Notes 2/15: Stablecoin Market Capitalizations and Legislation

There’s been considerable handwringing over regulatory action and its negative effect on cryptocurrencies in recent days. One place where that effect seems less pronounced is bitcoin price. While the crypto community erupted in protest against the SEC’s regulatory actions towards Kraken’s staking service and Binance’s stablecoin BUSD, bitcoin price seemed to take it into its stride.

As of this writing, bitcoin price is $22,843.81, up by almost 4% since yesterday. In the past five days, the cryptocurrency’s price has weathered news of the SEC’s actions and adverse news, such as a slowdown in decrease of inflation, to register an uptick of 5.4%.

Declining Stablecoin Market Capitalizations

One could chalk up the increase in bitcoin’s price movement to crypto resiliency- a sign of investor faith in the asset class. Except that resiliency is difficult to demonstrate during a time of decreasing market capitalizations for stablecoins – crypto’s rails that connect different exchanges and tokens.

BUSD’s market cap has tumbled from $16.14 billion to $14.59 billion since Sunday. USDC has fared no better. Its market capitalization fell to $40.84 billion on 13th Feb. – the day that the markets digested news of the double whammy against BUSD, from $41.24 billion earlier in the day. As of this writing, it stands at $41.20 billion, still down from its market cap of $41.54 billion a week ago.

Means Less Crypto Liquidity

The SEC and NYDFS targeted their regulatory cudgels at Binance; but its effects could be far-reaching. In a note yesterday, analysts at Morgan Stanley wrote that falling stablecoin market capitalization is an indicator of declining liquidity and leverage in crypto markets. According to them, it is indicative of a tightening in crypto market.

A tight crypto market means there is less money to go around in the system. In a mature market, tighter conditions mean a flight towards safety and proven projects and companies. There are none in an ecosystem that is still under construction. The absence of regulatory clarity has further added to the uncertainty.

On Regulatory Arbitrage

The regulatory one-two punch on crypto in the last couple of days has stoked fears about the regulatory climate for stablecoins in the United States. To many, the SEC’s and NYDFS’s action against BUSD was arbitrary and did not have much basis in legal precedent. The overly broad definition of securities, according to some, in the Howey and Reves tests will enable the SEC to classify most crypto tokens as securities.  

Meanwhile, the Federal Register published its opinion on stablecoins. While it did not disallow state banks from providing custody services for stablecoins, the board stated that issuing tokens on “open, public, and/or decentralized networks or similar systems is highly likely to be inconsistent with safe and sound practices.” In simple words, this means that the regulatory path ahead for stablecoins in the United States might be closed.

And so, a familiar refrain, one that is repeated after every regulatory crackdown, about moving out of the U.S. to friendlier regulatory jurisdictions is being sounded out again. The argument here is that other jurisdictions offer clarity and certainty for stablecoins.

No Clarity Here or There

Except stablecoin regulation is a work in progress in most jurisdictions. There is not much clarity or certainty. The Hong Kong Monetary Authority (HKMA) has disallowed algorithmic stablecoins from its jurisdiction. It also wants to supervise governance, issuance, and stabilization of fiat-backed stablecoin reserves. The authorities there also stated that they require reserves of “high quality” and “high liquidity” without identifying example assets that might fit those two criteria.

The Dubai Financial Services Authority (DFSA) also does not allow algorithmic stablecoins and has based its guidance on standards outlined by the Bank of International Settlements (BIS). The reserves should consist solely of cash, with only an “insignificant proportion” held in high quality liquidity assets. As in the case of HKMA, the agency has not defined or provided examples of such assets.

Onerous EU

Meanwhile, in the European Union, stablecoin issuers are subject to transaction limits and amounts for non-euro denominated coins. They will also be supervised by the European Banking Authority (EBA) and subject to similar capital requirements as mainstream banking authorities.

In a recent interview, Patrick Hansen, Director of EU policy at Circle – a stablecoin issuer, said the requirements were “onerous”. “We think there should be flexibility in capital buffers (to be held at stablecoin-issuing firms),” he said. There are other discussions related to stablecoins, such as legal rights of coin holders and contagion risks, that are also yet to be worked out.

On the whole, then, the legislative landscape does not look too promising for stablecoins across the world. The choice for them is to submit wholesale to the demands of regulators or make do with existing uncertainty. With US regulatory agencies not letting off on the pressure, stablecoins, and the larger crypto ecosystem, are caught between a rock and a hard place.

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