“Ensuring that a stablecoin maintains its peg even under stressed market conditions is a solvable problem,” Catalini says. In an optimal scenario, he says, reserves would be comprised exclusively of “high-quality liquid assets,” such as short-term U.S. government bonds, and suppliers would maintain an “adequate capital buffer.”
In the two years since Celsius filed for bankruptcy, Tether has voluntarily increased the size of its USDT reserve and slightly reduced the proportion of the reserve made up of collateralized loans, from 6.76 percent to 5.55 percent. But Tether “does not operate under a framework that limits what the directors of the company can and cannot do,” Catalini says. “This is where regulation is required.”
There have been several attempts to regulate the stablecoin industry in major markets. Earlier this year, rules for stablecoin issuers came into effect in the EU under the Crypto Asset Markets (MiCA) Act, including requirements on the amount of cash a stablecoin issuer must hold, the types of assets that can comprise a stablecoin reserve, secure custody of reserve assets, and more.
In April, US Senators Cynthia Lummis and Kirsten Gillibrand proposed a bill According to Cooper, the bill is unlikely to pass Congress before the next presidential election, but “both parties recognize that some level of regulation is necessary.”
Overall, though, stablecoin companies have been forced to figure out how to police themselves. “We’re dealing with a new asset class that, right now, is run by a bunch of people who are looking for guidance on what’s allowed and what’s not, and they’re not getting it,” Cooper says. “In an industry that thrives on risk-taking — and there’s a lot of that in crypto — it’s not surprising that some companies are pushing the boundaries.”
The difficulty for the first handful of regulators instituting stablecoin regimes will be to limit the threat of currency depeg without scaring away issuers. Risk appetite among stablecoin providers, whose profitability is tied to some extent to the risks they are allowed to take with reserve assets, could lead them to pull out of jurisdictions that impose the tightest restrictions. “The problem of regulatory arbitrage is as old as time,” Cooper adds.
Since the introduction of MiCA, Tether reportedly Tether has not yet applied for a license to operate in the EU. In an interview with WIRED earlier this month, Tether CEO Ardoino said the company is still “formalizing our strategy for the European market,” but expressed doubts about some of the reserve requirements imposed by MiCA, which he described as unsafe.
Meanwhile, while Ardoino sees stablecoins as a potential threat to traditional banks, he balked in the interview at the prospect of Tether being asked to comply with a similarly strict set of regulations, citing the freedom of banks to lend out most of the deposits they receive, unlike a stablecoin company.
But the window for regulatory arbitrage, whatever the motivation, will close, says Catalini, as an international consensus forms around the appropriate controls that should be applied to stablecoin issuers. “Regulatory arbitrage is a temporary phenomenon,” he says. “It’s only a matter of time before any stablecoin with significant scale is forced to comply.”