“Ensuring stablecoins maintain their pegs even under stressed market conditions is a solvable problem,” Catalini said. In an optimal scenario, reserves would consist only of “high-quality, liquid assets” like short-term U.S. Treasury securities, and providers would maintain “adequate capital buffers,” he said.
In the two years since Celsius filed for bankruptcy, Tether has voluntarily increased the size of its USDT reserve buffer, slightly reducing the percentage of its reserves made up of collateralized loans from 6.76% to 5.55%. But Tether “doesn’t operate under a framework that restricts what company directors can or can’t do,” Catalini said. “That’s where regulation comes in.”
There have been several attempts to regulate the stablecoin industry in major markets: earlier this year, the EU introduced rules for stablecoin issuers under its Markets in Crypto Assets (MiCA) Act, which includes requirements on the amount of cash that stablecoin issuers must hold, the types of assets that can make up stablecoin reserves, and the secure storage of reserve assets.
In April, Senators Cynthia Lummis and Kirsten Gillibrand introduced a bill that would ban stablecoin issuers from lending out their reserves. Cooper said the bill is unlikely to pass Congress before the presidential election, but that “there is recognition on both sides of the aisle that some level of regulation is necessary.”
But by and large, the stablecoin business is left to figure out how to regulate itself. “The new asset class we’re dealing with is currently run by a group of people who are looking for guidance on what’s allowed and what’s not allowed, and they’re not getting it,” Cooper says. “In an industry that thrives on taking risk, and crypto has plenty of that, it’s not surprising that some companies are pushing the envelope.”
The challenge for the first handful of regulators to implement stablecoin schemes will be to limit the threat of depegging without scaring off issuers. Stablecoin providers’ risk appetite, whose profitability is in part tied to the risk they are allowed to take on their reserve assets, could lead them to retreat from jurisdictions that impose the toughest regulations. “The problem of regulatory arbitrage is an old one,” Cooper adds.
Since the introduction of MiCA, Tether has reportedly yet to apply for permission to operate in the EU. In an interview with WIRED earlier this month, Tether CEO Ardoino said the company is still “developing its strategy for the European market,” but expressed concerns about some of the reserve requirements imposed by MiCA, calling them unsafe.
Meanwhile, while Ardoino sees stablecoins as a potential threat to traditional banks, he cautioned in the interview that Tether could be required to follow similarly strict regulations because, unlike stablecoin companies, banks are free to lend out a large portion of the deposits they receive.
But Catalini says that as an international agreement develops on the appropriate controls to be imposed on stablecoin issuers, the window for regulatory arbitrage will close, whatever the motivation. “Regulatory arbitrage is a temporary phenomenon,” he says. “It’s only a matter of time before large stablecoins are required to comply with regulations.”
