The following is a guest post by Abhinov Balagoni, CEO and Founder of Pax Credit.
The crypto winter is a term initially used to describe the market crash of 2018, where the prices of cryptocurrencies fell by 70%, including bitcoin.
This was the biggest crash the cryptocurrency market had ever seen back then, and it caused many people to lose a lot of money.
The crypto winter occurred from a combination of factors, including over-inflated prices, regulatory uncertainty, and a general lack of interest in the market. But, the market began to recover in 2019 and progressed well throughout the pandemic.
However, the bitcoin price is about $21,000, a decrease of over 70% from an all-time high of $68,990.90 in November 2021. Not just bitcoin, but the crash of UST, which had grown into the third-largest stablecoin, has been one of the biggest crypto crashes.
In addition, the total market capitalization of crypto assets has decreased to less than $1 trillion from its peak of $3 trillion in November. While it is early to say that we are amid a crypto winter, many in the crypto space are preparing for it.
In the context of the ongoing crypto winter, the idea of regulating cryptocurrencies, especially stablecoins, has been gaining traction. With looming regulations, let us examine the different types of stablecoins and how regulators respond to them across markets.
What are the types of stablecoins?
Stablecoins have characteristics of both fiat currency (price stability) and cryptocurrency (mobility). They can be broadly categorized into four types based on their underlying collaterals: fiat currency, cryptocurrency, commodity, and algorithm.
Fiat currency-backed stablecoins have fiat currency as collateral at a 1:1 ratio and are issued by a central entity. Some of the biggest stablecoins in this category by market value include Tether (USDT), USD Coin (USDC), and Binance USD (BUSD).
Cryptocurrency-backed stablecoins use other cryptocurrencies such as bitcoin and eth as collateral whenever they issue a new unit. As the prices of cryptocurrencies are volatile, these stablecoins tend to have over-collateralization. DAI is one of the popular stablecoins in this category.
Commodity-backed stablecoins have commodities such as gold as collateral and work similarly to a stablecoin backed by fiat currencies. Still, their value is attached to the price movements of physical gold. Paxos Gold (PAXG) and Tether Gold (XAUT) are two of the most popular gold-backed stablecoins.
Algorithmic-backed stablecoins do not have any type of collateral. Instead, they rely on smart contracts to maintain their price stability. TerraUSD (UST), Frax (FRAX) and Neutrino USD (USDN) are such stablecoins.
What are the legal frameworks being adopted?
Now that we have examined different types of stablecoins let us dive into the responses from regulators across the major countries.
Japan is one of the first major countries to recognize stablecoins and define them as ‘digital money,’ stating that they must be tied to the yen or other legal money and guarantee holders the ability to exchange them for fiat currency at face value.
The bill also states that only registered money transfer agents, licensed banks, and trust companies will be allowed to issue these stablecoins. The Financial Services Agency (FSA) has revealed that regulations for stablecoin issuers will be rolled out in the coming months.
In the EU, the Markets in Crypto Assets (MiCA) subjects issuers of large stablecoins to requirements such as maintaining reserves to cover all claims and providing immediate redemption rights to holders.
Also, a daily transaction limit of €200 million ($208 million) is imposed for issuers when stablecoins are used for payments. The European Banking Authority (EBA) will supervise stablecoins with more than 10 million users or 5 billion euros in circulation.
In the UK, HM Treasury initiated consultation for the crypto assets, specifically stablecoins. The proposal is to update the existing Electronic Money Institution (EMI) legal framework to regulate the usage of stablecoins. The Financial Conduct Authority (FCA) will be able to regulate issuers of stablecoins for payments and other entities providing related services.
Although the current state of regulation of cryptocurrencies varies by state in the US, the Director of the U.S. Financial Crimes Enforcement Network (FinCEN) clarified that stablecoins are covered by FinCEN’s definition of “money transmission services” under the Bank Secrecy Act (BSA). A comprehensive legal framework regarding cryptocurrencies, including that of stablecoins, may be available later this year.
Regardless, the complexity in terms of different stablecoins and regulating them is an ongoing issue for lawmakers. As things stand, stablecoin regulation could mark the first wave of regulations for the crypto markets. Still, different digital assets will be regulated in different ways in the following years.