G7 Pushes for Greater Crypto Regulation, and That Might Be a Good Thing

The call for greater regulation followed May’s spectacular meltdown of the Terra ecosystem and its TerraUSD stablecoin and native token LUNA, which were previously among the world’s most valuable crypto assets.

In a communique dated May 20, G7 finance chiefs and central bank governors announced that crypto asset issuers and service providers should be held to “the same standards” as the rest of the financial system. To that end, G7 stated that it supports the Financial Stability Board’s efforts to monitor and address the stability risk that arises from all kinds of crypto assets. It also wants to see increased global cooperation to address other regulatory issues regarding crypto, such as its use in cross-border transactions.

G7 further requested faster implementation of the Financial Action Task Force’s “travel rule”, and stronger disclosure and regulatory reporting with regards to the reserve assets backing stablecoins.

Stablecoins have been on the radar of regulators in many countries for several months already, However, the intensity of that scrutiny has increased since the collapse of TerraUSD, which wiped out billions of dollars of investor’s savings. The event had such an impact that even some centralized stablecoins, such as Tether’s USDT, briefly lost their dollar peg. The value of Tether slipped to a low of $0.95. Because stablecoins act as a bridge to various decentralized finance ecosystems, it meant much higher volatility across that market.

In the US, regulators have already seized on the incident to try and push for more stringent rules around stablecoins and the companies that issue them. US Treasury Secretary Janet Yellen said just days after TerraUSD’s crash that she intends to create stablecoin legislation by the end of the year.

Yellen explained that it would be “highly appropriate” to create a “consistent federal framework” for stablecoins to abide by, given the rapid growth in the market. She called for bipartisan support among members of Congress to enact the legislation for this framework.

Whatever rules the US comes up with around stablecoins could easily be imposed on Tether and another popular centralized stablecoin, USD Coin. Both Tether and USDC are backed by a US-based company, with a traditional asset-backed treasury that’s equal to the value of their stablecoin’s market capitalization.

Stifling Stablecoins to Accelerate CBDCs?

Some say the rush to introduce regulation around stablecoins is an effort to remove the competition ahead of plans to introduce state-backed digital currencies, known as Central Bank Digital Coins or CBDCs, which would be issued and controlled by governments.

Proponents of CBDCs argue people would rather place their trust in a central bank-issued digital asset, given what happened to TerraUSD, which was a so-called algorithmic stablecoin not backed by any liquid assets. Rather, it used a complex computer algorithm that involved burning and minting LUNA tokens to try and maintain its peg to the US dollar.

Stablecoins have long been a concern to politicians due to the lack of investor protections such as FDIC insurance in case losses occur. One of the problems is that most stablecoins are backed by commercial bonds rather than cash, which could lose value or prevent investors from cashing out. This is an issue because stablecoins are susceptible to liquidation by investors if they attempt to redeem their holdings all at once. Similar to a “run on the bank”, where skittish investors race to withdraw their funds while a bank only has a percentage of those assets on hand, it can lead to huge turmoil and potentially cause the value of stable assets to plunge.

Another concern politicians have with stablecoins is that they are perceived to be competing with the US dollar, potentially undermining its place as the global reserve currency.

Max Kordek, co-founder of the blockchain developer platform Lisk, told Cointelegraph in a recent interview that lawmakers are seizing upon the collapse of TerraUSD to make the case for CBDCs instead.

“Trust in algorithmic stablecoins is likely to have greatly diminished because of this incident, and it will be a while before that trust is restored,” Kordek said. “This will, unfortunately, be used by politicians as an example of why the world requires CBDCs. We don’t need CBDCs; what we do urgently need, though, is reliable, decentralized stablecoins.”

Such fears increased in June, when G7 finance chiefs announced they had agreed to work together to create “common principles” for state-backed digital currencies, otherwise known as Central Bank Digital Coins, or CBDCs. In a statement, G7 said CBDCs have the potential to become “both a liquid, safe settlement asset” and an “anchor for the payments system”. It added that G7 central banks have already been exploring the opportunities and challenges related to CBDCs, as well as their monetary and financial stability implications.

“Our objective is to ensure that CBDCs are grounded in long-standing public sector commitments to transparency, the rule of law, and sound economic governance,” G7 said in its statement. “CBDCs should be resilient and energy-efficient; support innovation, competition, inclusion, and could enhance cross-border payments; they should operate within appropriate privacy frameworks and minimize spillovers.”

Mixed Signals So Far

Despite the opposition to stablecoins, there have been mixed signals from G7 nations, with some countries looking to take a friendlier approach. In April the UK surprised many when it announced that it will be amending its regulatory framework to enable the use of stablecoins as a means of payment.

The UK announcement was notable because it looks like a targeted initiative that aims to introduce crypto as a means of payment for institutions, as opposed to simply loosening existing regulations on the crypto industry. The UK Exchequer was bullish in its assessment of stablecoins, saying they have the capacity to become a widespread means of payment for both consumers and retail customers.

The U.K.’s push to recognize and regulate stablecoins is part of a wider package of measures that aim to make the country a global hub of blockchain development. So while stablecoins as a means of payment are on the list, the UK could also be looking to embrace wider concepts around DeFi.

There are other reasons to think G7’s clampdown on stablecoins might not be so heavy-handed. G7 nations including Germany, France and Italy have all previously expressed support for crypto in general, highlighting its potential as a payment vehicle and an easier and cheaper way to move money. Further, some G7 nations have in the past recognized crypto’s potential to serve the billions of “unbanked” people around the world that lack access to basic financial services. There is a fear that if regulation is too heavy-handed, it could well hinder innovation and development in the space.

Regulation Will Boost Increase Investor Confidence

Some kind of regulation is on the horizon, and G7 will continue to analyze the prospects of CBDCs, but for the meantime it’s likely that whatever rules it does come up with will be fairly lenient, focused on ensuring investors have greater confidence to invest in areas such as DeFi.

Ensuring investor’s safety through the implementation of standards such as KYC and AML should be fairly easy to implement given that a lot of work has already been done in this area.

In the case of PhreeChain, it is building a compliant DeFi ecosystem-as-a-service that aims to make it easier for traditional financial institutions to build DeFi solutions within a regulated landscape. Phree says it’s focused on “reverse decentralization” with its platform that enables banks and financial service providers to build compliant DeFi products out of the box.

Phree believes that DeFi’s potential to bank the unbanked will remain untapped so long as it’s unable to access the liquidity of mainstream finance. That will only happen once there is a solution to the problems around risk control, security, systemic fraud and a lack of KYC/AML that currently plagues DeFi.

Interestingly, Phree not only promises a way for companies to launch compliant DeFi products when it launches its platform next year. In partnership with PWC Switzerland, it is also creating an asset-backed stablecoin pegged to the euro that it plans to issue to partners and DeFi protocols in exchange for fiat and other liquid assets. It’s a move that would bring greater transparency and trust into the stablecoin space.

Wth companies like Phree offering to build ready-made compliance for the crypto industry, DeFi and stablecoins, such a gentle introduction of regulation could have positive impacts for investors in cryptocurrencies. One likely impact is that regulation, if it’s well targeted, could lead to less speculation in crypto assets. Reduced speculation could in turn create more investor confidence in some assets, drawing in more institutional investors into the space that many have ignored due to its volatility.

Sam Bankman-Fried, chief executive officer of the cryptocurrency exchange FTX, told Bloomberg in a September 2021 interview that if regulation is introduced properly, it could be great for consumers.

“If done properly, they can give consumers way higher returns on their assets,” he said. “That could be appealing for sophisticated investors looking for higher returns on their capital. Still, it’s important to do it within existing regulatory frameworks, or build out new frameworks for them”.

Timothy Massad, former chairman of the Commodity Futures Trading Commission and a senior fellow at the Kennedy School of Government at Harvard University, shares the sentiment that greater regulation in crypto would be a good thing for investors. He told NextAdvisor in April that the lack of regulation means that investor protection is much weaker in the crypto and DeFi spaces than it is elsewhere. As a result, many are wary of putting money into crypto assets. The implication is that if the space is better regulated, it would attract far more cash from investors.

“Crypto isn’t subject to requirements to prevent fraud manipulation. It’s not subject to standards on conflicts of interest,” Massad said. “My point is simply that we don’t have the same kind of standards that we have in other markets. Today, that means buyer beware, essentially.

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