“Ensuring that a stablecoin maintains its peg even in a stressed market is a solvable problem,” Catalini says. In an optimal scenario, he says, reserves would consist entirely of “high-quality, liquid assets,” such as short-term U.S. government bonds, and providers would maintain “an appropriate capital buffer.”
In the two years since Celsius filed for bankruptcy, Tether has voluntarily increased the size of its USDT reserve buffer and slightly reduced the portion of its reserves made up of collateralized loans, from 6.76 percent to 5.55 percent. But Tether “doesn’t operate within a framework that restricts what its directors can and can’t do,” Catalini says. “That’s where regulation is needed.”
There have been several attempts to regulate the stablecoin industry in major markets. Earlier this year, the EU introduced regulations for stablecoin issuers under Crypto Asset Markets The Act (MiCA), which includes requirements regarding the amount of cash a stablecoin issuer must hold, the types of assets that can constitute a stablecoin reserve, the safekeeping of reserve assets, and more.
In April, U.S. Senators Cynthia Lummis and Kirsten Gillibrand proposed a bill that would bar stablecoin issuers from lending against reserve assets. The bill likely won’t pass Congress before the upcoming presidential election, Cooper says, but “there’s a recognition on both sides of the aisle that some level of regulation is necessary.”
But by and gigantic, stablecoin companies have been left to figure out how to police themselves. “We have a new asset class that’s being run by a bunch of people right now who are looking for guidance on what’s allowed and what’s not — and they’re not getting it,” Cooper says. “In an industry that thrives on risk — and there’s a lot of it in cryptocurrencies — it’s not surprising that some companies are pushing the boundaries.”
The challenge for the first handful of regulators to adopt stablecoin regimes will be to mitigate the threat of de-peg without scaring off issuers. Risk appetite among stablecoin providers—whose profitability is somewhat tied to the risks they can take on reserve assets—may encourage them to withdraw from jurisdictions that impose the most stringent restrictions. “The problem of regulatory arbitrage is as old as the hills,” Cooper adds.
Since the introduction of MiCA, Tether apparently has not yet applied for a license to operate in the EU. In an interview with WIRED earlier this month, Tether CEO Ardoino said the company is still “formalizing its strategy for the European market,” but expressed concerns about some of the reserve requirements imposed under MiCA, which he described as unsafe.
Meanwhile, while Ardoino views stablecoins as a potential threat to customary banks, in an interview he dismissed the prospect of imposing similarly stringent regulations on Tether, citing the freedom of banks to lend out the majority of the deposits they receive, unlike stablecoin companies.
But the window for regulatory arbitrage, regardless of the motivation, will close, Catalini says, as international consensus forms around the appropriate controls to impose on stablecoin issuers. “Regulatory arbitrage is a temporary phenomenon,” he says. “It’s only a matter of time before every stablecoin of significant size has to comply.”