How do you solve a problem like Stablecoins? Balancing Innovation, Risk and Regulation

This article has been prepared jointly by the teams at TLP Advisors and OL Consulting

Key Takeaways

• Stablecoins are pegged to assets like fiat currencies or commodities to maintain a stable value, making them suitable for cross-border payments and decentralised finance (DeFi).
• Different stablecoin models, such as algorithmic and fiat-collateralised, come with varying levels of risk. Algorithmic stablecoins, like TerraUSD, have shown higher vulnerability, as demonstrated by TerraUSD’s collapse in 2022.
• The Abu Dhabi Global Market (ADGM) focuses on fiat-referenced tokens and excludes algorithmic stablecoins. It requires a 1:1 ratio of liquid reserves in cash or liquid assets, with a minimum capital requirement of USD 2,000,000 or the stablecoin issuer’s annual audited expenditure, whichever is higher.
• The Virtual Assets Regulatory Authority (VARA) in Dubai excludes algorithmic stablecoins and does not include representations of equity claims or central bank digital currencies (CBDCs). Reserves must be 100% backed by reserve assets, with a minimum capital requirement of AED 600,000 plus 2% of the value of outstanding fiat-referenced virtual assets (FRVAs).
• The Central Bank of the UAE focuses on payment tokens tied to fiat currency and excludes algorithmic stablecoins. It requires reserves to be wholly denominated in the same currency as the stablecoin, with a minimum capital requirement of AED 15,000,000 initially, with ongoing requirements of 0.5% of the face value of outstanding tokens.
• The European Union covers both asset-referenced tokens (including commodity-backed stablecoins) and fiat-referenced tokens (e-money tokens). Reserves must maintain a 1:1 ratio, with at least 30% of funds in a separate account and the rest invested in secure, low-risk assets. The minimum capital requirement is EUR 50,000 to EUR 150,000, or 25% of the issuer’s fixed overheads, whichever is higher. It also includes transaction limits of 1 million daily transactions by volume or 200 million euros by value per day for USD-referenced tokens.
• The Monetary Authority of Singapore (MAS) requires stablecoins pegged to the Singapore Dollar or any G10 currency to be backed by reserves equivalent to at least 100% of the outstanding supply. Issuers whose circulation exceeds SGD 5,000,000 need to obtain a Major Payment Institution licence for stablecoin issuance services. The minimum capital requirement is SGD 1,000,000 or 50% of annual operating expenses, whichever is higher. Foreign-issued stablecoins are allowed under the broader Payment Services Act.
• Each jurisdiction imposes different reserve requirements, ranging from 100% in Singapore and Dubai to varying levels of liquid assets in the European Union.
• These regulatory frameworks illustrate the global effort to ensure stablecoins are backed by sufficient reserves, provide consumer protection, and mitigate risks of fraud, operational failure, and illicit use while recognising the unique risks posed by different types of stablecoins.

Introduction

As the global financial ecosystem continues to evolve, stablecoins have emerged as a key innovation within the broader spectrum of digital assets. Stablecoins are a type of cryptocurrency designed to maintain a stable value by pegging their worth to a reserve asset, such as fiat currencies or commodities. In order to maintain the stability of the stablecoin’s value, an amount of the pegged fiat currency or reserve asset proportionate (and, in some cases, equivalent) to the number of units of stablecoins is maintained in reserves as collateral. The introduction of stablecoins directly combats the volatility of cryptocurrencies like Bitcoin, making it a much more viable medium of exchange. This stability has led to rapid adoption across financial markets, bridging traditional finance and the digital economy.

In recent years, stablecoins have seen explosive growth, driven by increasing demand for secure, reliable digital payment solutions.[1] As regulators and institutions adapt to this changing landscape, stablecoins will likely play a crucial role in shaping the future of finance by enhancing cross-border transactions, significantly improving financial inclusion, and fostering the development of decentralised finance (DeFi) ecosystems.

The rationale behind regulating stablecoins

As stablecoins become increasingly embedded in the global financial system, regulation is essential to ensure stability, security, and trust. Stablecoins are not merely digital assets used within the virtual asset industry; they are emerging as reliable online and offline exchange mediums. People and businesses increasingly view stablecoins as a stable alternative to fiat currency due to their value stability and ease of use. Their role in enabling instant conversion to fiat provides a higher degree of comfort, making them attractive to a broad spectrum of users, from individual consumers to institutional investors.

Given stablecoins’ expanding role, the absence of a regulatory framework could expose the financial system to significant risks, including market volatility, fraud, and systemic shocks. Regulatory authorities are particularly concerned about the potential impact of stablecoins on consumers, market integrity, and financial stability. By regulating stablecoins, regulatory authorities can mitigate risks associated with their widespread use, such as money laundering, terrorism financing, and the potential for misuse in illicit activities.

Risks associated with Stablecoins and the need for regulation 

While stablecoins present numerous benefits, they are not without risks.[2] A significant concern is the potential for stablecoin issuers to engage in fraudulent practices, such as “rug pulls,” where an issuer advertises a project, raises money to develop it and then abandons the project, leaving investors with worthless tokens. Additionally, the anonymity and decentralisation associated with the digital asset sector make stablecoins attractive for illicit activities, such as money laundering or terrorism financing. There are also operational risks, where technological vulnerabilities in the underlying blockchain or smart contracts could lead to breaches or hacks, undermining confidence in these assets.

Among the most prominent risks are algorithmic and crypto-collateralised stablecoins, both of which have shown vulnerabilities during market turbulence. These models, often dependent on volatile assets or complex mechanisms, are particularly susceptible to failure during times of stress, exposing users to significant losses.

A notable example of a stablecoin that imploded is TerraUSD (UST), an algorithmic stablecoin that collapsed in 2022.[3] During the period of market volatility, TerraUSD’s system failed to maintain its peg to the US dollar, wiping out billions of dollars in investor value and causing significant disruption to the broader cryptocurrency market. This collapse highlighted the inherent risks in algorithmic stablecoins, which rely on complex mechanisms to maintain their peg, making them more vulnerable to market instability.

To address these risks, regulators are focusing on creating a level playing field where stablecoin issuers are held accountable. Regulation ensures that issuers maintain transparency, uphold consumer protections, and adhere to clear standards to safeguard individual users and the wider economy. By imposing stricter controls on stablecoin issuance and mandating adequate reserves, authorities aim to prevent future collapses like TerraUSD’s and promote financial stability. The table below compares existing and proposed stablecoin regulatory frameworks in several key jurisdictions (namely, the United Arab Emirates, the European Union and Singapore).

Regulator—Criteria	Abu Dhabi Global Market’s FSRA	VARA	Central Bank of UAE	European Union	Monetary Authority of Singapore (“MAS”) Contributed by: OL Consulting Inc.
Regulation	FSRA’s Proposed Regulatory Framework for Issuance of Fiat-Referenced Tokens[4]	Fiat Referenced Virtual Assets Issuance Rules, Virtual Asset Issuance Rulebook[5]	Payment Token Services Regulation[6]	Markets in Crypto-Assets Regulation[7]	Proposed Stablecoin Regulatory Framework under Payment Services Act 2019 of Singapore[8]
Applicability	Fiat-referenced tokensExcludes algorithmic stablecoins	FRVAs do not include Virtual Assets which are—representations of any equity claim;issued by central banks acting in their monetary authority capacity [e.g. central bank digital currencies]; or tokenised bank deposits used only for interbank settlement purposes.	Payment Tokens whose value is denominated in AED or any foreign fiat currency.Excludes algorithmic stablecoins	Asset-referenced tokens (including commodity-backed stablecoins) and fiat-referenced tokens (known as e-money tokens)	Single currency stablecoins issued in Singapore that are pegged to Singapore Dollar or any G10 currencies with circulation exceeding SGD 5,000,000 will need to obtain a Major Payment Institution licence for stablecoin issuance service. The issuer will be recognised as an issuer of MAS-regulated stablecoins.Foreign issued stablecoins and other types of stablecoins are not prohibited from being used within Singapore, and, where applicable, will continue to be governed under the Payment Services Act as a digital payment token service.
Reserve requirements	1:1 ratio of liquid reserves in the form of a combination of cash and rapidly liquid assets like debt securities	Sufficient reserve assets such that the stablecoin is at least 100% backed by reserve assets.	Cash wholly denominated in the same currency as pegged by the payment token	1:1 ratio of liquid reserves, with at least 30% of the funds deposited in a separate account and the remaining invested in secure, low-risk assets	At least 100% of the outstanding stablecoins in circulation always, held in cash, cash equivalents or debt securities issued by the central bank of the pegged currency or certain other government organisations with no more than three months residual maturity.
Application process/timeline	TBD	TBD	TBD	TBD	TBD
Minimum capital requirements	USD 2,000,000, or the stablecoin issuer’s annual audited expenditure (whichever is higher)	VASPs Licensed to issue stablecoins shall always maintain their own capital equal to the total of—i.     AED 600,000; andii.    2% of the value of the outstanding supply of the FRVA.	At least AED 15,000,000 initially, and an ongoing capital requirement of at least 0.5% of the face value of outstanding tokens in fiat currency	EUR 50,000 (this may increase up to EUR 150,000 depending upon the type of crypto-asset service being provided), or 25% of the fixed overheads, whichever is higher.	At least SGD 1,000,000 or 50% of the annual operating expenses, whichever is higher.
Application fees	USD 70,000 (proposed)	N/A	N/A	N/A	TBD. Existing fees for a major payment institution licence range between S$0 – S$1,500.
Effective status	Consultation Phase	Effective from September 2023.	Transition period until June 2025.	Came into effect on 30 June 2024 with respect to stablecoins. The regulations will be fully applicable on all CASPs on 30 December 2024	Consultation closed on 15 August 2023, legislative amendments awaited.
Transaction limits	N/A	N/A	N/A	1 million daily transactions by volume or 200 million euros by value per day (applicable to USD-reference tokens)	N/A
Examples of licenced entities	N/A	N/A	N/A	Circle (issuer of USDC and EURC)[9]SG-Forge (issuer of EURCV)[10]	N/AExisting stablecoin issuers licensed for “digital payment token service” include: StraitsX (issuer of XSGD and XUSD)[11]   Paxos (issuer of Paxos USD)[12]

Conclusion

Finding the right regulatory balance is crucial as stablecoins continue to reshape the financial landscape. While they offer significant benefits in terms of stability and innovation, addressing the associated risks is essential for maintaining financial integrity. The varied global regulatory approaches highlight the complexity of this issue. Effective regulation will be key to ensuring that stablecoins contribute positively to the financial system while mitigating potential risks. Solving a problem like regulating stablecoins may not be as easy as do re mi fa so la ti do, but as the financial landscape changes, regulators are constantly innovating to effectively adapt their regulations.

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TLP Advisors is a dynamic and forward-thinking consulting, strategy and law firm specialising in providing cutting-edge solutions to our diverse clientele. With our roots deeply embedded in financial services, gaming, web3, and emerging tech, we offer unparalleled knowledge and support tailored to these rapidly evolving sectors’ unique challenges and opportunities.

TLP Advisors has consistently been the firm of choice for L1 chains, DeFi protocols, gaming companies, fintech and payment companies, foundations, funds, and investors. We have built a reputation for excellence through frequent collaborations with regulators, funds, and technology incubators. Our deep understanding of the intricate regulatory landscapes and industry dynamics allows us to provide strategic guidance and innovative solutions that empower our clients to navigate complex challenges and seize emerging opportunities.

www.techlawpolicy.com

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OL Consulting is a premier corporate advisory and services firm with a strong niche in providing high quality fractional in-house counsel and strategic advisory services to blockchain and web3 projects, fintech, gaming, and AI founders, projects, and companies.

OL Consulting brings to the table different core expertise ranging from fundraising, regulatory, corporate, web3 & digital assets advisory, disputes to intellectual property, allowing us to connect with, understand and support clients throughout their business lifecycle. OL Consulting is committed to delivering cutting-edge solutions that empower businesses to thrive in the digital age while staying ahead of regulatory developments and mitigating business risks.

www.teamoutlaw.io 

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[1] Feng Jin, Preferring stablecoin over dollar: Evidence from a survey of Ethereum platform traders, 131 Journal of International Money and Finance, March 2023, https://www.sciencedirect.com/science/article/abs/pii/S0261560622001991.

[2] Report, Stablecoins Top Choice for Crypto Scams, Independent Community Bankers of America, (Jan. 19, 2024), https://www.icba.org/sitefinity/status?ReturnUrl=https:%2F%2Fwww.icba.org%2Fnewsroom%2Fnews-and-articles%2F2024%2F01%2F19%2Fstablecoins-top-choice-for-crypto-scams-report.

[3] What Really Happened To LUNA Crypto?, Forbes (Sep. 02, 2022), https://www.forbes.com/sites/qai/2022/09/20/what-really-happened-to-luna-crypto/.

[4] Consultation Paper No. 7 of 2024, Proposed Regulatory Framework for the Issuance of Fiat-Referenced Tokens, available at: https://en.adgm.thomsonreuters.com/sites/default/files/net_file_store/Consultation_Paper_No._7_of_2024_FRTs.pdf

[5] Annex 1, Virtual Asset Issuance Rulebook, available at: https://rulebooks.vara.ae/rulebook/annex-1-fiat-referenced-virtual-assets-issuance-rules

[6] Payment Token Services Regulation, available at: https://rulebook.centralbank.ae/en/rulebook/payment-token-services-regulation

[7] Regulation (EU) 2023/1114 of the European Parliament and of the Council of 31 May 2023 on markets in crypto-assets, available at: https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX%3A32023R1114&pk_campaign=todays_OJ&pk_source=EURLEX&pk_medium=TW&pk_keyword=Crypto%20assets&pk_content=Regulation&pk_cid=EURLEX_todaysOJ

[8] Consultation Paper on Proposed Regulatory Approach for Stablecoin-related Activities, Monetary Authority of Singapore (Oct. 26, 2022), https://www.mas.gov.sg/publications/consultations/2022/consultation-paper-on-proposed-regulatory-approach-for-stablecoin-related-activities  . Note that there is an existing general regulatory framework under the Payment Services Act 2019 of Singapore which regulates activities relating to virtual assets that are “digital payment token services”, including activities relating to stablecoins.

[9] Ryan Browne, Crypto firm Circle gets approval to issue stablecoin in EU under bloc’s strict rule, CNBC (Jul. 1, 2024), https://www.cnbc.com/2024/07/01/eu-mica-law-crypto-firm-circle-gets-french-license-for-stablecoin.html

[10] SocGen Forge awarded e-money license for EURCV stablecoin, Ledger Insights (Jul 2, 2024), https://www.ledgerinsights.com/socgen-forge-awarded-e-money-license-for-eurcv-stablecoin/

[11] Ryan LI, Two blockchain firms to be added to MAS’ licensing list, Finance Asia (Nov. 21, 2023), https://www.financeasia.com/article/two-blockchain-firms-to-be-added-to-mas-licensing-list/492893

[12] Singapore green lights 3 stablecoins. To settle on private blockchains?, Ledger Insights (Nov. 16, 2023), https://www.ledgerinsights.com/singapore-stablecoins-private-blockchains/