If you want to get regulators onside to launch a new global payments technology, there’s one place in particular where you need to plead your case.
It’s Basel in north-west Switzerland, the home of the Bank for International Settlements (BIS), arguably the most powerful institution in traditional finance.
It’s the BIS, via its Committee for Payments and Infrastructures (CPMI), that decides how the world’s financial system is wired together.
It’s a complex picture, since there is no global payments system—yet. The BIS publishes weighty tomes called ‘red books’ for each of 23 CPMI member states and for the eurozone. In a red book, the national payment systems, many of which have formed over centuries, are mapped out.
“The bar for regulatory approval will be high”
But Facebook’s announcement in June of plans for a new digital token called Libra has jump-started a race for a harmonised global framework for money transfers.
And in mid-September the Libra Association, the entity created by Facebook to take forward its payment plans, went to Basel to present them to a group of central bankers from around the world.
“When such initiatives cross national borders, it’s important for regulators to coordinate and come to a common understanding,” the BIS quoted Agustín Carstens, its general manager, as saying in a short press release issued following the meeting.
“The bar for regulatory approval will be high,” Carstens added.
What’s the big deal about stablecoins?
Facebook’s CEO, Mark Zuckerberg, says he wants to give people around the world a new medium of exchange—for example, something you could store in a mobile digital wallet and use for everyday purchases. Or you could easily send the same digital token to relatives or friends abroad, cutting out expensive middlemen.
If Libra receives the green light from regulators, it will be available to the 2bn-plus users of Facebook’s social networks, which include WhatsApp, Messenger and Instagram. Facebook says it will be as easy to send money across WhatsApp using Libra as it is to share a message or photo.
A key feature of Libra is that it aims to be relatively stable when measured against traditional currencies.
Stablecoins strike much closer to home
That means Libra, and other tokens like it, are quite different from cryptocurrencies like bitcoin.
Bitcoin has gone from $20,000 to $3,000, back up to $14,000 and then down to $8,000 a coin within the space of a year and a half. But the Libra ‘stablecoin’ would keep its value against a basket of existing national currencies, like the dollar, euro or yen.
If it achieved widespread acceptance, Libra—or another stablecoin that rises to prominence—could also become entrenched in our mental models for calculating prices: in other words, as a unit of account, one of the key attributes of money.
So while regulators don’t like bitcoin, they are not so worried about its immediate impact on the monetary status quo. But they are falling over themselves this year to have a say on stablecoins, which strike much closer to home.
And the reception has so far ranged from lukewarm to hostile. Politicians from France and Germany have sounded an aggressive anti-Libra note over recent weeks.
Some commentators say Libra may already be faltering. Last Friday, payments firm PayPal quit the project. David Marcus, Libra’s head, used to be PayPal’s president.
But Zuckerberg sounds confident. According to the leaked transcript of a recent internal Facebook meeting, the company’s boss says he expects to have at least 100 consortium members by the time Libra launches.
He is also playing a long game against politicians and regulators. According to the leaked transcript, Zuckerberg said he is prepared to ‘go to the mat and fight’ against anyone trying to break up the company in which he still controls 58 percent of the votes.
That’s a shot across the bow of Democrat presidential candidate Elizabeth Warren, who has vowed to dismantle the big US tech companies.
Who’s in the stablecoin race?
But the stablecoin race is not just about Facebook’s Libra.
There are at least 54 stablecoin projects underway around the world, using a variety of design approaches and targeting different categories of user, from large financial institutions to retail customers.
Stablecoins are on the rise
In a report published in August, the European Central Bank (ECB) distinguished between four types of stablecoin.
In the first structure, said the ECB, the stablecoins in issue are fully backed by fiat currency held in reserve by a custodian, and they are fully redeemable against that fiat currency. The ECB calls this a ‘tokenised funds’ structure, since the stablecoin is used to ‘tokenise’ the funds held in reserve.
The second type of stablecoin, said the ECB, is backed by collateral held by a third party but ‘off-chain’. In other words, the custodian of the collateral records it in a separate database to that used by the stablecoin itself.
In the third structure, records of both the stablecoin and its collateral backing are recorded in a single, joint database by means of a ‘smart contract’. This structure, which the ECB calls an ‘on-chain collateralised stablecoin’, can therefore exist without the need for a trusted third party, such as a custodian.
Finally, ‘algorithmic stablecoins’, a concept which so far exists only on paper, are backed by users’ expectations about the future purchasing power of their holdings. This stablecoin structure does not require the custody of any underlying asset, and its operation is totally decentralised.
So far, says the ECB, the first type of stablecoin dominates the market, with tokenised funds initiatives accounting for more than 97% of the whole sector by value.
But stablecoins are on the rise: their total value has almost tripled over the last eighteen months, the ECB says, rising from €1.5bn in January 2018 to €4.3bn in July 2019.
The tether paradox
And that last statistic illustrates a central paradox in the stablecoin race.
While regulators ponder whether to give a green light to initiatives like Facebook’s Libra, a march has already been stolen by one stablecoin project that exists, at best, in a legal grey area—tether.
Tether’s range of apparently successful stablecoins is dogged by controversy
Tether, reportedly the 2014 creation of executives at the Bitfinex cryptocurrency exchange, currently has a market capitalisation of $4.1bn and turns over four to five times that amount in daily trading, suggesting widespread use as a payment tool across the cryptocurrency ecosystem.
Tether tokenises the two leading fiat currencies, the US dollar and euro, and its transactions are recorded on the two most popular public blockchains, bitcoin and ethereum.
Tether has also recently launched a stablecoin backed by the Chinese yuan, pre-empting plans by China’s central bank to issue its own digital currency.
But Tether’s range of apparently successful stablecoins is also dogged by controversy. Tether faces allegations of fraud in the New York state courts, where the Attorney General has provided evidence that the cryptocurrency is less than fully backed by dollar reserves.
And just this week Tether and its senior executives have been hit with a new fraud allegation in the New York courts.
“A sophisticated scheme to defraud investors, manipulate markets, and conceal illicit proceeds”
A group of US-based cryptocurrency investors allege that tether’s creators cooked up “a sophisticated scheme to defraud investors, manipulate markets, and conceal illicit proceeds”.
The plaintiffs are seeking damages of up to $1.4trn.
Earlier this year, Tether conceded that its stablecoin tokens were now less than fully backed by dollars held in reserve. Instead, said Tether, tether tokens would henceforth be backed not only by currency reserves, but also by loans made by Tether to third parties.
But according to New York’s Attorney General, those third parties include a related entity, Bitfinex, to whom Tether allegedly provided a loan of up to $900m late in 2018 to meet a cash shortfall at the exchange.
According to reports based on the 2017 Paradise Papers leak, Bitfinex and Tether were not only founded by the same individuals, but also share a CEO, Jan van der Velde, who is one of the respondents in this week’s New York lawsuit.
In early July Bitfinex issued a statement, saying that it had repaid $100m of its loan from Tether.
When contacted by New Money Review, a spokesperson for Bitfinex declined to clarify the ownership relations between it, Tether and another related entity, iFinex.
Bitfinex also declined to comment on the repayment schedule for the rest of its loan from Tether, and whether Tether intended to restore full fiat currency backing for its stablecoins in issue.
But the dominant stablecoin is still there.
“Tether has proved incredibly resilient, despite attacks from the New York regulators and disclosures of loans going on behind the scenes. It’s doubled in size despite all of that,” Garrick Hileman, head of research at Blockchain, said at a Coinscrum event in London last week.
CBDC or sCBDC?
Fraud allegations aside, tether illustrates the difficulties of establishing formal relationships between the anarchic, unregulated world of cryptocurrencies and the traditional banking system.
But another kind of stablecoin could give the general public a totally reliable, easy-to-use digital fiat token. And that would be one issued by central banks themselves.
The problem is that central banks have so far proved reticent to bring such stablecoins—called central bank digital currency, or ‘CBDC’—into existence, fearing that they could disrupt the whole banking system.
“sCBDC offers significant advantages over its full-fledged cousin”
Instead, suggest Tobias Adrian and Tommaso Mancini-Griffoli, economists at the International Monetary Fund (IMF), a solution to this conundrum might be a synthetic CBDC, or ‘sCBDC’.
Under this structure, say Adrian and Mancini-Griffoli, the sCBDC provider would hold client assets at the central bank, allowing stablecoin holders to transact in a central bank digital currency, albeit indirectly.
But the stablecoins would remain the legal liability of private issuers, and client assets would have to be protected against the bankruptcy of the stablecoin provider.
The sCBDC structure would relieve the central bank of having to deal with millions of private account holders, something which tech firms are better equipped to cope with, say Adrian and Mancini-Griffoli.
“sCBDC offers significant advantages over its full-fledged cousin (CBDC), which requires getting involved in many of the steps of the payments chain. This can be costly—and risky—for central banks, as it would push them into unfamiliar territory of brand management, app development, technology selection, and customer interaction,” the IMF economists write in their blog.
“In the sCBDC model, which is a public-private partnership, central banks would focus on their core function: providing trust and efficiency. The private sector, as providers of stablecoins, would be left to satisfy the remaining steps under appropriate supervision and oversight, and to do what they do best: innovate and interact with customers.”
A number of private sector projects are already building similar structures.
They include Fnality, a consortium of banks aiming to build a stablecoin for use in the clearing and settlement of institutional transactions. The stablecoin, called the Utility Settlement Coin, would be fully backed by assets held at central banks.
Who’s the winner?
Who will win the stablecoin race?
Tether’s continuing growth in the face of lawsuits and controversy suggests governments and central banks may not have the ultimate say over the outcome.
Banks are forging a comeback by launching their own digital fiat tokens. JP Morgan, for example, which is launching its own dollar-based payments coin, also presented its plans to the BIS conclave in September.
No-one can predict who will prevail in what the IMF calls ‘the battle raging for your wallet’.
“But one thing is sure,” says the IMF.
“The world of fiat money is in flux, and innovation will transform the landscape of banking and money. You can bet your bottom dollar on it.”