation. The tax treatment of stablecoins is further complicated by different tax treatments across jurisdictions.
A second challenge for tax-collecting authorities is that stablecoins (like other cryptoassets) can also facilitate avoidance of tax obligations. Jurisdictions can apply the terms and obligations of financial institutions to stablecoin operators, but the lack of a central intermediary in a DLT system makes this difficult to enforce. Additionally, the level of anonymity of the stablecoin makes it difficult for authorities to track transactions and identify the beneficiaries of the stablecoin, making it even more difficult to identify tax evasion.
2.10 Tether/Bitfinex Case Analysis
The vague legal structure between stablecoin issuer Tether and crypto asset exchange Bitfinex (two separate companies with the same group of executives) has attracted widespread criticism. The New York Attorney General Office (NYAGO: NYAGO) wants to sue Tether because it believes that Bitfinex lost $850 million and then used its funds with associated stablecoin operator Tether to covertly cover this huge loss. Bitfinex first questioned that NYAGO had no jurisdiction, and then denied the relevant allegations.
From the perspective of modern currency creation principles, it is common sense for commercial banks to create deposit currencies by purchasing financial assets (such as foreign exchange and gold). When new currencies are put into the market, chasing limited financial assets to push up the latter’s price is also a reasonable result, especially The encrypted asset market currently accounts for almost 70% of the total market value of Bitcoin, so it is also an acceptable expectation that the price of Bitcoin will rise sharply with each additional issuance of USDT. The essential problem here is that the laws and governance of USDT issuers, exchanges, managers of reserve assets (that is, custodian dollars) and custodians are not clear, and there are serious market integrity issues. Tether/Bitfinex is undoubtedly cheating. It does not provide a 100% reserve fund as claimed in the white paper, a fact that has been acknowledged by it (Tether once argued in its response to NYAGO that other stablecoin issuers are not 100% reserve fund, why Tether is required to be). In the governance structure of USDT, the responsibilities of the custodian bank are not clear, so Tether has the opportunity to misappropriate the custodian funds at will to buy Bitcoin and sell Bitcoin when it is due for audit, which actually forms a negative impact on the price of Bitcoin. periodic manipulation. Tether also has a possible motivation to profit from this periodic buying and selling of Bitcoin. After all, its amount of funds has made it a "giant whale" with the actual ability to affect prices. Because Tether's Bitcoin transactions are mainly conducted off-site in the legal currency USD, it actually forms the fact that the price of Bitcoin is set by OTC transactions. The opacity of this off-market and on-site pricing mechanism is a serious act of market dishonesty. In addition to the suspicion of manipulating the price of Bitcoin, the lack of escrow duties also gives Tether the opportunity to embezzle users’ escrow funds to make up for the trading losses of the brother company Bitfinex. Although Tether has always argued that it is innocent, the fact is that it has so far been unable to provide an effective audit report to meet the most basic requirements of transparency. You may have seen Tether's balance numbers in its custodian bank accounts, but this is obviously not convincing, and it does not prove the flow of these funds at other times than showing the balance numbers.
The opacity of Tether’s operations has indeed caused a loss of user confidence and led to huge selling pressure. The exchange rate with the U.S. dollar once fell to around .70, and several leading exchanges came forward to “support” to tide over the difficulties. This involves the issue of Tether liquidity management. Its liquidity is mainly provided by market makers (that is, exchanges), but there is no clear governance structure to define the obligations of market makers, such as how market makers fulfill their market-making "obligations" under extreme market conditions. At present, the relationship between Tether and the exchange is more like a "binding", because the USDT's great market acceptance before the exchange opened USDT-based trading pairs contributed the main fee income of the exchange, so the collapse of USDT is not in line with the transaction interests. But this bundle of interests does not form a clear governance structure and legal constraints. Once the exchange supported USDT to tide over the difficulties, there is no guarantee that after the competition in the stablecoin market changes in the future, the exchange will choose to support USDT again under similar market pressure.
Therefore, the formulation and implementation of future regulatory policies for stablecoins by global regulation will deal a fatal blow to Tether's current operating model. If Tether fails to make thorough improvements in terms of governance, law, and market integrity in a timely manner, a compliant global stablecoin similar to Libra will be launched, and Tether/USDT will be driven into the abyss with a devastating force.
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3 Public Policy Challenges for Potential Global Stablecoins (GSCs)
Stablecoins such as Libra offered by large technology platforms can scale rapidly because of their established global customer base and interfaces that provide easy access to the platform. Such arrangements have the potential to become global, surpassing the challenges posed by small stablecoins, and thus pose additional public policy challenges, including competition policy, financial stability, monetary policy transmission, and the long-term implications of the international monetary system.
3.1 Fair competition in the financial market
GSC arrangements are likely to gain market dominance due to the strong network effects that drove their adoption in the first place, the high fixed costs required to build large-scale business operations, and the exponential benefits of data access. A GSC may affect market competition and a level playing field if the GSC arrangement is based on a proprietary system, as this may be used to prohibit others from entering or increase barriers to entry into the system. This could happen if the corporates leading the stablecoin arrangement control the key channels that consumers and business users use to access a range of services.
Although there is no obvious GSC case that hinders fair competition in the market, the competition between the payment platforms of China's two major domestic technology companies and China's regulatory response is a close case. Both Ant Financial’s Alipay and Tencent Pay’s economic activity could dwarf the size of many national economies. The two have in fact become an information oligopoly, monopolizing the value of data obtained through their respective networks, and lack of interoperability with their peer network platforms, forming a market fragmentation. However, the People's Bank of China cut off the channels between banks and all third-party payment service providers and established a network platform to be responsible for the online payment settlement of non-bank payment institutions. It also took the reserve accounts of Ant Financial and WeChat Pay from commercial banks to the Central Bank, Canceling the reserve interest and raising the reserve ratio requirement from 20% to 100%, thus significantly weakening their monopoly data privilege and profitability, and effectively maintaining the central bank's monetary authority.
3.2 Vulnerabilities within GSC-specific components
Mechanisms used to stabilize the value of GSCs need to incorporate high standards of financial risk management to address market, credit and liquidity risks. If risks are not adequately addressed, this could undermine confidence and trigger a “run” akin to bank deposits, where users would all try to redeem their GSCs at a reference value.
An event that damages the reputation of the GSC arrangement could result in a sudden flow of GSC sell-offs. GSCs that rely on market makers to stabilize prices in the open market may be vulnerable if these market makers are not obligated to stabilize prices under all circumstances and may exit the market when GSCs come under strong selling pressure. Even if GSC is committed to honoring redemptions, it remains vulnerable to confidence damage and a run. Poor governance, such as non-segregated funds in reserves, ambiguous or misunderstood legal obligations of the issuer, or weak mechanisms enabling stablecoin holders to realize or redeem value from the issuer, could make GSCs vulnerable to runs or loss of confidence.
GSC whose reference assets include bank deposits may be exposed to the bank's credit risk and liquidity risk. A default or liquidity issue could mean that GSC is unable to meet redemption requests. GSCs that hold a broad range of assets, such as bonds, may be exposed to market and liquidity risk in those assets, as well as credit risk of issuers. A decline in the value of reserve assets triggered by overall market conditions or idiosyncratic changes in the fundamental value of the assets may reduce the value of the GSC. Furthermore, if the GSC has a notional value, the reduced value of the reserve asset may result in a gap between the notional and reserve value. This gap could trigger a run, where users attempt to redeem GSC's underlying assets, possibly requiring the issuer to liquidate their assets below market value (fire sale). GSCs that hold a wider range of assets need to have liquidity arrangements in place to ensure that there is always funds available to honor redemptions even in the event of a stablecoin under heavy selling pressure.
Although Libra claims a 100% reserve, its issuance represents a share of the underlying asset portfolio. The Libra Association will not deposit cash reserves in FDIC-covered commercial banks to earn interest, because the interest rate is too low (less than one thousandth) and the FDIC does not provide a deposit insurance plan for the extra part of more than 250,000 US dollars, so there is a high probability that it will Put reserve assets in money market funds. It would be exposed to all of the financial stability risks described above. The Libra Association claims that it is close to the currency board system of the Hong Kong dollar. As a comparison, the Hong Kong dollar currency issuance system can be examined. First, for the Hong Kong dollar base currency issuance, its reserve asset ratio in 2018 was about 110%, and the Hong Kong Monetary Authority’s foreign exchange fund holds the Hong Kong government’s huge foreign exchange reserves, which are close to seven times the base currency. Any amount of liquidity. Second, the Hong Kong Monetary Authority provides various facilities, such as strong-side/weak-side convertibility guarantees, discount windows, lenders of last resort, etc., to establish reasonable expectations for the market and obtain liquidity under any circumstances. As a stable currency, Libra lacks a strong enough loss-absorbing capacity like the Hong Kong dollar, and it also lacks professional tools to manage liquidity.
3.3 There are several channels through which GSCs can increase vulnerabilities in the wider financial system
First, if users hold GSCs permanently in deposit-type accounts, banks' retail deposits could fall and banks would have to rely more on more expensive and less volatile funding sources, including wholesale funding. In basket currency countries, a portion of deposits that flow out of the banking system (when retail users purchase GSCs) may find their way back (via stablecoin issuers) into domestic bank deposits and short-term government securities. This means that some banks may receive more wholesale deposits from stablecoin issuers than from large numbers of retail depositors. Wholesale deposits are more sensitive to interest than retail deposits, so the bank's financing becomes more unstable, which increases the bank's interest rate risk and operational risk, thereby affecting the bank's ability to provide credit to the society.
Second, if new financial intermediaries capture the majority of financial intermediation activities in the GSC ecosystem, this could further reduce bank profitability, possibly causing banks to take on more risk, or shrink lending to the real economy. This has the potential to particularly affect smaller banks and banks in non-basket currency countries.
Third, depending on the level of uptake, purchasing safe assets for stablecoins could lead to a lack of High Quality Liquidity Assets (HQLA) in certain markets, potentially affecting financial stability. HQLA generally comes from the bond market. A country’s bond market is seriously lacking in depth. It may issue a small amount of government bonds because of its good financial situation (such as Australia), or it may be because the economy is small and the bond market is immature (this is the case for most small countries). If Libra's operation in these countries involves the purchase of a large amount of national debt, this will lead to this result.
Fourth, stablecoins pegged to a basket of foreign currencies may be more stable than domestic currencies in many countries. Stablecoins linked to underlying assets or claims on them may provide access to major (international) currencies and developed market assets, which are considered more stable than domestic currencies. Thus, residents may flock to a particular GSC during times of domestic financial instability (similar to sudden dollarization). GSC arrangements (depending on their location) that are transferred from domestic bank accounts to primarily foreign assets may result in capital outflows from the country. GSC's transaction speed may be a welcome feature in normal times, but it can be disruptive in turbulent times. Authorities may lack the time needed to effectively intervene to stop this destructive process, and GSCs may act as highways for capital outflows. This process of "digital dollarization" is happening faster and more destructively than traditional dollarization, not only for countries with weak monetary systems, but also for economies with stable currencies, as long as the latter is economically or socially is open to GSC. Libra is a GSC with such potential, which has aroused the high vigilance of almost all sovereign countries in the world, including EU member states and China.
3.4 Transferring risks to the real economy
If a GSC becomes a widely used means of payment, any disruption to payments could end up hurting real economic activity. Such delays may result in additional financial
Stabilization risk. The impact will depend on the extent to which other payment systems, including cash, can be substituted.
If a GSC is used as a store of value, with unbanked or underbanked groups using it as a form of savings account, any shock to the value of the GSC has a wealth effect on its holders. That could have a bigger impact on the economy as people adjust their spending plans accordingly. In addition, if there are GSC-denominated borrowings, fluctuations in their value can also have balance sheet effects on the company.
Banks and other financial institutions that are directly exposed to GSCs (for example, because they hold GSCs to provide services to their clients) may suffer losses if the value of GSCs falls. Without deposit insurance and lender-of-last-resort functions, these intermediaries would be more vulnerable to runs. Furthermore, disruption of these intermediaries could undermine confidence in the entire GSC system.
GSC's reserve assets can be large, which has significant implications for financial markets. Large-scale buying or selling of other assets, such as bonds, can affect prices (and yields) in those markets. In extreme cases, where a GSC run occurs, if the issuer has to sell assets quickly to meet redemption calls, it could lead to a fire sale and potentially disrupt custodian bank funding. Finally, in times of stress, if a GSC offers an alternative to fiat currency, it could undermine monetary sovereignty.
3.5 Effects of monetary policy on domestic interest rates and credit conditions
If GSCs are widely used as a store of value, assets denominated in GSCs will remain on the balance sheets of companies and households. In such a scenario, the impact of domestic monetary policy may be weakened as it may have limited earnings impact on the portion of assets held by GSCs. This impact will depend on the design of the GSC and the scope of GSC holdings, as well as the existence of financial intermediaries denominated in GSC.
If the GSC pays (interest) returns, any impact on the transmission of monetary policy through interest rates will depend on how the rate of return is determined. This return may reflect the return on assets in the reserve basket. In this case, if the domestic currency is the only asset in the basket (such as Libra, which is single-pegged to a certain fiat currency), then the return on GSC holdings will be equal to the interest rate on domestic currency deposits (possibly less certain fees). Thus, the transmission of domestic monetary policy through interest rates is likely to have had little, if any, impact. Conversely, if there are multiple currencies in the basket, the return on holding GSC may be a weighted average of interest rates against the GSC reserve currency, weakening the link between domestic monetary policy and the GSC-denominated deposit rate. This is especially the case when the national currency is not included in the reserve asset basket at all, which is probably the case in most of the world's economies.
This effect can be even greater in countries with unstable currency values and poor payment infrastructure. In these countries, GSCs pegged to assets denominated in currencies other than their own currency could become widely used payment and saving instruments, thereby undermining the effectiveness of monetary policy, even if the GSCs do not pay returns. This would also result in less seigniorage revenue for the central bank (and related fiscal revenue for the government). These effects would be similar to those observed in countries with reduced cash use due to dollarization. However, given the inability to engage in a sovereign-to-sovereign discussion of the public policy implications of such substitution, GSC currency substitution may have different impacts than foreign fiat currency substitution (classic dollarization).
In addition, as domestic savers will be able to switch between local currency deposits and GSC holdings, the return on GSC may affect the number of local currency deposits and thus the deposit and lending rates in the local currency financial system, further weakening the monetary policy rate transmission mechanism effectiveness. This is similar to the effect that dollarization has already seen in some countries, and it may also happen to other countries that are not currently affected by dollarization.
In the discussion above, GSC is considered a form of savings, but intermediation between savers and borrowers continues to take place within the domestic financial system in local currency. But new intermediaries may emerge who borrow (or accept deposits) in GSC and lend currency to borrowers (thus "creating" currency). This would further weaken the transmission of domestic monetary policy, as both the returns to domestic savers and the interest rates paid by domestic borrowers would be less responsive to monetary policy.
Considering that the benchmark interest rates of central banks in China and the United States are still at an appropriate level, other central banks generally have low interest rates or even negative interest rates. Therefore, Libra linked to the US dollar will directly weaken/amplify the country’s interest rate-based interest rates in all countries where it may operate in the future. Monetary policy transmission mechanism.
By facilitating cross-border payments, GSCs may increase cross-border capital mobility and the substitutability of domestic and foreign assets, thereby amplifying the responsiveness of domestic interest rates to foreign interest rates and weakening domestic monetary controls.
As long as trade continues to be denominated in conventional currencies, the use of GSCs as an international means of payment does not in itself necessarily change the response of international trade to exchange rates. However, if a GSC becomes the unit of account for international trade and trade is invoiced against that GSC, international prices denominated in that GSC may be more sticky. The trade terms would then depend on the value of the GSC against the home currency, not on the bilateral exchange rate between the trading partners' home currencies. Thus, the effect of the exchange rate on trade and economic activity can be eliminated – an outcome similar to that often attributed to the pricing of international trade in the US dollar.
If GSCs become widely used globally, demand for those assets included in the Reserve Basket may increase in the long run. This could trigger national capital outflows in non-reserve basket currencies, as well as national capital inflows in reserve basket currencies. This may raise market interest rates in the former countries and lower them in the latter. Any resulting shortage of HQLA could impair open market operations as eligible collateral becomes scarce.
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