Regulating the Crypto Ecosystem

Regulating the Crypto Ecosystem

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Regulating the Crypto Ecosystem

The Case of Stablecoins and
Arrangements
Parma Bains, Arif Ismail, Fabiana Melo, and Nobuyasu Sugimoto
NOTE/2022/008

FINTECH NOTE

Regulating the Crypto
Ecosystem
The Case of Stablecoins and Arrangements
Prepared by Parma Bains, Arif Ismail, Fabiana Melo, and Nobuyasu
Sugimoto
September 2022

FINTECH NOTES

Regulating the Crypto Ecosystem: The Case of Stablecoins and Arrangements

©2022 International Monetary Fund
Regulating the Crypto Ecosystem: The Case of Stablecoins and Arrangements
NOTE/2022/008
Parma Bains, Arif Ismail, Fabiana Melo, and Nobuyasa Sugimoto*

DISCLAIMER: Fintech Notes offer practical advice from IMF staff members to policymakers on
important issues. The views expressed in Fintech Notes are those of the author(s) and do not
necessarily represent the views of the IMF, its Executive Board, or IMF management.

RECOMMENDED CITATION: Bains, Parma, Arif Ismail, Fabiana Melo, and Nobuyasa Sugimoto.
2022. “Regulating the Crypto Ecosystem: The Case of Stablecoins and Arrangements.” IMF Fintech
Note 2022/008, International Monetary Fund, Washington, DC.

ISBN:

979-8-40022-167-5 (Paper)
979-8-40021-997-9 (ePub)
979-8-40022-169-9 (PDF)

JEL Classification Numbers:

D18, E26, E42, F31, G28, G18 , O30

Keywords:

stablecoin; DLT; crypto-asset; DeFi; Tether; TerraUSD; FSB; CPMIIOSCO; IOSCO; regulation; Economic sectors; Emerging technologies;
Financial crises; Financial sector policy and analysis; Financial sector
stability; Financial services; Fintech; Systemic risk; Technology

Authors’ email addresses:

PBains@imf.org
AIsmail@imf.org
FMelo@imf.org
NSugimoto@imf.org

* The authors would like to thank Tobias Adrian for his guidance, and Marina Moretti, Jay Surti, Tommaso-Mancini Griffoli, Agnija
Jekabsone, Caroline Wu, Jan Nolte, Marianne Bechara, Juan Sebastian Viancha Trujillo, and Cristina Cuervo for their
comments and contributions to this note.

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Contents
Acronyms/Glossary …………………………………………………………………………………………………………………… 5
Executive Summary …………………………………………………………………………………………………………………… 6
Introduction …………………………………………………………………………………………………………………………….. 10
Scope…………………………………………………………………………………………………………………………………. 10
Why Stablecoin Regulation Matters ……………………………………………………………………………………….. 11
I. The Stablecoin Ecosystem: Components and Risks ………………………………………………………………. 14
II. Issuance, Redemption, and Stabilization ………………………………………………………………………………. 17
Challenges and Risks …………………………………………………………………………………………………………… 20

 a) Reserve Composition, Allocation, and Management ………………………………………………………….. 20
 b) Reserves Custody …………………………………………………………………………………………………………. 23
Considerations for Regulatory Responses ………………………………………………………………………………. 23
III. Transfer ………………………………………………………………………………………………………………………………. 31
Challenges and Risks …………………………………………………………………………………………………………… 34
Considerations for Regulatory Responses ………………………………………………………………………………. 35
IV. Access ……………………………………………………………………………………………………………………………….. 38
Conclusion ………………………………………………………………………………………………………………………………. 38
References ………………………………………………………………………………………………………………………………. 41

BOXES
1. US President’s Working Group on Financial Markets and Executive Order on Ensuring Responsible
Development of Digital Assets …………………………………………………………………………………………………….. 15
2. Stablecoins Issued by a Commercial Bank and Deposit Tokenization…………………………………………… 18
3. Tether and Its Reserves ………………………………………………………………………………………………………….. 21
4. Failures of Algorithmic Stablecoins …………………………………………………………………………………………… 22
5. Stablecoins and Legal Uncertainty …………………………………………………………………………………………… 24
6. Stablecoins and Lessons from Money Market Funds and E-Money Regulations ……………………………. 26
7. Stablecoins and Deposit Insurance ………………………………………………………………………………………….. 29
8. Guidance on the Application of the Principles for Financial Market Infrasctructures to Stablecoin
Arrangements ……………………………………………………………………………………………………………………………. 32
9. Cybersecurity and Operational Risk …………………………………………………………………………………………. 37

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FIGURES
1. The Growth of Stablecoins by Market Capitalization …………………………………………………………………… 13
TABLES
1. Recommendations for Prudential and Conduct Regulation of the Crypto Ecosystem: Stablecoins……… 9

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Acronyms/Glossary
AML ……….. Anti–Money Laundering

FSB ……….. Financial Stability Board

CFT ……….. Combating the Financing of
Terrorism

FSOC …….. Financial Stability Oversight Council
(US)

CBDC …….. Central Bank Digital Currency

GFSR …….. Global Financial Stability Report

CPMI ……… Committee on Payments and
Market Infrastructure

IMF ………… International Monetary Fund

DeFi ……….. Decentralized Finance

IOSCO …… International Organization of
Securities Commissions

DEX ……….. Decentralized Exchange

MMF ………. Money Market Fund

DIS ………… Deposit Insurance System

PFMI ……… Principles for Financial Market
Infrastructures

DLT………… Distributed Ledger Technology

SA …………. Stablecoin Arrangement
FDIC ………. Federal Deposit Insurance
Corporation (US)

SSB ……….. Standard Setting Body

FMI ………… Financial Market Infrastructure

UST ……….. TerraUSD

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USDT …….. Tether

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Executive Summary
Stablecoins are crypto assets that aim to maintain a stable value relative to a specified asset or a pool or
basket of assets.1 To achieve stability, assets backing stablecoins are usually held.2 These can be fiat
currencies, bank deposits, short-term market instruments, and even other crypto assets. There are
various types of stabilizing mechanisms, some of which are vulnerable to risks in a stressed market
environment. So far, stablecoins have been issued by nonbanks, which are lightly regulated or
unregulated. This paper focuses on stablecoins with a face value denominated in a monetary unit of
account, such as the US dollar, and backed by financial assets, such as high-quality bonds.
Stablecoins have experienced periods of rapid growth, which also accelerated links between
traditional finance and the crypto ecosystem. In 2021, the market value of stablecoins quadrupled in
conjunction with the rise of decentralized finance (DeFi), although it has since fallen in line with the
broader crypto market. Dollar-denominated stablecoins are growing in popularity in emerging market and
developing economies as a potential store of value and hedge against inflation and exchange rate
volatility, raising risks of dollarization and cryptoization. The involvement of large financial institutions in
areas like reserve management, custody, and issuance has the potential to rapidly generate new risks. In
addition, higher volatility correlation has been observed between stablecoins and stock markets,
especially during recent market stress periods. Without proper regulation, contagion risks between
traditional finance and crypto ecosystem will increase.
Comprehensive, consistent, and coordinated global standards are required to achieve effective
crypto regulation and supervision, especially for stablecoins and their broader ecosystem. While sectorspecific global standards are useful, cross-sectoral coordination is essential to achieve an effective
regulatory framework for the crypto ecosystem, particularly stablecoins. The Financial Stability Board
(FSB) is well placed to take the lead in coordinating and establishing global standards to support national
regulation of crypto assets, including stablecoins, and their ecosystem (or “arrangements”), taking into
account sector-specific standards developed by other standard setters.
Any global regulatory framework for stablecoins should be comprehensive, risk-based, and
flexible, and it should provide a level playing field. The regulatory framework should be comprehensive,
adequately covering all entities carrying out core functions, including issuers and crypto asset service
providers that interact with the stablecoin, such wallets, exchanges, and reserve managers. The
regulatory framework needs to look at more than just the final economic functions, which will change over
time and across countries. For instance, a stablecoin’s intended issuance may be for one purpose, but its
primary use may be for another, and the same stablecoin may perform a different economic function in
different jurisdictions (for example, hedge against inflation in one, and payment in another). Regulation
should be risk based and ensure that the entities carrying out multiple activities are subject to greater
prudential requirements. Regulation should provide a level playing field to ensure it is proportionate to the

1

Reference https://www.fsb.org/work-of-the-fsb/financial-innovation-and-structural-change/crypto-assets-and-global-stablecoins/
and glossary in https://www.fsb.org/wp-content/uploads/P160222.pdf.
2
In the case of algorithmic stablecoins there may be no backing assets.
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risks and reflects the structural features, characteristics, and economic functions of the underlying
stablecoin.
In particular, regulation should be risk-based, focusing on the structural features of stablecoins
and in some cases their usage. This allows policymakers to look through terminology and marketing of
issuers and intermediaries. Key risks to users stem from the inability of issuers to deliver on the purported
structural features of their stablecoins. These include the denomination of the stablecoin’s face value,
investment mandate of the composition of reserves, and the pledge to redeem into cash. In some cases,
regulation may need to be adapted for the use of stablecoins, such as to access the wider crypto
ecosystem or represent bank deposits. Appropriate regulation would vary depending on the stablecoin’s
structural features and usage and ultimately its risks. Here are examples:
 Stablecoins denominated in a monetary unit of account and offering redemption into cash on
demand—that will likely be used for payments—should be fully backed in perfectly safe and liquid
assets. Here, regulation might take its cue from e-money frameworks. Where a stablecoin
becomes widely used, requirements might be similar to those in bank regulation.
 Stablecoins offering redeemability within an elapsed time may be backed with safe but less liquid
assets. And stablecoins offering redemption at the going market value of the underlying assets
(or in kind) may hold riskier assets (for example, a tokenized bond). In these cases, regulation
may also draw on that for money market funds (MMFs), including from constant net asset value
funds.
 Issuers and intermediaries should clearly disclose and explain the structural features of their
offering to end users.
Requirements on stablecoins should be tailored to address risks across the entire ecosystem and
in relation to the three key functions of stablecoins. Although redemption risks are first order, other risks
must also be addressed. Stablecoins involve not only the creation of assets that should be prudentially
overseen but also the use of alternative infrastructure networks or transfer mechanisms that should be
safe, sound, and efficient. The stablecoin ecosystem includes components that perform functions related
to (1) issuance, redemption, and stabilizing mechanisms (involving issuers, reserve assets, custodians
holding reserves, market makers, and individuals or entities in charge of governance); (2) transfer
(involving, for instance, the network, network validators, and operators); and (3) access (normally through
components such as wallets and exchanges). Key elements of the regulatory framework should address
financial stability; consumer protection; credit; market; liquidity; operational, financial, market integrity; and
concentration risks. Depending on the stablecoin arrangement structure and country circumstances,
necessary regulatory adjustments would be different.
Given the variety of legal frameworks in IMF’s membership, this note does not intend to be
prescriptive on the legal denominations or design of the regulatory framework but to provide key elements
that should feature in any regulatory arrangement (see table 1 for regulatory consideration). Global
standard setting bodies (SSBs) are cognizant that various components of stablecoin arrangements may
be performing an equivalent economic function to one performed by instruments and intermediaries of the
traditional financial sector, and in some countries would already be subject to the legal and regulatory
framework that applies to these (“same activity, same risk, same regulation”). In practice, available
resources, existing legal and regulatory structure, and desired timeframe will ultimately affect domestic
regulatory responses in different countries, while the novel nature of underlying technology might call for
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same regulatory outcome rather than same regulation. While the design of domestic regulatory responses
will vary, the following are essential:
 Authorities consider the most efficient and effective approach given the country’s circumstances.
For example, in some countries it may be less resource-intensive and more expedient to narrow
the universe of stablecoin issuers to entities that are already regulated and for which an
established supervisory framework exists. This would reduce the need for regulatory adjustments
to focus only on the risks arising from that activity. Authorities, however, would need to pay
particular attention to risk management in these institutions and carefully assess
interconnectedness and spillovers to the broader financial sector, and this may raise competition
issues and limit user choice.
 Where currently unregulated/underregulated entities will be allowed to perform functions in the
stablecoin ecosystem, authorities must develop bespoke regulation or revise existing regulatory
frameworks to ensure that all entities that perform these functions are licensed or authorized.
Licensing and authorization criteria should be clearly articulated, the responsible authorities
clearly designated, and coordination mechanisms among them well defined. Regulation,
supervision, and oversight for the various components should be proportional to the risks and
functions to be performed and should adhere to the principle of “same risk, same activity, same
regulation,” while considering the novel risks of the underlying technology.
 If those issuers become systemically important, authorities need careful analysis and regulatory
adjustment to address new risks as well as contagion risks arising from stablecoin activities to
other parts of their financial sector. They should apply requirements comparable to those
applicable to systemically important banks—regarding more intensive supervision, safety and
soundness, stress testing, recovery, and resolvability, while considering differences in business
models, especially where stablecoins do not offer maturity transformation. Access to the financial
safety net could be considered when stablecoins reach a systemic scale and when commercial
banks issue their own stablecoins or tokenize their deposits, subject to safeguards.
Authorities must coordinate to address the risks arising from stablecoins both domestically and
globally. By their very nature, stablecoins are cross-border, and stablecoins denominated in one currency
might be used in markets that use a different unit of account. Issuers might be headquartered in one
jurisdiction and market their services globally. This can lead to issues around capital flows and the
monetary independence of jurisdictions. Dollar-denominated stablecoins held in emerging markets and
developing economies can accelerate dollarization or cryptoization.
In markets where risks are growing quickly, authorities should take immediate action by using all
the tools at their disposal. The growing systemic implications of crypto assets, including stablecoins, may
warrant immediate regulatory actions, particularly in some emerging markets and developing economies.
Regulators should use existing regulatory powers, guided by relevant international standards, and focus
on areas of vulnerability, such as wallets, exchanges, and financial institutions’ exposures. Where
stablecoins generate systemic risk, applicable regulatory requirements should reflect their main risks and
economic functions, with rules aligned with those of similar products. The regulatory framework should
retain the flexibility to incorporate the internationally coordinated standards for crypto assets and
stablecoins that are under development at the FSB and other standard setters.
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The alternative of restricting certain uses of stablecoins or imposing complete bans, while
attractive in the short term, may constitute a disproportionate response to risk and is likely to be difficult to
enforce in the long run. Where authorities face severe and immediate risks before the establishment of
robust global standards, they may need to introduce measures to slow down stablecoin adoption in
certain functions to protect customers and financial stability. However, those measures should not be
seen as a permanent solution because there are strong incentives and technological alternatives for
circumvention. Instead, authorities need to address the main drivers of stablecoin use, such as potentially
weak macroeconomic conditions or unmet digital payment needs.
Table 1. Recommendations for Prudential and Conduct Regulation of the Crypto Ecosystem:
Stablecoins
Policy Objectives
Financial Stability

Consumer and Investor
Protection

Most Salient Risks


Run/liquidity risk




Operational and Cyber-Resiliency


Regulatory Consideration

Prudential requirements to
address mismatches



Concentration limits

Currency substitution and bank
disintermediation

Misleading disclosures

Inappropriate use of client
assets

Disclosure and audit
requirements

Segregation of the reserve
assets and restriction of the
reuse of reserve assets

Implementation of IOSCO
recommendations on crypto
trading platforms

Limits or restrictions on the use
of leverage

Requirements for the
robustness, resiliency, and
integrity of operating system

Segregation of the client’s
private keys in cold wallets

Compliance with the PFMI
where applicable

Interlink with wider financial
sector and DeFi

Conflicts of interest
Use of leverage

Operational failures
Cyberattacks

Cross-border cooperation
Compliance with PFMI (for
designated and global
stablecoin arrangements)

Financial Integrity

AML/CFT

Adopt Financial Action Task
Force standards

Embracing the Potential of
Stablecoins While Managing
Risks

Lack of sufficient powers or
scope of regulatory authorities

Legislative change to empower
regulators

Lack of regulatory resource and
expertise

Authorities to determine legal
classification of stablecoins

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Introduction3
Scope
The FSB defines stablecoins as crypto assets that aim to maintain a stable value relative to a specified
asset or to a pool or basket of assets.4 This broad definition implies that stablecoins could be backed by a
monetary unit of account such as the dollar or euro, a commodity such as gold, or a currency basket. The
value of a stablecoin, as expressed against the asset to which it is pegged, would need to be stable if it is
to be redeemed at par, in cash immediately, and at all times. Much hinges on how effective the
stabilization mechanisms are and whether a stablecoin issuer has the means to honor a redemption
request. Some stablecoins may be far from stable. Therefore, the use of the term to stablecoins in this
note merely follows a common naming convention; it does not imply actual stability.5
This paper focuses on stablecoins with a face value linked to a commonly used monetary unit of
account and backed by financial instruments. Currently, stablecoins with a face value linked to a
monetary unit of account (for example, dollar-backed stablecoins) are used primarily in crypto asset
markets to access other crypto assets across different exchanges and are growing especially rapidly as a
means of generating yield in DeFi applications. But this class of stablecoins could see rapid adoption if it
can ensure nominal stability relative to a unit of account widely used to price goods and services as well
as financial assets. Such stablecoins could potentially become popular as a means of payment, including
across borders, and as a store of value, and compete with other forms of money such as bank deposits,
cash, or even central bank digital currency (CBDC) if introduced. Foreign currency stablecoins could also
lead to currency substitution if they are used as a store of value and means of payment in countries with
weak currencies.
This note—and its companion note on Regulating the Crypto Ecosystem: The case of Unbacked
Crypto Assets (Bains and others 2022)—builds on the key elements of Regulation of Crypto Assets
(Cuervo and others 2020). The two Fintech Notes together provide a closer look at the regulatory
challenges brought by unbacked crypto assets, asset-backed stablecoins, and their ecosystem. In
January 2020, staff issued a Fintech Note discussing various elements on the regulation and supervision
of crypto assets.6 The note covered (1) risk assessment of crypto assets, initial coin offerings, crypto
asset exchanges, and stablecoins; and (2) regulation of crypto assets, initial coin offerings, and crypto
asset exchanges. That paper raised some important regulatory issues and considerations of stablecoins;
however, it did not discuss their regulation in detail, nor did it look closely at other entities and functions of
the broader crypto asset ecosystem. This note reflects evolving market developments and their
associated risks, as well as regulatory and supervisory developments, and provides a closer look at
rapidly growing elements such as stablecoins and their arrangements. It also discusses other key entities
3

Any reference to existing crypto assets and companies in this paper uses publicly available information and does not mean to
endorse or analyze specific features of crypto assets or arrangements.
4
Reference https://www.fsb.org/work-of-the-fsb/financial-innovation-and-structural-change/crypto-assets-and-global-stablecoins
and glossary in https://www.fsb.org/wp-content/uploads/P160222.pdf.
5
In fact, many if not most marketed “stablecoins” are neither stable nor coins. See P. Krugman’s opinion piece, “From the Big Short
to the Big Scam,” The New York Times, June 6, 2022.
6
Cuervo, Morozova, and Sugimoto (2020), https://www.imf.org/en/Publications/fintech-notes/Issues/2020/01/09/Regulation-ofCrypto-Assets-48810.
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that carry out core functions in the stablecoin ecosystem. The main purpose of this note is to help
regulators and supervisors identify key challenges and risks, providing high level guidance for their
consideration when designing a regulatory and supervisory approach to address risks.
This note is part of a broader set of IMF publications focused on crypto assets and digital money.
In addition to the Regulation of Crypto Assets Fintech Note (Cuervo and others 2020), the companion
Fintech Note Regulating the Crypto Ecosystem: The Case of Unbacked Crypto Assets (Bains and others
2022) covers closely related issues of the wider ecosystem, such as crypto asset exchanges and wallet
service providers. Other IMF publications have covered crypto assets and financial integrity (Schwarz and
others 2021),7 digital money,8 and capital flow management measures in the digital age (He and others
2022).9 The Fintech Note on blockchain consensus mechanisms (Bains 2022) focuses narrowly on the
underlying technology that delivers crypto assets.10 The greater role of BigTech entities in the crypto
asset ecosystem is an important development, and the BigTech in Financial Services Fintech Note
(Bains, et al. 2022) discusses the unique regulatory considerations required to manage their risks.11
The IMF has also recently dedicated two Global Financial Stability Report (GFSR) chapters,
including policy recommendations, to the crypto asset ecosystem. A chapter of the October 2021 GFSR
explores the growing systemic risk of crypto assets, including stablecoins,12 while the April 2022 chapter
covers DeFi lending, in which stablecoins play an important role. In the chapter, the authors argue that
proper stablecoin regulation is essential for the overall stability of DeFi applications. The IMF has also
discussed crypto asset risks in a series of blogs exploring both the risks of crypto assets as legal tender13
and the regulatory implications of the growth of crypto asset markets. The latter blog called for a global
regulatory framework that provides a level playing field along the activity and risk spectrum, to be led by a
global standard-setting body, such as the FSB.14
While CBDC is outside the scope of this note, some recommendations may be relevant to
components of the CBDC ecosystem that have similar characteristics. Service providers and technologies
related to CBDC could be subject to risks and challenges similar to those of stablecoin arrangements and
other crypto ecosystems, to the extent that they rely on private sector firms to provide critical services, as
most CBDC projects do. These may include technology vendors and wallet service providers, which
should be subject to the same regulatory approaches discussed in this note.

Why Stablecoin Regulation Matters
Stablecoins have grown rapidly, with market capitalization quadrupling in 2021 (Figure 1), coupled with
the growth of DeFi. Market capitalization reached a peak of over $175 billion in December 202115 before
falling to less than $160 billion by mid-2022. During the phase of rapid growth in 2021, stablecoin trading

7

Virtual Assets and Anti-Money Laundering and Combating the Financing of Terrorism (1) (imf.org).
The Rise of Public and Private Digital Money (imf.org).
9
Capital Flow Management Measures in the Digital Age (imf.org).
10
Blockchain Consensus Mechanisms (imf.org).
11
BigTech in Financial Services (imf.org).
12
Global Financial Stability Report, October 2021 (imf.org).
13
Cryptoassets as National Currency? A Step Too Far (IMF Blog).
14
Global Crypto Regulation Should be Comprehensive, Consistent, and Coordinated (IMF Blog).
15
According to DeFi Pulse; see https://www.defipulse.com/.
8

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volumes outpaced those of all other crypto assets, primarily because they are usable for the settlement of
spot and derivative trades across crypto asset platforms and applications without the need to convert to
fiat currencies. DeFi also grew during this period to around $100 billion by December 2021,16 supported
by the availability of stablecoins in a symbiotic two-way relationship, before falling significantly in 2022.
The growth of stablecoins is linked to the growth of crypto markets and DeFi. Stablecoins are the
“currency” of DeFi and enable other services. DeFi aims to provide financial services without centralized
financial entities, although centralization exists to varying degrees. It operates on permissionless
blockchains where financial transactions are executed automatically based on predefined conditions
through programmed smart contracts. Operations such as developing protocols, decision-making, and
liquidation are conducted autonomously and often anonymously. While DeFi activities are mostly
conducted on chain, admin key and governance token holders provide an avenue of centralization.17 The
GFSR observed that DeFi seems to be largely used by a small number of institutional entities, but
because of pseudonymity of on-chain data, these were not identifiable. Anecdotal evidence suggests
those entities include market makers and hedge funds, with many protocol developers funded by venture
capitalists, especially in advanced economies. The GFSR concluded that the regulatory approach for
DeFi should focus on elements of the crypto ecosystem that enable DeFi, such as stablecoin issuers
(which define technical specification and use cases); centralized crypto exchanges and hosted wallet
service providers (which connect crypto markets with the broader financial system); and reserve
managers, network administrators, and market makers (which play important roles in operationalization
and stability).

16

DeFi includes decentralized exchanges that allow users to trade crypto assets without an intermediary, and credit platforms that
match those of borrowers and lenders without the need for a credit risk evaluation of the borrower, among other growing uses.
17
Many decentralized applications (dApps) allow token holders to have voting rights, with those holding a greater proportion of
tokens having a greater share of voting rights. In other dApps, only a certain class of token has voting rights, and these tokens
are conferred on a select group of individuals and/or entities.
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Figure 1. The Growth of Stablecoins by Market Capitalization

Risks will increase as unregulated stablecoins grow, as they become more interconnected with
the existing financial system, and if they become used as a means of payment and store of value.
Stablecoins supported by high-quality and liquid reserves could potentially become a stable store of
value. This stable store of value will advance the stated goal of many stablecoins—to create a means of
payments and become a credible, widely accepted means of exchange. Although that is not yet the case
(stablecoins are mainly used within the crypto ecosystem), they could be widely accepted by, and
become interconnected with, existing financial entities and payment infrastructures in the future. They
could also potentially be used to improve the efficiency of cross-border payments. However, absent
robust regulatory frameworks, prudential, conduct, and payment system–related risks will increase across
the stablecoin ecosystem, potentially leading to instability.
Stablecoins could be used as a hedge against inflation and weak currencies in emerging markets
and developing economies and exacerbate currency substitution. Crypto asset adoption in some
emerging markets and developing economies has outpaced that of advanced economies, particularly in
retail holdings. Stablecoins could potentially be issued by BigTech or other large technology-driven firms
that enjoy international recognition among a broad range of users, thereby providing greater convenience
and an additional sense of security to users, especially in emerging markets and developing economies
with weak macroeconomic conditions. This could accelerate currency substitution through crypto assets
(cryptoization) and could be the source of spillovers into the exchange rate market as described in the
October 2021 Global Financial Stability Report.
Given the potential involvement of BigTech,18 some stablecoins could also be systemic at launch,
or quickly scale. A stablecoin ecosystem could combine features that attract a broad range of users

18

Other large technology-driven entities such as PayPal have also led developments in the crypto asset space.

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across multiple jurisdictions. While the Diem project is no longer led by Meta, other BigTech entities could
enter financial markets by issuing a stablecoin and developing its ecosystem or by partnering with
existing stablecoin issuers. The potential involvement of BigTechs as issuers or members of the
stablecoin ecosystem, counting on their large consumer base and potential for strong network effects in
payment and remittance services, could result in stablecoins’ quickly achieving systemic importance.
Standard-setting bodies are advancing the development of global standards to address risks in
stablecoin arrangements, but the focus so far has been narrow. Some cross-sectoral standards apply,
such as the Financial Action Task Force standards for anti–money laundering and combating the
financing of terrorism (AML/CFT), but their scope is limited (financial integrity). The FSB’s 10 high-level
recommendations for regulation, supervision, and oversight are also cross-sectoral but apply only to
global stablecoins. Additionally, the Committee on Payments and Market Infrastructures (CPMI) and the
International Organization of Securities Commissions (IOSCO) have published guidance on how their
Principles for Financial Market Infrastructures might be relevant for systemic stablecoin arrangements.
IOSCO has also published guidance on crypto asset trading platforms (commonly known as crypto asset
exchanges). The Basel Committee on Banking Supervision has issued two consultation papers on the
prudential treatment of bank exposures to crypto assets (June 2021 and June 2022).
More coordination is required among standard setters to develop comprehensive international
standards, especially for nonsystemic stablecoins. Further coordination is necessary to address the risks
stablecoins pose to financial stability, financial and market integrity, operational stability, and consumer
and investor protection—particularly for stablecoins that are not considered global or systemic. In this
regard, the FSB’s recent work on the vulnerabilities concerning existing stablecoins and the recent
statement on international regulation and supervision of crypto asset activities are steps in the right
direction.19 Nonglobal or nonsystemic stablecoins tend to share many of the risks with global stablecoins;
therefore, it is necessary to apply similar but proportionate rules to address those risks. This paper aims
to contribute to this endeavor by identifying considerations for potential regulatory responses to emerging
risks.

I. The Stablecoin Ecosystem: Components and
Risks
The various components of the stablecoin ecosystem perform functions related to issuance of, transfer of,
and access to stablecoins.20 First, stablecoins need to be created (or destroyed) and associated with a
stability mechanism. These functions will involve stablecoin issuers (which may hold a balance sheet
consisting of tokenized customer funds as liabilities); reserves assets; and other related components,
such as custodians holding reserves, market makers, and individuals or entities in charge of governance.
Second, stablecoins are traded and transferred, and several components of the ecosystem are involved
19

FSB Assessment of Risks to Financial Stability from Crypto-assets, February 2022 https://www.fsb.org/wpcontent/uploads/P160222.pdf and FSB Statement on International Regulation and Supervision of Crypto-asset Activities, July
2022 https://www.fsb.org/wp-content/uploads/P110722.pdf.
20
See FSB, Regulation, Supervision and Oversight of “Global Stablecoin” Arrangements: Final Report and High-Level
Recommendations, October 2020.
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in these functions: the network, network operators, and validators. Third, stablecoins need to be accessed
by end users, normally through components such as wallets and exchanges.
Depending on the arrangements, these functions may be carried out by the same or different
entities and generate risks unique to their specific functions. In some stablecoin arrangements, the same
firm is involved in issuance, transfer, and access. Others involve multiple specialized firms. In some
cases, several firms or individuals provide the same function, such as multiple technology vendors
managing a network, or several custodians over which reserves are split.
Crypto exchanges provide important services and functions and may carry out multiple activities.
They act as underwriters and distributors at the issuance stage. Many stablecoin issuers rely on crypto
exchanges as redemption gates. Some crypto exchanges act as market makers of stablecoins, which
perform important stabilization functions. Crypto exchanges also perform transfer functions among their
own wallets through off-chain transactions. Crypto exchanges often provide hosted wallet services to their
account holders.21
Each function of the stablecoin ecosystem is associated with important challenges and risks
arising from the specific functions undertaken and the combination thereof. The most salient challenges
related to the issuance functions are liquidity mismatch and run risk, legal certainty, sound governance,
consumer/investor protection, and concentration of economic power to key service providers. Other risks
are also relevant, including risks to operational resiliency, cybersecurity, and data protection. The
functions associated with the transfer of stablecoins raise concerns regarding sound governance,
operational resilience, cyber-resilience, and safety and integrity. Finally, components performing functions
related to access to stablecoins are vulnerable to issues such as financial integrity, consumer protection,
data privacy, and cybersecurity.
Some recent initiatives to identify challenges and risks from stablecoin arrangements and
propose regulatory responses have also focused on the underlying functions of stablecoins. For instance,
the US president’s Executive Order on the development of digital assets, focused on payment
stablecoins, highlighting risks emanating from the issuance, transfer, and access functions, where the first
raises stability and run risks, the second transfer risks, and the third concentration risks. These are
summarized in Box 1.

Box 1. US President’s Working Group on Financial Markets and Executive
Order on Ensuring Responsible Development of Digital Assets1
In November 2021, the US president’s Working Group on Financial Markets published a report
focused on the potential for increased use of stablecoins as payments, foreshadowing the potential
regulatory direction in the United States. The report (US President’s Working Group, November
2021) states that the current regulatory framework does not adequately manage the risks of
payment stablecoins, so it calls for urgent legislative action to impose federal prudential regulation
and overcome gaps (see page 16). New federal legislation would “complement existing authorities

21

For more detail on crypto exchange functions, see the companion note on the regulation of unbacked crypto assets.

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with respect to market integrity, investor protection, and illicit finance,” and would address three
broad areas:

1. Stability/run risks: To address risks to stablecoin users and guard against stablecoin runs,
legislation should require stablecoin issuers (institutions or holding companies) to be
insured by depository institutions subject to supervision and regulation (including capital,
liquidity, and resolution requirements) and eligible for Federal Reserve emergency
liquidity.
2. Transfer risks: To address payment system risk, legislation should require federal
oversight over stablecoin issuers and custodial wallet providers. Any entity that performs
critical functions for stablecoin arrangements should be required to meet appropriate riskmanagement standards.
3. Concentration risks: To address concerns about systemic risk and concentration of
economic power, stablecoin issuers and wallet providers should have restrictions that limit
affiliation with commercial entities. Standards to promote interoperability among issuers
should be introduced to address concentration of economic power. Other standards for
custodial wallet providers, such as on accessing users’ transaction data, should also be
considered.
Absent Congressional action, the report recommends that certain activities of stablecoin
arrangements be considered as systemically important. This designation by the Financial Stability
Oversight Council (FSOC) would trigger the application of relevant risk-management standards
and examination and enforcement frameworks.
In March 2022, the US president issued an executive order on ensuring responsible development
of digital assets (White House 2022). The executive order calls for measures to do the following:
 Protect US consumers, investors, and businesses by directing the Department of the Treasury
and other agency partners to assess and develop policy recommendations to address the
implications of the growing digital asset sector and changes in financial markets for
consumers, investors, businesses, and equitable economic growth. The order also encourages
regulators to ensure sufficient oversight and safeguard against any systemic financial risks
posed by digital assets.
 Protect US and global financial stability and mitigate systemic risk by encouraging the FSOC to
identify and mitigate economy-wide (i.e., systemic) financial risks posed by digital assets and
to develop appropriate policy recommendations to address any regulatory gaps.
 Promote US leadership in technology and economic competitiveness to reinforce US
leadership in the global financial system by directing the Department of Commerce to work
across the US government in establishing a framework to drive competitiveness and
leadership in and leveraging of digital asset technologies. This framework will serve as a
foundation for agencies and integrate this as a priority into their policy, research and
development, and operational approaches to digital assets.

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Support technological advances and ensure responsible development and use of digital
assets by directing the US government to take concrete steps to study and support
technological advances in the responsible development, design, and implementation of digital
asset systems while prioritizing privacy, security, combating illicit exploitation, and reducing
negative climate impacts.
The executive order also described the next steps where the relevant authorities are assigned
to produce reports to achieve the objectives described previously. For example, within 210 days of
the date of this order, the Secretary of the Treasury should convene the FSOC and produce a
report outlining the specific financial stability risks and regulatory gaps posed by various types of
digital assets and provide recommendations to address such risks.

1
The executive order covers a range of issues, including central bank digital currency. This box summarizes issues
relevant to the scope of this note.

The remainder of this note explores these key components and functions, the risks and
challenges they might generate, and potential regulatory responses. As mentioned, components that
perform key functions within the ecosystem are both sources of, and vulnerable to, risks. This note
focuses on elements that are unique to stablecoins and proposes regulatory considerations. Some
components (like wallets and exchanges) that are relevant to stablecoin arrangements are also key
elements of the broader crypto ecosystem and are therefore covered in the companion Fintech Note,
Regulating the Crypto Ecosystem: The Case of Unbacked Crypto Assets (Bains, et al. 2022).
In addition to the functions of stablecoins, regulators should track their use, which may change
over time and across countries. The use of the same stablecoin could differ across countries—for
instance, a stablecoin may be designed mainly for payment purposes in one country but function as an
investment vehicle in other countries. In some countries, the main use case of stablecoins may be to
provide access to other crypto assets, whereas in other countries it may be to serve as an inflation hedge.
Regulation might reflect these changing uses to ensure that new risks arising from changing uses are
managed. Cross-sectoral cooperation is important to ensure that regulation is consistent and addresses
the risks across jurisdictions in line with “same risk, same regulation.”

II. Issuance, Redemption, and Stabilization
Stablecoins backed by financial instruments usually have an identifiable issuer, unlike many unbacked
crypto assets. They are more likely to be issued by a single issuer or a small number of known issuers
(such as a consortium) in a closed network. The destruction of stablecoins is also usually carried out by
the issuer. Issuers could be banks, nonbank financial entities, and large technology conglomerates known
as BigTech.
Decisions for stablecoin arrangements are usually taken by a governance body. The power and
composition of these governance bodies are likely to differ among arrangements, but in many stablecoin
arrangements governance bodies are composed of token holders with governance rights. These rights
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may be distributed broadly in an open manner or be concentrated in a few known entities that exercise
ultimate control. Governance rights may be held by just an issuing entity, or they could be held by broader
network members (such as network administrators). They may include decisions on the type of assets
that reserves can be invested in and on setting the collateral ratio (in instances of overcollateralization).
A key element of stablecoin issuance is the stabilization mechanism, which aims at reducing
volatility and underpins the holder’s expectation that stablecoins will be redeemed at par, on demand, and
in any state of the world. For most stablecoins covered in this note, the stabilization mechanism is a peg
to a fiat currency, sustained by reserves. Stablecoin issuers and network administrators face pressure
from end users to meet redemptions at, or very close to, par upon request, even if issuers have no
obligation to do so. The ability to meet such requests hinges on the safety and liquidity of the assets held
as reserves. The management of reserves is specified by the governing body (usually the issuer).
Reserves are typically held in custody by a third party, such as a financial institution. Reserves, though,
can vary along a continuum from highly liquid to illiquid depending on the redemption pledge by the issuer
and the redemption needs from the end-holders.
Banks may also be issuers of stablecoins or crypto asset–linked products. Typically, applicable
laws and regulations in many jurisdictions do not allow banks to issue stablecoins directly, but banks can
create a special-purpose vehicle or subsidiary to do so in the same way as nonbank issuers. In addition,
some banks are considering tokenizing their deposits (Box 2). Some banks are considering issuing
stablecoins to allow for more efficient payments and delivery compared with payment of securities. The
latter may occur within a closed network created by a consortium of banks (for example, Utility Settlement
Coins initiated by UBS Group but with wider participants).
Some stablecoins are being tested for domestic payment services and cross-border remittances.
For example, some issuers offer debit cards using stablecoins, thereby linking the stablecoin universe
with the full array of payment services, although few merchants accept such payments. In another
example, Novi, a Meta-owned subsidiary, launched a pilot program of remittances, since closed, that
partnered with Coinbase, a centralized crypto asset service provider. The pilot involved users in the
United States and Guatemala, with a maximum value of $1,000 per wallet. Novi used a stablecoin (Pax
Dollar) for domestic payment and remittance services, and users could transfer money within the United
States and between United States and Guatemala through WhatsApp. Some crypto exchanges have also
introduced credit and debit cards to their users.

Box 2. Stablecoins Issued by a Commercial Bank and Deposit Tokenization1
Some commercial banks are actively exploring the potential of stablecoins and distributed ledger
technology (DLT) applications. J.P. Morgan is developing JPM Coin. Silvergate Bank purchased a
blockchain-based network from the Diem group. UBS Group is leading the project for Utility
Settlement Coin. Many of those projects aim to reduce the cost and time of money transmission for
their customers.
In some jurisdictions, banks are not permitted to directly issue stablecoins. In those
jurisdictions banks may need to wait for the authorities to clarify and add stablecoin issuance
activities as permitted activity. Alternatively, some banks are considering establishing a subsidiary

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or an affiliate to issue their coins. In those cases, the banking regulator may consider the issuing
subsidiary sufficiently relevant to be included in the scope of consolidation. Many of the prudential
regulations (such as capital, liquidity, and concentration limits), therefore, would be applicable to
the exposures of the issuing entities. In addition, those entities are likely to be subject to any new
regulation specifically applicable to stablecoin issuers and virtual asset service provides. It is
expected that such stablecoin regulations would be imposed regardless of issuer’s ownership
structure, in addition to bank regulations that would be applicable at the group level.
Issuing banks are focusing on permissioned networks and stricter policies around unhosted
wallets. Permissionless networks and unhosted wallets make it very difficult for banks to comply
with existing regulations. Therefore, projects led by commercial banks aim to eliminate or minimize
certain risks arising from permissionless network and unhosted wallets (such as settlement finality
and anti–money laundering and combating the financing of terrorism [AML/CFT] risks). Many
existing projects choose permissioned networks, allowing only existing account holders or hosted
wallets.
Alternatively, banks are exploring the option of tokenizing deposits. Tokenization of deposits
means that “bank depositors would be able to convert their deposits into and out of digital assets—
the tokenized deposits—that can circulate on a DLT platform. These tokenized deposits would
represent a claim on the depositor’s commercial bank, just as a regular deposit does.”2 The idea is
that this would address some of the risks and some of the regulatory and legal uncertainties of
stablecoins. For regulators, that would mean that, in principle, these tokenized deposits would be
subject to existing regulations (including prudential, conduct, and AML/CFT). Although not yet
clearly defined or operational, tokenized deposits would operate and transfer in a closed network
and only among existing bank account holders.
Nevertheless, the operational aspects of tokenization of liabilities are complex, and banking
regulation and supervision would need to be adjusted to address potential new features and risks.3
For tokenized deposits to work as intended, it would be necessary that the DLT network would
ensure instant settlement, and that tokenized deposits issued by a bank were interchangeable with
tokenized deposits issued by another bank. In addition, while tokenized deposits would operate in
a safer environment than stablecoins, they may create additional risks to the issuing banks and the
users. For example, hosted wallet services are likely to be provided by the issuing banks
themselves, and so banks may need to provide support in case the end users lose their private
keys. If banks rely on third parties for key functions, the same concerns expressed in this note
regarding third-party risks would apply. The legal and regulatory framework may also need to be
adjusted to address new features and risks. Legal status of the tokenized deposits would need to
be established or clarified in all countries if tokenized deposits are used for cross border payments.
1

Caroline Wu and Nobu Sugimoto are the authors of this box.

2

NYFED (February 2022) The future of payments is not stablecoins
https://libertystreeteconomics.newyorkfed.org/2022/02/the-future-of-payments-is-not-stablecoins/.
3
https://www.citibank.com/tts/insights/articles/article191.html.

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Challenges and Risks
Key risks to consumers and markets can arise from issuance functions. These functions include
components related to the issuer itself as well as the governance of the arrangements (including
decisions on composition of reserves, reserve custodians, and redemption). The risks and risk drivers are
related not only to the characteristics of the stability mechanisms and reserves—which underpin
stablecoins’ price stability—but also the governance and management of risks such as operational risk,
conflicts of interest, and concentration.

a) Reserve Composition, Allocation, and Management
The composition of reserves can generate not only risks to consumers and investors but also
financial contagion and instability. Risks stem from reserves’ being insufficient, risky, illiquid, or opaque—
and concentrated. Some stablecoins are backed by risky and illiquid assets, including commercial paper,
and in those cases, reserves might not always be redeemable at par. The incentive for investing in less
liquid, higher-risk assets generally comes from a search for yield but could also be the result of, for
example, conflicts of interest between the issuer and its related parties (such as crypto exchanges). As
described in Box 3, the reserves of one major stablecoin have not always covered the value of
stablecoins issued. Even if the value of assets exceeded the value of stablecoins issued, the reserves
were not always cash or cash equivalent.
The composition and allocation of reserves are often opaque, elevating risks of conflict of interest
between issuers and custodians and of misappropriation of reserve assets. While some stablecoins
provide attestations, major issuers (including Tether, Circle, and Binance) are yet to release audit reports
regularly by independent auditors. An investigation22 by the New York attorney general also revealed that
Tether lent a substantial amount of its reserve assets to its related party (Bitfinex), raising concerns of
misappropriation (see Box 3).
Concentration of reserves in certain institutions and on certain assets brings risks to consumers,
investors, and the financial system. Many commercial banks avoid establishing relationships with
stablecoin issuers for several reasons, including regulatory uncertainty and concerns about financial
integrity. As a result, stablecoin issuers may place reserves in only a few commercial banks. Moreover,
the asset allocation of stablecoin reserves tends to be relatively undiversified. Asset concentration may
have implications of systemic risk, as liquidity pressures from higher redemptions of stablecoins would
create a stronger impact on the market for the underlying assets.

22

New York Attorney General ends virtual currently trading platform Bitfinex’s illegal activities in New York (February 2021)

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Box 3. Tether and Its Reserves
Recent disclosures1 show that Tether, the world’s largest stablecoin by market capitalization, which
has reached a market capitalization of over $60 billion, may have exposed users to significant
risks, raising consumer and user protection concerns. Lack of information about the profile and
location of Tether’s users makes it difficult to conduct a meaningful analysis of systemic
implications. The issuing entity of Tether is domiciled in the British Virgin Islands and is largely
unregulated. While Tether is pegged to the dollar, US authorities may have limited influence over
the issuer. At the same time, Tether is not available to US households and firms.2
US authorities have taken some enforcement actions. The office of the New York attorney
general identified that a significant amount of Tether’s reserve assets had been provided to its
related crypto exchange (Bitfinex), which was suffering from a liquidity shortage without proper
disclosure—this loan would not have been allowed if Tether were a financially regulated entity. In
February 2021, Bitfinex and Tether agreed to pay a fine, cease their services to New York
residents and entities, and start providing quarterly transparency reports. The Commodity Futures
Trading Commission also identified that Tether held sufficient fiat reserves for only 27.6 percent of
the days in a 26-month sample period from 2016 through 2018 and imposed civil monetary
penalties in October 2021.
The recent disclosures (at the end of March 2022) still lack important information but make it
clear that Tether’s assets risk exposures are still high. Only 6 percent of Tether is backed by cash,
indicating liquidity mismatches as Tether allows direct and “immediate” redemption at face value
into US dollars through Bitfinex, with small fees (although it reserves the right to delay redemptions
or redeem in kind with reserve assets). Exposures to commercial paper and MMF are high (28
percent and 10 percent, respectively). To respond to the order from New York attorney general and
Commodity and Futures Trading Commission (CFTC), the issuer began to disclose more details in
2021, including duration and credit ratings of the bond and loans, although not the issuers of the
bonds and loans and their geographic information. The issuer also increased their liquidity by
holding US treasury bills (which account for 56 percent).
1
2

Transparency (tether.to).
Terms of service of Tether prohibit a US person from using any services offered by Tether.

Greater use of stablecoins could trigger fire sales of collateral assets in stress, bringing risks to the
broader financial sector. If use were to grow and as users expect to be able to redeem their stablecoins
quickly at par, issuers and service providers may need to sell bonds and withdraw bank deposits.
Depending on the size, nature, and concentration of the reserve assets, if large issuers have trouble, this
might have a negative impact not only on the token holders but also on the broader financial sector, such
as banks and bond markets (see Box 4). Any collapse in the price—or trust—of stablecoins could trigger
further redemptions, adding pressure on short-term credit markets already hit by the liquidation of
stablecoin reserve holdings. Some analyses have suggested that the price instability of stablecoins and

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concerns over insufficient reserve assets could be related to trading activities of their affiliated exchanges
in the unbacked crypto market.23

Box 4. Failures of Algorithmic Stablecoins1
Algorithmic stablecoins are generally not significant—but it is important to observe how
developments in algorithmic stablecoins can affect the wider crypto market. The collapse of
TerraUSD is a good example on how runs on even small stablecoins can have ripple effects on the
trust of the broader crypto ecosystem.
In May 2022, TerraUSD (UST), the third largest stablecoin and the largest algorithmic
stablecoin (market cap at $18 billion before the crash), experienced a sudden failure. The collapse
of UST started from a $2.5 billion UST withdrawal from Anchor (a decentralized finance lending
platform on Terra blockchain) on May 8, for unclear reasons. On the same day, $150 million in
UST liquidity was removed from UST’s primary decentralized exchange (DEX), Curve3Pool (DAI,
Tether [USDT], USD Coin (USDC)), to test for an upgrade of the Curve4Pool (UST, FRAX,
USDT,USDC),2 leaving the liquidity pool balanced but much smaller. Within a few hours after the
withdrawal, a few unforeseen large swaps to other stablecoin occurred (the highest at $85 million),
leaving the liquidity pool extremely unbalanced and vulnerable to even small transactions.3
The stabilization protocol was able to maintain the peg within 200 basis points for one day,4 but
the panic sell-off of UST continued and eventually outran the stabilization mechanism. Notably,
large depositors disproportionally withdrew from UST, adding to the pressure and leaving smaller
depositors more exposed. UST eventually depegged on May 9, sending it into a death spiral (the
supply of LUNA exponentially increased as an attempt to repeg UST, but at the same time greater
supply meant more selling pressure on LUNA’s price). By May 16, the price of UST dropped to
$0.16 and the price of LUNA fell from over $80 to $0.0002.
UST/LUNA’s failure rippled through the entire crypto ecosystem because of Luna Foundation
Guards’ (LFG) attempt to defend the peg by selling $2 billion worth of bitcoin.5 Bitcoin price sharply
fell by $2,000 right before UST first materially depegged. Tether, the largest stablecoin, also
dropped below its peg on secondary markets.
Algorithmic stablecoins rely on a smart contract-based algorithm to regulate between a pair of
tokens, a stablecoin, and a balance token, although details can differ from model to model. The
price-stabilizing arbitrage is performed when the value of one stablecoin is higher than $1, to burn
$1 of balance token and mint one stablecoin and, in contrast, when the value of one stablecoin is
lower than $1, to burn stablecoin and mint the balance token until the stablecoin returns to the
peg.6 This mechanism is vulnerable as the balance token (LUNA) is also issued by Terraform Labs
and thus relied on market confidence on Terraform Labs.
The stability of algorithmic stablecoin protocols relies to a large extent on market confidence
and market making by and through exchanges. UST market liquidity was based primarily on DEX,
which was significantly lowered during the initial sell-off of UST. Through DEX, UST holders were

23

See Griffin and Shams (2020) for their analysis.

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swapping UST for a more reliable stablecoin (such as USDT). It is also notable that only small
depositors on Anchor (original wallet size under $10K) increased their position from May 6 to 9.
Liquidity in centralized exchanges (CEX), at the same time, disappeared even more rapidly,
causing a trading halt of UST/LUNA on several CEXs.7 This disproportionally prevented retail
investors to exit UST. The governance structure of UST was also unclear, with opaque allocation of
responsibilities between Terraform Labs and the LFG on which would do what to defend the peg.
The LFG chose bitcoin, a known volatile crypto asset, as the backstop for repegging UST in case
of emergency. At the time of the initial stress, how and when the bitcoin reserve would kick in were
not publicly known.
The collapse of UST showed the potentially significant spillovers of stablecoins to the broader
crypto ecosystem, raising concerns not only on other noncollateralized stablecoins but also on how
generally stablecoin protocols would function in a bank run–like situation.
1
2

Caroline Wu is the author of this box.
Do Kwon on Twitter.

3

Jump Crypto – The Depegging of UST | Jump Crypto.
Through minting more LUNA and through the actions of the Luna Foundation Guard (LFG), a nonprofit organization that
act as a reserve for UST.
4

5

Luna Foundation Guard (LFG) on Twitter.
Malwa Shaurya, “Anchor Protocol Will Readjust Interest Rates Each Month, ANC Falls by 5%,” CoinDesk, March 25,
2022.
6

7

Riyad Carey, “A Data-Driven Exploration of UST’s Collapse,” Kaiko, May 2022.

b) Reserves Custody
Third parties involved in custody and redemption can amplify run risks by delaying redemptions and
adding costs. Some stablecoin issuers may rely on crypto asset exchanges, market makers, commercial
bank/ATM operators, or other money transmitters to meet the redemption requests and distribute cash to
end token-holders. For example, even though Tether allows direct redemptions to the holders, those are
allowed only for requests larger than $100,000. The second largest stablecoin (USD Coin or USDC) also
limits the redemption rights to institutional investors. As a result, the majority of retail holders of
stablecoins must rely on crypto exchanges to convert their stablecoins to fiat currencies.

Considerations for Regulatory Responses
The regulation of stablecoins is at an early stage, and more work is needed to ensure risks are
appropriately managed and addressed. A key limitation of the development of international standards so
far is that the approaches have had a sector-specific (payments, banking, or securities) or productspecific focus (“global” stablecoins). However, stablecoins are not used widely for payments, nor is it clear
that any existing stablecoins would be considered systemic or global. In both cases, the broader risks
from the various stablecoins that currently exist are unlikely to be fully captured. Furthermore, some major
US dollar–linked stablecoins are regulated by existing regimes (such as those for money transmitters and
trust companies by individual states within the United States), while other US dollar–linked stablecoins
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operate in offshore jurisdictions outside the remit of existing regulatory frameworks. Discussions of the
legal classification of stablecoins are also in the early stages (see Box 5 for more details).

Box 5. Stablecoins and Legal Uncertainty1
Legal certainty helps achieve policy objectives, preserve financial stability, and mitigate risks of
major financial losses. Legal certainty is essential for the predictability and enforceability of the
rights and obligations of the parties in a stablecoin arrangement. In most jurisdictions, there is still
no certainty on the legal classification of stablecoins, and the use of distributed ledger technology
(DLT) could amplify existing legal uncertainties.
Jurisdictions are grappling with the legal classification of stablecoins and exploring various
solutions such as applying existing classifications or designing new reforms to achieve legal
certainty. Such certainty is premised on the combination of private and financial law, with solutions
varying across stablecoins’ business models and countries’ legal systems. In some cases, this
could result in discrepancies of legal treatments and fragmented approaches that fail to mitigate all
the risks involved.
 Private law. Depending on its business model, a stablecoin could be classified as an
intangible property, a claim, or a sui generis asset. That, in turn, defines many fundamental
aspects of stablecoins, including the boundaries of contract freedom; the rights and obligations
of parties; how stablecoins can be transferred, lent, or pledged; and the extent of protections
available to the holders of stablecoins. This classification would also govern the rights of the
holders in the event of insolvency of the issuer or the custodian.
 Financial law. Under financial law, a stablecoin instrument may be potentially classified as a
deposit, a security, e-money, or a commodity. The classification of the instrument will be
informed by its private law nature and will in turn be relevant to consider the issuer, for
example, as a depository institution, money transmitter, securities issuer, e-money provider, or
trust. Depending on such classification, participants in a stablecoin arrangement may have
different rights and obligations with respect to the issuance, custody, assets backing the
stablecoin, and redemption mechanisms.
Additionally, legal uncertainties are either amplified or created from the use of DLT:
 In such a decentralized setting of stablecoins that spreads across borders, what is the
applicable law?
 How is settlement finality provided for in the context of chain immutability and nonrepudiation?
 Are the digital data just the representation of evidence of ownership or are they a separate
asset on their own?
 Does the knowledge of the private key equate to the stablecoin possession as movable
property?
 Will holders benefit from the innocent acquirer rule, or will stablecoins’ traceability hinder this
protection?
1

Marianne Bechara and Juan Sebastian Viancha Trujillo are the authors of this box.

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The first general consideration for regulation is that the assets of end users should be segregated from
the issuer’s asset. This segregation requirement would minimize the risk of losses of the end user’s
assets or of delayed access to them. The assets should be held in supervised and regulated entities
(typically commercial banks) that are able to ensure robust accounting practices, effective safekeeping,
and internal controls. Prompt access to assets should be ensured. User assets could be invested in
instruments that carry minimal credit, market, and liquidity risks.
To ensure adequacy of reserves and redeemability, requirements should be set on reserve asset
allocation, custody, and transparency. Issuers must adhere to the specified requirements for assets held
in reserve, including credit quality, maturities, and diversification in terms of issuers and sectors. The
requirements should be based on the redemption pledge made by the issuer and marketed by the
intermediaries. These requirements should reflect the underlying risks (such as capital and liquidity
requirements on high-risk and less liquid investments), similar to prudential requirements for banks.
However, banking regulations would need to be adjusted considering that some stablecoin issuers may
not engage in maturity transformation and may have simpler business models.
Depending on the structural features of stablecoins, regulatory approaches akin to MMFs and emoney could apply. If a stablecoin is denominated in a monetary unit of account and is redeemable into
cash upon demand, it needs to be fully backed by perfectly safe and liquid assets. If the issuer clearly
pledges redeemability within an elapsed time, then it may hold safe but less liquid assets. And if the
issuer offers redemption at the going market value of the underlying assets (or in kind) and intermediaries
explained such features very clearly, then it may hold riskier assets. While e-money regulation may offer
more useful guidance in the first case, and MMF regulation in the second (including from constant net
asset value money market funds), the two have similarities. Both are based on operational thresholds—
such limits regarding illiquid assets, maturity, and diversification requirements—that may be fine-tuned to
the specific structure features of stablecoins (see Box 6).
.

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Box 6. Stablecoins and Lessons from Money Market Funds and E-Money
Regulations
Where stablecoins do not pledge redemption at par and on demand, reserve assets can be
invested into illiquid assets for higher returns, and so money market fund (MMF) and similar
regulatory considerations may offer guidance. MMFs are subject to comprehensive requirements,
such as disclosure, audit, and governance, to ensure users’ protection without explicit safety net
arrangements. After the 2008 global financial crisis, prudential regulations on MMFs have been
enhanced. MMFs are now subject to various prudential requirements (investment limits regarding
credit quality, maturity limits, diversification requirements, redemption restrictions) to address firstmover advantage in case of excessive redemptions. However, it should be noted that the March
2020 market turmoil triggered government intervention to address significant redemptions in some
MMFs.
Some stablecoin issuers have already adopted liquidity management tools similar to those
applicable to MMFs, but those may not be suitable for all stablecoins. Some stablecoins have
similar risks to those of MMFs, so liquidity management tools used by MMFs, such as redemption
gates and in-kind redemptions,1 can help address the liquidity risks of stablecoins held as
investment products. However, the implementation of some liquidity management could prevent
the user’s immediate redemption of stablecoins for their day-to-day operation. In such a scenario,
the issuer would need to adopt different measures to address their liquidity mismatch risks.
For stablecoins issued with immediate redemption pledges, guidance from e-money
regulations may be useful. E-money institutions are typically subject to comprehensive prudential
requirements, such as investment limits, simple minimum and ongoing capital charges (as a share
of the float), or diversification requirements. Reserve assets are typically required to be segregated
and ring-fenced from the provider’s own funds and need to be deposited into a commercial bank’s
trust or escrow account or central bank. In some jurisdictions, while segregation is not required, Emoney institutions are required to have insurance or a guarantee to protect the users’ funds. As for
e-money issuers, regulation on stablecoin issuers should ensure the certainty of the claim by the
end users.
1

Redemption gates allow an issuer to suspend or limit redemptions for a short period. In-kind redemptions allow an issuer
to transfer its underlying assets to the redeeming holders instead of cash.

Application of MMF regulation would need to be tailored to the specificities of stablecoins, and some
risks may be better addressed by relevant components of bank regulations. Given the pseudonymity of
some stablecoin holders, some of the liquidity management tools used by MMFs (such as in-kind
redemptions) are difficult to implement. Therefore, to address the risk arising from liquidity transformation,
banklike regulation (such as the liquidity coverage ratio and the net stable funding ratio) could be useful.
Stablecoin issuers should be also subject to adequate reporting requirements. In addition, supervisors
need to conduct more intensive supervision, similar to that for banks, including liquidity stress testing.
Resolution authorities should require issuers to prepare recovery and resolution plans.

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To enable regulators to monitor evolving risks, stablecoin arrangements should be required to have
robust systems of collecting, storing, and safeguarding data. Regulators must continually assess the
changing industry landscape, participants, business models, interconnectedness, and risk concentrations.
Regulators also need to enhance their data collection and analytical capabilities and exchange
information with other relevant regulators both across borders and across sectors. Authorities should
remain flexible in order to address the evolving and new risks that the monitoring identifies.
To improve overall transparency, including on reserve holdings, timely and public disclosures should
be required. An issuer should disclose in a publicly accessible manner, such as a website or a separate
document, a detailed explanation of its reserve holdings (preferably no more than a predefined number of
business days after the end of each month).24 Furthermore, publication of a white paper could be
mandatory—an information document to provide fair and comprehensible information to potential
investors and users. The white paper should contain, for example, general information on the issuer and
its governance arrangement, description of reserve assets and their investment policy if applicable,
nature and enforceability of redemption rights, and information on the underlying technology used and the
related risks.
Intermediaries should be subject to robust regulations to ensure that their marketing of stablecoins
are unbiased and clearly explain the structural features of stablecoins. Intermediaries play an important
role in distributing stablecoins to end users. However, their marketing often omits important structural
features of stablecoins, such as redemption limits both in normal and extreme circumstances. Misleading
marketing could create panic and run scenarios on the stablecoins in extreme cases. Intermediaries
should be subject to robust regulation that requires them to clearly disclose and explain the structural
features of their offering to end users. For a more complete overview of the type of regulation these
intermediaries might be subject to, please see the companion Fintech note, Regulating the Crypto
Ecosystem: The Case of Unbacked Crypto Assets (2022).
Requirements for independent audits should be introduced to help ensure the accuracy of disclosures
and that reserve assets actually exist and are properly invested. That said, independent audits are costly
and so their frequency and detail need to be tailored to the size of the reserve assets and the risks that
the issuer presents to local and global markets. Most jurisdictions require the issuers of public offering of
securities and collective investment schemes to disclose annual financial reports with proper audit. In a
market that moves as quickly as crypto assets, any auditing might be at least annual or even more
frequent in order to provide confidence to authorities, markets, and consumers.
To further address the risk of conflicts of interests, custodians should be regulated and independent.
Independent third-party custodians play a key role in ensuring safety and proper investment of the
reserve assets and need to be regulated accordingly. As is the case for collective investment schemes,
authorities may want to limit the role of reserve custodians to regulated financial institutions only, such as
commercial banks and/or trust companies licensed by financial authorities. It is also important to ensure
sufficient independence of the custodian from the issuer and its related parties (such as crypto exchanges
and market makers of the stablecoins). Authorities may explore the conditions of independence in

24

Michel and Schulp, A simple Proposal for Regulating Stablecoins (November 2021)https://www.cato.org/sites/cato.org/files/202111/briefing-paper-128.pdf (accessed 5/29/2022)

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individual cases, for example if the issuer is a commercial bank, the authorities may or may not allow the
bank to use its own entity as custodian.
Where redemption depends on third parties, the governance body of the arrangement must have
clear plans to ensure redeemability in case of failure of the third parties. The governance body should
have robust operational and liquidity arrangements with those third parties to ensure immediate and at/or
near par redemption even during periods of market stress. For example, even if direct redemption by end
users is not allowed in normal market circumstances, the issuer should be prepared to offer other
redemption options, including direct redemption, in case liquidity providers and crypto exchanges cannot
provide timely and efficient conversions from stablecoin to fiat currency.
When the issuer engages with lending services, conflict of interests should be carefully managed or
otherwise should be prohibited. Some stablecoin issuers provide lending services, which often attract
many investors to the stablecoin for high returns. Such lending service should be operated on an
arms-length basis with the issuing and other critical functions of the stablecoin arrangement and should
not provide unsustainable guarantee of returns. Conflict of interests with the lending services should be
carefully managed by imposing proper market conduct requirements. When the governance framework of
the stablecoin arrangement cannot ensure proper control of the lending service, the authorities should
prohibit the stablecoin issuer to engage in lending services.
Issuers should have little or no credit or liquidity risk, in particular if the stablecoin is to be considered
an acceptable payment alternative. If a stablecoin is used as the settlement asset, participants will be
subject to the credit and liquidity risks of the stablecoin itself, the stablecoin issuer, and/or the settlement
institution. The governance body of the stablecoin arrangement should ensure that the stablecoin
provides its holders with a direct legal claim on the issuer and/or claim on, title to, or interest in the
underlying reserve assets for timely convertibility at par into other liquid assets and a clear and robust
process for fulfilling holders’ claims in both normal and stressed times.
If stablecoins are linked to a foreign currency or a basket of foreign currencies, the authority should
coordinate with the authorities of the referring currencies to address the additional risks. Stablecoins
linked to a foreign currency, or a basket of foreign currencies would create additional risks, including of
currency substitution and thus to the transmission of monetary policy of both the issuing and recipient
jurisdictions. Relevant authorities should have close coordination to ensure that additional risks are
appropriately mitigated before commencing any operation in the jurisdiction.
If stablecoin arrangements become systemic domestically, additional requirements on issuers, similar
to those of systemically important institutions, may be needed. International standards on global
stablecoins provide high-level guidance, but further cross-sectoral standards are required. The FSB high
level recommendations on global stablecoins offers guidelines on these additional requirements.
Similarly, CPMI-IOSCO provide additional guidance to minimized risks related to the transfer function.
However, as noted, detailed requirements have not yet been established by any standard setting body,
and the level at which a stablecoin is considered systemic is at the discretion of authorities. Additional
requirements, similar to those applicable to systemically important financial institutions, may include more
intensive supervision, safety and soundness, stress testing, recovery and resolvability. Finally, coverage
by deposit insurance may be considered for stablecoins issuers that become systemic, subject to strict
safeguard including robust prudential regulation (Box 7).

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Box 7. Stablecoins and Deposit Insurance1
A deposit insurance system (DIS) protects depositors against the loss of insured deposits at
supervised deposit takers. International standard setters have yet to issue guidance on whether
asset-backed stablecoins, such as those backed by bank deposits, should also be covered by
deposit insurance. The Financial Stability Board (FSB) stressed the need for recovery and
resolution planning for global stablecoins but did not touch upon the issue of extending deposit
insurance, which it viewed as being outside of its scope (FSB 2020). The International Association
of Deposit Insurers recently established a Fintech Technical Committee to consider the issues. In
advance of international consensus, authorities are considering national approaches. The
President’s Working Group (PWG) in the United States recommended that payment stablecoins
backed by fiat currency be subject to a prudential framework, which would require stablecoin
issuers to be “insured depository institutions” (meaning members of the US DIS, the Federal
Deposit Insurance Corporation [FDIC], and thereby subject to the regulations of the FDIC)
resolution regime (PWG Report on Stablecoins, November 2021). The Bank of England expects
that stablecoins issued as tokenized deposits by banks subject to the bank regulatory regime
would be covered by the DIS, while a modified insolvency regime would suffice for systemic
nonbank stablecoins.2
A precondition for deposit insurance is that DIS members be well regulated and supervised.
Extending deposit insurance to unregulated stablecoins backed by illiquid reserve assets could
create moral hazard and burden regulated banks with the costs of failed, volatile stablecoins.3 The
operational complexity of stablecoin arrangements, including its distributed ledger technology, may
raise challenges when operationalizing deposit insurance (for example, which entity would retain
the user information needed by the DIS to identify and reimburse insured users).
When discussing the potential extension of deposit insurance to the conceptual models
discussed in this paper, the following preliminary conclusions may be drawn:
 A prudent regulatory framework for stablecoins and legal certainty (Box 5) should be prior
conditions for deposit insurance coverage.
 Stablecoins that have less-liquid reserve assets (such as commodities, crypto assets) and are
mainly used for investment purposes or are not redeemable at par should not be insured.4
From their purpose and risk profile, these coins are more comparable to securities investments
(such as money market funds or other securities funds), to which deposit insurance is not
extended.
 Where commercial banks, which are already members of a DIS, issue tokenized insured
deposits or their own stablecoins backed by insured bank deposits that can be redeemed on a
one-to-one basis for fiat currency, deposit insurance coverage could apply. This is because
issuers would already fully meet the requirements, including for regulation and supervision.
 If stablecoins are issued by nonbank entities and are used primarily for payment purposes,
then deposit insurance coverage may not be warranted. Similar to e-money and in the absence
of being systemic, regulatory arrangements to safeguard users may be sufficient.5 As with
e-money, this should include regulation that addresses redeemability, reserve assets

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management (including a matching requirement, ensuring high liquidity of the reserve assets,
and addressing concentration risks), and strict customer asset segregation and ringfencing.6
Consideration could be given to extending deposit insurance to nonbank-issued stablecoins if
they became systemic (that is, presented similar financial stability risks and consumer
protection issues to—and were regulated like—bank deposits).
1
2

Jan Nolte is the author of this box.
Bank of England, “Financial Stability in Focus: Cryptoassets and Decentralised Finance,” March 2022.

3

A separate insurance mechanism for stablecoins, which would insulate banks from losses, would likely not be viable for a
small pool of stablecoin issuers.
4
Non–asset-backed stablecoins (such as those based on an algorithm) should not be covered by deposit insurance.
5
Even with these safeguards in place, a loss of user funds could be triggered by the failure of the issuer, such as if reserve
assets were misappropriated or the bank in which reserve assets were deposited failed.
6
Dobler et al., “E-Money: Prudential Supervision, Oversight, and User Protection,” December 2021.

Stablecoins issued by commercial banks should be subject to adjusted bank regulation. Some risks
arising from issuing stablecoins could be addressed by existing prudential and conduct regulations at the
entity and group levels. However, other risks (especially those arising from public blockchains and
unhosted wallets) may not be fully addressed by the existing banking regulatory framework. Banking
regulators should specify under what conditions and technologies commercial banks are allowed to issue
their own stablecoins. The Basel Committee on Banking Supervision’s’ second consultation paper (June
2022) on prudential treatment of crypto asset exposures clarifies some prudential treatments (such as
liquidity charges for issuing a stablecoin) in case bank-issued stablecoins.
Additional risk management and prudential requirements for banks may be applied. Careful analysis
is needed if an issuing entity is established independently from the prudentially regulated financial
institutions. When appropriate, the issuing entity should be consolidated into the banking/financial group
and should be subject to existing prudential regulation, such as liquidity coverage ratio and net stable
funding ratio requirements.25 While banks may not be legally obliged to meet redemption requests to the
issuing entity, they may face strong pressure to step in and provide liquidity if this could cause
reputational damage to the group. In any case, financial institutions are expected to manage operational
risk (arising from the platform operation of cross-border payment services) and conduct risk (for example,
when issuing structured bonds).26
Finally, effective cross-border cooperation between home and host supervisors is necessary to
address various risks arising from stablecoin arrangements. While the drivers for adoption are likely to be
different between advanced economy and emerging market and developing economy users, prudential
regulation on issuers is typically imposed by the home supervisor where issuers are domiciled. The home
supervisor would need to consider different economic functions and business models globally and tailor

25

If the issuing entity is truly independent and there are sufficient safeguards or firewalls between the stablecoin issuing entity and
banking group, it may be acceptable not to include the issuing entity as part of the banking group.
26
Some financial institutions have already issued structured bonds linked to crypto assets. Marketing of structured products in
general needs to observe requirements regarding obligations to investors, which become more complex when crypto assets are
involved (https://www.finra.org/rules-guidance/notices/05-59).
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the regulations accordingly, considering the risks arising from these functions and business models.
Effective cross-border cooperation mechanisms are critical for achieving consensus among home and
host supervisors on the regulation that captures globally active stablecoin issuers.

III. Transfer
Stablecoins’ potential use as a means of payment depends on the reliability of transfer functions in the
stablecoin arrangement. The transfer function permits the transfer of stablecoins between users, and it
entails the operation of a platform, a set of transfer rules, and a mechanism for transaction validation.27
This section is most relevant for stablecoin arrangements and their regulation if a stablecoin has been
adopted for payment purposes and where safe and reliable transfers are important.
CPMI and IOSCO have noted that the transfer function inherent in stablecoin arrangements is
comparable to the transfer function in financial market infrastructures (FMIs). Their report on the
application of the principles for financial market infrastructures (PFMI) to systemically important stablecoin
arrangements28 provides concrete guidance to stablecoins arrangements performing these transfer
functions (see Box 7). The guidance is not intended to create additional standards but to highlight
structural features from stablecoin arrangements that create new risks. Furthermore, the guidance does
not discuss issues specific to stablecoins denominated in, or pegged to, a basket of fiat currencies.
Recognizing that stablecoin arrangements present novel features and risks compared with other FMIs,
the report covers only a subset of principles, that is, governance (Principle 2), framework for the
comprehensive management of risks (Principle 3), settlement finality (Principle 8), and money settlements
(Principle 9).
Other principles from the PFMI remain relevant. Principles such as legal certainty of the stablecoin
arrangement, management of business and operational risk, and the interlinkages between arrangements
should all be considered. Guidance from CPMI and IOSCO emphasizes the importance of not only
addressing new risks, but also the usual risks (such as liquidity and credit risks) applicable to systemically
important systems. The key risks and considerations below draw directly from the guidance and the
relevant text in the PFMI.

27
28

CPMI-IOSCO 2022, 4.
CPMI-IOSCO Application of the Princioples for Financial Market Infrastructures to stablecoin arrangements (July 2022)
https://www.bis.org/cpmi/publ/d206.pdf.

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Box 8. Guidance on the Application of the Principles for Financial Market
Infrastructures to Stablecoin Arrangements1
CPMI-IOSCO guidance on the application of the principles for financial market infrastructures
(PFMI) to stablecoin arrangements (SAs) applies to SAs considered as systemically important
financial market infrastructures (FMIs), including the entities integral to such arrangements. While
the guidance is provided on only a subset of principles, a systemically important SA used primarily
for making payments is expected to observe all the relevant principles. Depending on the design of
an SA, types of entities, and functions involved, the principles that apply to payment systems will
apply to SAs that are used primarily for making payments based on a functional approach (“same
business, same risks or risk profile, same rules”). When an SA provides functions that more closely
resemble those provided by other types of FMIs (such as securities settlement system or trade
repository), the SA should observe the respective principles.
Principle
Governance
(Principle 2)

Guidance
A systemically important SA should have appropriate governance
arrangements.
A systemically important SA should consider how:
 the SA’s ownership structure and operation allow for clear and direct
lines of responsibility and accountability, for instance, it is owned and
operated by one or more identifiable and responsible legal entities that
are ultimately controlled by natural persons.
 the SA’s governance allows for timely human intervention, as and when
needed.
 the SA’s ownership structure and operation allow the SA to observe
Principle 2 and the other relevant principles of the PFMI irrespective of
the governance arrangements of other interdependent functions.

Comprehensive
management of
risks
(Principle 3)

A systemically important SA should regularly review the material risks that
the FMI function bears from and poses to other SA functions and the entities
(such as other FMIs, settlement banks, liquidity providers, validating node
operators and other node operators, or service providers) which perform
other SA functions or on which the SA relies for its transfer function.
A systemically important SA should develop appropriate risk-management
frameworks and tools to address these risks. In particular, it should identify
and implement appropriate mitigations, taking an integrated and
comprehensive view of its risks.

Settlement
finality
(Principle 8)

A systemically important SA should provide clear and certain final settlement,
at a minimum by the end of the value date, regardless of the operational
settlement method used. Where necessary or preferable, such settlement
should be provided on an intraday or real-time basis.
A systemically important SA should:

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Money
settlements
(Principle 9)

clearly define the point at which a transfer of a stablecoin through the
operational method used becomes irrevocable and unconditional.
ensure that there is a clear legal basis that acknowledges and supports
finality of a transfer.
have robust mechanism(s) for preventing any misalignment between the
state of the ledger and legal finality and ensure that legal finality of a
transfer, once it has occurred, is maintained regardless of competing
state(s) of the ledger.

A stablecoin used by a systemically important SA for money settlements
should have little or no credit or liquidity risk. In assessing the risk presented
by the stablecoin, the SA should consider whether the stablecoin provides its
holders with a direct legal claim on the issuer and/or claim on, title to or
interest in the underlying reserve assets for timely (as soon as possible, at a
minimum by the end of the day and ideally intraday) convertibility at par into
other liquid assets such as claims on a central bank, and a clear and robust
process for fulfilling holders’ claims in both normal and stressed times.
A systemically important SA should determine whether the credit and liquidity
risks of the stablecoin that it uses for money settlements are minimized and
strictly controlled and the stablecoin is an acceptable alternative to the use of
central bank money. Relevant factors may include but are not limited to:
 The clarity and enforceability of the legal claims, titles, interests and
other rights and protections accorded to holders of the stablecoin and SA
participants in relation to the issuer of a stablecoin and reserve assets
backing it, including their treatment (e.g. seniority) in the event of
insolvency of the issuer, its reserve manager or a custodian of the
reserve assets and/or other protections such as thirdparty guarantees.
 The nature and sufficiency of the SA’s reserve assets to support and
stabilize the value of the outstanding stock of issued stablecoins, and the
degree to which the SA’s reserve assets could be liquidated at or close
to prevailing market prices.
 The clarity, robustness, and timeliness of the process for converting the
stablecoin into other liquid assets such as claims on a central bank in
both normal and stressed circumstances. The stablecoin should be
convertible into other liquid assets, as soon as possible, at a minimum by
the end of the day and ideally intraday.
 The creditworthiness, capitalization, access to liquidity, and operational
reliability of the issuer of the stablecoin, provider of the settlement
accounts, and custodian(s) of the reserve assets. Reserve assets held or
placed in custody should be protected against claims of a custodian’s
creditors. Any chosen custodians should have robust accounting
practices, safekeeping procedures, and internal controls to protect the

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assets as well as a sound legal basis supporting its activities, including
the segregation of assets.
The sufficiency of the regulatory and supervisory framework that applies
to the issuer, reserve manager(s), and/or custodian(s) of the reserve
assets.
The existence of risk controls that could, where needed, reduce credit
and/or liquidity risks. Possible examples include collateral pools
supporting committed lines of credit, third-party guarantees and
procedures for allocating losses arising from a default by the issuer, or a
decrease in value of the stablecoin.

1 Agnija Jekabsone is the author of the content in this box.

Challenges and Risks
Clarity and transparency of the governance of the transfer or exchange function of stablecoins may be
clouded by software automation. Unlike traditional FMIs where an identifiable legal entity can be held
responsible for decisions, for stablecoin arrangements such decision functions may be performed solely
by software (smart contracts). While such automation may introduce numerous benefits such as
potentially decreased governance coordination costs, the ability to hold an entity clearly accountable is
diminished. Governance risks may be exacerbated during times of crisis.
Uncertainty over settlement finality and irrevocability is a key risk. The potentially large-scale
deployment of emerging technologies such as DLT may have an impact on how an FMI observes certain
PFMI principles, for example, in terms of finality of transfers. Unlike in centralized FMIs, where settlement
is final and irrevocable, once a book entry is made (usually in the ledger of the central bank), stablecoin
arrangements may use consensus mechanisms to achieve settlement. These processes may lower the
certainty of when settlement finality is reached. This “probabilistic settlement” may be caused by a
misalignment between the state of the ledger and when legal finality may occur.29 Without a responsible
legal entity, it could be challenging to enforce the legal finality or the resulting legal claim.
Settlement in privately issued money can expose users to counterparty risks. The PFMI sets the
expectations for the settlement asset(s) and states that money settlement should be conducted in central
bank money where practical and available as the central bank is able to provide a safe and liquid
settlement asset. Stablecoins are privately issued forms of value but not central bank money. To comply
with the requirements of Principle 9 on money settlements, a privately issued settlement asset should
have little or no credit or liquidity risk to be considered an acceptable alternative to central bank money

29

CPMI-IOSCO 2022, 16. “Technical settlement (or operational settlement) describes the point in time at which the state of an SA’s
electronic ledger reflects that a transaction has occurred. In some DLT arrangements, it can take time to update and
synchronise changes to the ledger of each node. The first instance of an update may not represent technical settlement
because it may take time for consensus to be achieved across the nodes in the synchronization of ledgers. In arrangements that
use a proof-of-work or other consensus mechanisms, technical settlement is probabilistic (‘probabilistic settlement’).”

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(CPMI-IOSCO 2022).30 Depending on the model, participants may be subject to credit and liquidity risk
from the issuer, settlement account provider, and reserve assets’ custodian.
Risks arise from interdependent functions. Stablecoin arrangements typically perform other functions
beyond a transfer function, and the boundary with other functions may vary across stablecoin models.
Such functions have been discussed earlier in this note (such as issuance, redemption, and stabilization
of the value) and might be governed and/or performed by a single entity or several entities different from
the entity performing the transfer function. These multiple interdependent functions can exacerbate risks
in relation to the transfer function (such as legal, operational, and other risks) and so affect the ability of a
systemic stablecoin arrangement to observe the PFMI.
Stablecoin arrangements might lead to additional friction and concentration, particularly where there
are closed ecosystems or a lack of interoperability. Where stablecoins operate on private or permissioned
blockchains, or otherwise operate in siloed ecosystems, these arrangements could increase
concentration in the provision of services and potentially generate additional frictions in payments through
a lack of interoperability. This is particularly true where such arrangements might grow to form a key
component of domestic or cross-border payments infrastructure. This risk is not limited to DLT–based
systems, and significant efforts are underway to improve operationalization on certain public blockchains.
Because of cost or lack of interoperability, market concentration could potentially increase, creating
financial stability risk.
Lack of interoperability among blockchains and stablecoins may lead to market fragmentation and
excessive concentration. As discussed in the companion Fintech note of Regulating the Crypto
Ecosystem: The Case of Unbacked Crypto Assets (2022), widely used blockchains are not yet
interoperable with each other; hence issuers have created stablecoins that are available on multiple
blockchains. These stablecoins minted by different issuers are not entirely interoperable with each other
and so require strong support from market makers to ensure price stability. This is also true where the
same stablecoin (minted by the same issuer) operates on several blockchains: Each unit of stablecoin
issued may not be directly fungible with the same token in a different blockchain. This might create
market fragmentation and excessive concentration by large firms, including BigTechs, and may hinder
competition and inclusion. Furthermore, should these stablecoins become systemic, a lack of
interoperability between different stablecoins could create additional market frictions. Finally, it will be
important to consider potential interoperability issues among private stablecoins, commercial bank
money, and central bank money, should these stablecoins be used more broadly for payments.

Considerations for Regulatory Responses
To strengthen governance, stablecoin arrangements should have identifiable decision-making structures
that are transparent and promote safety and efficiency of the arrangement. This would support the
objective of ensuring that stakeholders place high priority on the safety and efficiency of the arrangement.
Furthermore, the lines of responsibility and accountability and the decision-making process, including any
conflict of interest, should be clearly defined and documented. Also, the risk-management framework

30

CPMI-IOSCO (2022).

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should be established and documented. The governance arrangements of other interdependent functions
should not hinder observation of the relevant principles of the PFMI.
An adequate registration or licensing regime should apply to the entities involved in the transfer
function of stablecoins. Registration or licensing allows the collection of information and data necessary
for proper supervision and oversight and for monitoring potential financial stability risks while protecting
individual user privacy. Such approaches should include a set of strict and comprehensive conditions and
prudential requirements (such as initial capital and own-funds requirements) proportionate to the
operational and financial risks faced by such entities in the course of their business.
The entity applying for authorization or licensing should comply with key requirements and
conditions,31 such as having (1) robust governance arrangements, which include a clear organizational
structure with well-defined lines of responsibility, effective procedures to manage the risks to which it is or
might be exposed, and adequate internal control mechanisms, procedures, and mechanisms
proportionate to the nature, scale, and complexity of the payment services provided; (2) measures to
safeguard payment service users’ funds; (3) procedures to monitor, handle, report, and follow up on
security incidents; (4) processes to file, monitor, track, and restrict access to sensitive payment data; (5)
business continuity arrangements, which include identification of critical functions and contingency plans;
(6) security policy and risk-management framework for payment services comprising security controls and
mitigation measures; and (7) internal control mechanisms to comply with AML/CFT obligations.
To strengthen risk management, a robust risk-management strategy and review process must be in
place for stablecoin arrangement. A systemically important stablecoin arrangement should develop
appropriate risk-management frameworks and tools32 by taking an integrated and comprehensive view of
its risks. Risk-control policies and practices should include, but not be limited to, legal, credit, liquidity,
general business, and operational resilience33 (including outsourcing, fraud and cyber risk, risk of loss of
data; and various nonfinancial risks, such as data integrity; operational resilience (i.e., operational
reliability and capacity); third-party risk management and AML/CFT related risks.
To reduce settlement risk, there should be certainty on how finality and irrevocability is achieved.
First, stablecoin arrangements should be transparent about the settlement methods in use. If settlement
is probabilistic, then the exact moment when finality and irrevocability is reached should be defined.
Second, the settlement method should be supported by an enforceable legal framework. Third, there
should be defined risk-management processes to prevent misalignment between the operational and
legal settlement processes. And finally, given that stablecoin arrangements may span multiple
jurisdictions, there should be legal consistency regarding settlement finality across jurisdictions.
Stablecoin arrangements should determine whether the credit and liquidity risks are minimized and
strictly controlled.34 The CPMI-IOSCO guidance provides a list of factors to be considered by stablecoin
arrangements to determine if the stablecoin is an acceptable alternative to central bank money. That
includes clarity and enforceability of the legal claims, titles, interests, and other rights; the nature and

31

Example of requirements and conditions from the European Union regulatory framework on payment services directive.
CPMI-IOSCO (2022).
33
CPMI-IOSCO (2022).
34
CPMI-IOSCO (2022).
32

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sufficiency of reserve assets; clarity and robustness of conversion process of the stablecoin into liquid
assets and several others.35
While the PFMI guidance is applicable to systemically important stablecoin arrangements, other
nonsystemic arrangements are often encouraged to comply with the key requirements of the PFMI in a
proportionate manner. For instance, requirements on clear and robust governance arrangements, finality
of transfer, measures for safeguarding stablecoin service users’ funds, and comprehensive and efficient
risk-management frameworks, including for operational risk, would be critical and valid for any stablecoin
arrangement that is used as a means of payment so as to ensure safe, sound, and reliable transfer of
funds. Furthermore, a requirement for authorization or licensing or at least provision of information
requirement for all stablecoin arrangement service providers can provide supervisors with the information
needed to assess financial stability risks and implications.
Finally, authorities should consider appropriate policy and regulatory responses where stablecoin
arrangements lead to additional friction and concentration, particularly where there are closed
ecosystems or a lack of interoperability. Standards to promote interoperability should also be introduced
to limit concentration risk and supplier lock-in to particular technologies.

Box 9. Cybersecurity and Operational Risk
Cyber- and operational risks permeate all functions and components of the stablecoin ecosystem.
While distributed ledged technology may be more resilient to certain operational threats and
cyberthreats than traditional payment systems, cyber- and operational risks can still materialize in
the various components of the stablecoin ecosystem. Network operations, exchanges, and wallets
make alluring targets for cybercrime, but operational risks extend further than that and may affect
the capacity of stablecoin arrangements to perform many of its functions, including transfer and
redemption. To strengthen cyber- and operational resilience, stablecoin arrangements must ensure
appropriate policies and controls are in place. Entities involved in stablecoin services should have
robust operational risk-management frameworks with appropriate policies, procedures, and
controls in place. Systems should be designed to ensure a high degree of security and operational
reliability, including sufficient capacity. Business continuity procedures should be in place for timely
recovery of operations. Operational interdependencies between the actors (such as technical
service providers) involved in the arrangement should be identified and relevant risks properly
managed. In addition, entities should observe other relevant international standards on operational
and cyber-risks, such as International Organization for Standardization (ISO) standards for
information security management or US National Institute for Standards and Technology
standards, guidelines, and best practices for cybersecurity-related risks.

35

CPMI-IOSCO (2022).

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IV. Access
An access point is needed for an interface with the stablecoin ecosystem. User interface consists of client
software that connects the DLT network to a computer terminal. Some ecosystems offer more userfriendly wallets and websites that also provide additional services (such as storage of cryptographic keys,
transaction initiation). These interfaces, such as wallets and exchanges, are vulnerable to various risks
such as custodial operational, and concentration risks. See the companion Fintech note of Regulating the
Crypto Ecosystem: The Case of Unbacked Crypto Assets (2022) for more details of the wallet service
providers and exchanges and proposed considerations for regulatory framework, which include
recommendations for governance requirements, asset segregation, operational and cyber-resilience,
record keeping, AML-CFT controls, reporting and disclosure, and wind-down arrangements and
resolution.
If the wallet is used to store and transfer stablecoins for payment purposes, those could be subject to
additional regulations applicable to electronic payment instruments and further operating requirements.
For example, Eurosystem has developed an oversight framework for electronic payment instruments,
schemes, and arrangements (the Payment Instruments, Schemes and Arrangements (PISA) framework),
which is based on the most relevant principles of the PFMI. A payment arrangement can be defined as “a
set of operational functionalities which support the end users of multiple payment service providers in the
use of electronic payment instruments” such as payment initiation and facilitation of transfers of value and
“storage of personalized security credentials or data related to electronic payment instruments.”36 The
oversight activities should be proportionate to the level of importance of the arrangement and potential
risks to the efficiency and safety of the overall payment system. Where the payment system becomes
systemic, authorities might want to consider the implications of the failure of a wallet provider, including
the merit and scope of user protection. In fact, some jurisdictions have implemented user protection
schemes for e-money, and some jurisdictions may adopt a similar approach for crypto asset wallets if
they become systemic. Moreover, additional operating rules and requirements may be needed for
stablecoin wallet providers and/or merchants, because they access existing payment systems.37

Conclusion
Stablecoins may play a role in the future of finance, but absent robust regulatory frameworks, they will
introduce significant risks. If developed and implemented under appropriate regulation, stablecoins have
the potential to reduce costs of cross-border remittances; complement and improve existing payments’
infrastructure; provide competition in the payment space; and generate efficiencies when used for more
wholesale or back-end functions involving large, regulated entities. However, without an appropriate

36

European Central Bank, Eurosystem Oversight Framework for Electronic Payment Instruments, Schemes and Arrangements
(2021), 21.
37
Some examples may include compliance to EMV (Europay, Mastercard, and Visa) standards, PCI DSS (Payment Card Industry
Data Security Standard) requirements, and two-factor authentication.
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regulatory framework in place, stablecoin issuers and arrangements could generate risks to consumers,
markets, and—where systemic—financial stability. This may be the case particularly where reserve
compositions are complex, less liquid, or opaque. It may also be true where key participants in the
stablecoin arrangements—such as wallets and exchanges—are not appropriately regulated and there is
little recourse for consumers in the event of operational failures, cyberattacks, or frauds and scams.
Developing such a robust and comprehensive regulatory framework for stablecoins will involve
intense monitoring and a targeted approach and focus on all actors. An appropriate and consistent
framework should provide a level playing field along the activity and risk spectrum and, given the rapid
growth of stablecoins in some jurisdictions, authorities will have to move fast. This includes strengthening
surveillance to monitor new developments and managing any data gaps to gather accurate insights and
determine proportionate regulatory responses. Such regulation should be aimed at key participants of the
stablecoin ecosystem, including issuers, wallets, exchanges, network providers, governance bodies, and
reserve managers.
Yet developing a regulatory framework for stablecoins is likely to face some challenges that are
similar to those associated with broader crypto asset regulation. Data availability and extra territorial
oversight are common challenges across the crypto asset ecosystem, including stablecoins. The notion of
known entities does not make effective supervisory oversight easier, as many entities may operate from
offshore financial centers. The cross-sector and cross-border dimensions of stablecoins make domestic
and international coordination and cooperation key. Activities related to stablecoins already are, and will
continue to be, more cross-border and cross-sectoral than many traditional financial activities. This
requires close international cooperation and coordination38 to address regulatory gaps and prevent
potential regulatory arbitrage. Consistent regulatory approaches can prevent the potential risk of a race to
the bottom by regulators and policymakers and address regulatory arbitrage by financial entities.
Where a regulatory framework for stablecoins is deemed necessary, it can take cues from similar
products and business in the market, such as commercial banking, e-money, FMIs, and MMFs, while
addressing novel risks. A combination of conduct, payment, and prudential regulation that takes cues
from similar products and activities in the market might be a sensible approach to regulating crypto
assets, including stablecoins. Such an approach should focus on key components and their functions and
risks, to ensure those entities are licensed and authorized. This provides for a ”same risk, same
regulation” approach. To ensure same risk, same regulatory outcome, authorities might also want to
consider any unique risks from the underlying technology, volatility, market awareness, and product
knowledge/understanding, and how the stablecoins are being used. While a technology-neutral approach
to regulation might be considered, supervisory approaches should consider the unique risks of different
methods of delivery and operation, and authorities should be confident in identifying where particular
types of technologies might challenge (or support) their objectives. Regulators may also want to consider
cross-sectoral issues that may need bespoke responses.
The regulatory, supervisory, and oversight approaches used for existing payments could apply, to
some extent, to stablecoins that are intended to create means of payment and enable transfer of coins
between users. While existing e-money regulation might not be fit for purpose for all aspects of stablecoin

38

While data, privacy, and tax issues are outside the scope of this note, it is important to address those issues regarding crossborder cooperation and cross-agency coordination.

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arrangements, the existing regulatory requirements or adjusted frameworks that take their cues from such
regulation could cover some of the risks associated with stablecoins or entities active in these
arrangements. Similarly, existing regulatory approaches for payment service providers and payment
institutions could also be relevant for certain services provided by stablecoin arrangements.
The transfer function of systemic stablecoins must adhere to the PFMIs, especially if they integrate
with existing payment systems. Because the transfer function of a systemic stablecoin is comparable to
the transfer function performed by other types of systemic financial market infrastructures, the CPMIIOSCO guidance has established that the PFMI and the additional guidance on specific principles apply
to systemically important stablecoin arrangements. However, the risks and their mitigation measures
described in the PFMI could also be relevant for other nonsystemically important stablecoins, although
applied in a proportionate manner. More specifically, risks related to legal certainty, governance,
settlement finality, and operational risk warrant added attention because of the decentralized nature of
stablecoin arrangements.
In jurisdictions where stablecoins are systemic, immediate policy action may be warranted, albeit
broad-based restrictions are unlikely to be a long-term solution. In the short term, in some emerging
markets and developing economies where crypto assets such as stablecoins already generate risks to
financial stability, waiting for global regulatory standards might not be an option. In these jurisdictions,
authorities should use existing regulatory powers to best manage any risks and gain time to develop more
comprehensive regulations. At the same time, in jurisdictions where users move to stablecoins as a way
of hedging against inflation or currency devaluation risk, implementing stronger domestic macroeconomic
policies, such as strengthening monetary policy credibility, safeguarding the independence of central
banks, and maintaining a sound fiscal position, may dampen incentives. Restricting the use of crypto
assets for certain activities—such as restricting derivatives linked to or payments in crypto assets—could
be a short-term solution to dampen crypto asset growth. Broadly banning the use of crypto assets,
however, would likely stifle innovation and could trigger even stronger incentives for regulatory arbitrage
and circumvention—and enforcing broad bans would be extremely difficult.
Finally, robust international standards are indispensable to ensuring effective and efficient crosssectoral and cross-border cooperation. Relevant SSBs are undertaking significant effort to develop their
own standards according to their mandates. While these are important steps, the economic functions of
stablecoins are likely to change over time, changing the suitability of sector-specific regulations. Against
this background, it is important for the FSB to take a leading role in coordinating efforts across sectoral
SSBs. The FSB is well placed to take a leading role in coordinating and establishing global standards for
the regulation of stablecoins, taking into account sector-specific standards developed by other SSBs. Use
cases also vary among the jurisdictions, so the home authority where an entity carrying out core functions
for stablecoins is domiciled needs to coordinate with other relevant authorities where the users of the
stablecoins are located. IMF staff are actively contributing to the SSBs’ activities to facilitate the
development and implementation of robust international standards.

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NOTE/2022/008