G7 report is a giant warning to stablecoins

The G7 has finally released a major report on the potential impact of global stablecoins. 

Following months of work, the G7 Working Group on Stablecoins came to the same recommendation that Rep. Maxine Waters (D-Calif), chair of the House Financial Services Committee, came to within hours: Libra cannot be allowed to go forward until regulations are in place.

“The G7 believes that no global stablecoin project should begin operation until the legal, regulatory and oversight challenges and risks outlined above are adequately addressed,” the report read. It was prepared in cooperation with the International Monetary Fund (IMF) and Bank for International Settlements.

Even with those risks, the report added, stablecoins generally could fix the deficiencies of the current international payments system in ways that Bitcoin and other cryptocurrencies have failed to do.

The existing system is “slow, expensive, and opaque, especially for retail payments such as remittances,” the report acknowledges. But, it declares, cryptoassets’ problems are worse.

“[T]hey have suffered from a number of limitations, not least severe price volatility,” it said. “Thus, cryptoassets have served as a highly speculative asset class for certain investors and those engaged in illicit activities, rather than as a means to make payments.”

Unproven potential

Stablecoins share “the innovative potential of the underlying [blockchain] technology” that powers cryptoassets, the G7 report found. But, because they are backed by a pool of assets like dollars or euros, they are much more stable. 

“Therefore, stablecoins might be more capable of serving as a means of payment and store of value,” it added. “They could potentially contribute to the development of global payment arrangements that are faster, cheaper and more inclusive than present arrangements.” 

Among those who could benefit most are the 1.7 billion people with little or no access to traditional banks, the report found.

None of that, the authors added, makes stablecoins inevitable.

They are “just one of many initiatives that seek to address existing challenges in the payment system,” they said. “[A]nd, being a nascent technology, they are largely untested.” 

Risks and challenges

To become a true store of value that can be used to pay for goods and services, stablecoins have a long way to go, the G7 Working Group noted.

Among these are:

•      Legal certainty
•      Sound governance, including the investment rules of the stability mechanism
•      Money laundering, terrorist financing and other forms of illicit finance
•      Safety, efficiency, and integrity of payment systems
•      Cyber security and operational resilience
•      Market integrity
•      Data privacy, protection, and portability
•      Consumer/investor protection
•      Tax compliance

And that doesn’t include the problems that arise when a stablecoin becomes truly global, as Libra would almost overnight.

Facebook has 2.4 billion customers, 2.7 billion if you include its Instagram and WhatsApp messaging service customers who don’t overlap.

With this scale, the G7 said, “[s]ome risks are amplified and new risks might arise if adoption is global in nature.”

These include challenges to monetary policy, financial stability, the international monetary system, and fair competition. 

Big tech, big problems

Nor is this a problem limited to Facebook, in the authors’ opinion. 

Other large tech firms are singled out as getting into the payments business. These include Apple (Apple Pay), Google (Google Pay), Amazon, and China’s Alibaba (Alipay) and Tencent (WeChat Pay).

“Stablecoins offered by large existing platforms (such as big techs) could scale rapidly due to their established global customer bases and links to platforms that offer an easily accessible interface,” the report notes.

Combine that with their enormous amounts of customer data and ability to create new activities to monetize, it said, and the “business model inherent in big techs could give them an advantage in payment services.”

What is this “market integrity” of which you speak?

Given that Bitwise Asset Management told the U.S. Securities and Exchange Commission in March that 95% of bitcoin trades are faked in a failed—surprise!— attempt to get approval for a Bitcoin exchange traded fund (ETF), cryptocurrency market integrity is a big concern that spills over into stablecoin regulation.

The G7 report’s authors indirectly pointed this out. 

“In a manner akin to what may occur with some existing cryptoasset trading platforms, businesses in the stablecoin ecosystem could face a conflict of interest,” they said. “For example, they may have an incentive to disclose untruthful information on their activities, such as the number of customers and trading volume for advertising and other purposes.”

Another concern they mention—and we’re all looking at you, Tether—is that “stablecoin issuers could intentionally (or unintentionally) mislead their customers on the critical functions they perform, such as the way they manage collateral assets.”

Sherman’s antitrust march

Another concern the authors highlight is the potential for anti-trust issues.

One the one hand, the authors note that stablecoins and global stablecoins could “challenge the market dominance of incumbent financial institutions,” giving consumers more choice.

On the other hand, the market dominance that could come with a first-mover advantage and staggering start-up costs could be a big barrier to entry, suppressing competition. Add in “the exponential benefits of access to data,” and a proprietary global stablecoin could actually “prohibit entry” of competitors, the report said.

Not that Facebook and Libra are mentioned.

Global stablecoin, global instability

Like traditional banks could face a run if customers lose faith in their ability to repay deposits, a global stablecoin (GSC) would face the same reputation-based risks, the report said. 

“An event which damages the GSC arrangement’s reputation could lead to sudden selling flows out of the GSC,” the G7 said. 

GSC’s that rely on market-makers could be fragile, it warned, if those liquidity providers are not “obliged to stabilize the price in all circumstances and could exit the market when the GSC comes under strong selling pressure.”

Even absent that, if a GSC issuer “is not transparent about its reserve holdings or if the GSC’s reporting lacks credibility,” a run could result, it warned. Again, we’re all looking at you, Tether.

Other potential causes of a run mentioned include poor governance, non-segregated reserve funds, ambiguous or misunderstood legal obligations of the issuer, or weaknesses in the ability of GSC holders to redeem their tokens for fiat currency.

Wide use of GSCs could pull funds out of banks, making them rely on more expensive and volatile funding sources, the report said. Lower profitability could lead banks to riskier investments or to loan less money, potentially damaging economies.

On the flip side, it added, readily available GSCs could worsen runs on traditional banks facing runs. 

Cross-border regulation

Another concern noted is that a single GSC could face different regulations and even definitions in different countries, in much the same way that U.S. regulatory agencies have fought over whether cryptocurrencies from bitcoin on down are securities or commodities.

As a result, an alphabet soup of international financial regulatory and standard-setting organizations “are intensifying their efforts to assess how their existing principles and standards could be applied to… stablecoin arrangements,” the G7 reported. They are also developing new policy recommendations where needed, it added. 

The report’s authors did asset that “[i]t is clear that the existing regulatory frameworks for financial integrity, data protection, and consumer and investor protection will apply to GSCs.” 

More than anything, the report concluded, this means that for GSCs to succeed, legal and regulatory agencies around the world will have to work together across borders and well as across agencies. 

What’s a “Libra”?

One amusing aspect of the G7’s report is the hoops it jumps through not to be a “Libra report.”

For one thing, it managed to not mention Facebook’s stumbling stablecoin project until page 25.

In total, the report said: “For example, the Libra Association has proposed making its stablecoin accessible to everyone, and so it is considered a retail stablecoin, while USC [stablecoin] is intended for use only by financial institutions that are part of the USC consortium, so it is considered it a wholesale stablecoin.”

That “USC” stablecoin apparently refers to banking consortium Fnality’s Utility Settlement Coin, which is abbreviated USC. It can only be used by members, and should not be confused with the USDCoin, abbreviated USC on exchanges and ranked 2,125 by CoinMarketCap. Which in turn should not be confused with Coinbase’s 24th-ranked USD Coin.

And even this talk about specific stablecoins is not technically in the report at all. Rather, it is in one of the three annex sections following the report. Stablecoins Tether, TrueUSD, and Paxos get the same amount of space—just one sentence combined. And Facebook’s Calibra digital wallet division, the social media giant’s face on the governing Libra Association, makes it into a chart in another annex.