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E-MailSteven L. Schwarcz is Stanley A. Star Distinguished Professor of Law & Business at Duke University School of Law. This post is based on his recent paper.
In Regulating Global Stablecoins: A Model-Law Strategy, I examine the challenges of facilitating “retail” consumer payments by issuing digital currencies—monetary currencies that are evidenced electronically and not in physically tangible form.
Two types of retail digital currencies are likely to become feasible in the near future: central bank digital currencies (“CBDC”), which are sponsored by governmental central banks, and “stablecoins,” which are non-government issued digital currencies that are backed by “reference assets” having intrinsic value, such as government fiat currencies. In contrast, bitcoin and other privately issued cryptocurrencies that are not backed by reference assets are unlikely to become successful consumer currencies because of their unpredictably fluctuating value.
This paper focuses on stablecoins that become widely used internationally (“global stablecoins”). That widespread use is likely; according to the Financial Stability Oversight Council’s 2021 annual report, for example, the market capitalization of stablecoins already being used in the United States already well exceeds $100 billion dollars.
Global stablecoin use poses a host of cross-border legal issues. At the outset, that use would generate high costs if stablecoins are governed by multiple, and potentially conflicting, legal frameworks. Furthermore, the interaction of conflicting legal frameworks could create uncertainty about the enforceability of contractual obligations.
To reduce these costs and better assure enforceability, this paper compares two potential regulatory strategies: an international treaty, and a uniform model law. Treaties are more formal than model laws, being binding upon contracting states and only be able to be modified or denounced by a treaty amendment. Although this binding feature provides greater certainty that treaty-bound nations will follow through on their commitments, that can be a disadvantage for experimenting with new proposals—such as global stablecoins. The expectation that a treaty needs widespread consensus can also discourage its adoption, and the need for that consensus makes a treaty particularly unsuitable for global stablecoins, where the market is rapidly developing.
In contrast, a model law is simply proposed statutory text for a law, which governments are asked to enact uniformly as domestic law in their jurisdictions. The UNCITRAL Model Law on International Commercial Arbitration exemplifies a model law in an international context, and the Uniform Commercial Code (UCC) in the United States exemplifies a model law in a subnational context.
The more relaxed nature of a model-law strategy can provide flexibility to experiment. Model laws may be amended or denounced unilaterally by a nation without violating international law. Furthermore, the less formal process of developing and enacting a model law can promote open communication. A model-law strategy also can minimize delay because it becomes effective for each nation as soon as it enacts the uniform text. For these reasons, the paper concludes that a model-law strategy may be more successful than a more formal treaty strategy to engage in the urgent and novel experiment of regulating global stablecoins.
The paper next examines how such a model law should be designed. Key goals for regulating stablecoins should include maintaining the currency’s stable value, protecting consumers and privacy, and safeguarding monetary integrity and financial stability. To assure stable value, for example, stablecoin holders must be able to redeem their stablecoins, on demand, for the specified reference asset at the specified redemption value. The paper examines several ways to ensure the issuer’s ability to satisfy that redemption obligation, including possibly making stablecoins the equivalent of insured deposits. It also examines such second-best approaches as collateralizing or otherwise maintaining reserves against the issuer’s redemption obligation or hedging redemption risk with derivatives or other guarantees.
To safeguard monetary integrity, the paper compares the recommendations of the Financial Action Task Force (FATF), the inter-governmental body that sets standards for combating money laundering and countering terrorist financing. It also analyzes how those standards could be applied to global stablecoins. The paper then examines how regulation could help to control other threats to monetary integrity, such as breaches of stablecoin cybersecurity (including cyberattacks) and failures of operational resilience (such as processing errors that delay or otherwise disrupt payments). The paper also explains why stablecoin issuers should be limited to persons that demonstrate integrity and reliability, such as deposit-taking government-insured banks or other government-approved issuers.
Safeguarding financial stability would require, among other things, maintaining consumer confidence in a widely-used global stablecoin. The primary reason that consumers could lose that confidence would be the issuer’s inability, or even perceived inability, to redeem the stablecoin for its underlying reference asset. That inability would resemble a classic bank run if, for example, the issuer is unable to obtain sufficient reference assets to satisfy correlated demands by stablecoin holders. Therefore, the paper observes, the same protections that would maintain a stablecoin’s stable value should also help to safeguard financial stability.
Finally, the paper redacts its analysis into proposed text for a model law that could be used to regulate global stablecoins. The paper also examines the model law’s legal, economic, and political feasibility. Because the model law starts with the basics of stablecoin regulation and then adds cross-border elements, it should be applicable not only to regulating global stablecoins but also, by excluding its cross-border elements, to regulating domestic stablecoin usage.
The text of the model law is generally consistent with the principles and recommendations for regulating global stablecoins proposed by authoritative multinational organizations such as the Financial Stability Board (FSB) and the Bank for International Settlements (BIS) as well as by many of the world’s leading central banks. For that reason, the model law could serve as a possible legal template for enactment in nations in which stablecoins become widely used. Because the aforesaid principles and recommendations have been stated at a very high level, however, the model law’s text must necessarily be tentative. Nonetheless, it should at least help to foster a dialogue about how to apply those high-level principles and recommendations.
The complete paper is available for download here.
