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G7 Report: How Should Regulators and Central Banks React to Global Stable Coins such as Libra?

Authors: Jonas Gross, Philipp Sandner

On October 18, 2019 the G7 Working Group on Stable Coins has released a remarkable report about the benefits, challenges of and rules for (global) stable coins. Stable coins are a broad topic ranging from the Euro or the US dollar on the blockchain to Facebook’s Libra initiative. The authors argue that stable coins can be useful instruments to increase financial inclusion and to address frictions in the payment sector if challenges, e.g. with respect to governance, financial integrity, safety, financial stability and competition are properly addressed. Central banks are encouraged to act now and to develop road maps, how they aim to increase financial inclusion and how to increase efficiency in the worldwide payment sector. Further, the authors stress that regulatory authorities have to cooperate to set proper guidelines for global stable coins.

Key benefits and risks of stable coins

Policy-makers take stable coins more and more seriously as instruments to improve the efficiency of worldwide payments. On October 18, 2019, the G7 Working Group on Stable Coins released a report about the impact of (global) stable coins. This working group is chaired by Benoît Cœuré, member of the Executive Board of the European Central Bank (ECB), and consists of experts from central banks and from other international institutions such as the International Monetary Fund (IMF). In short, this working group includes the “who-is-who” of worldwide economists.

What is the main content of the report? First, the benefits of stable coins are explained. The authors argue that stable coins can be seen as financial innovations, which have the potential to foster faster and cheaper worldwide payments. Simply put: The authors admit that stable coins have the potential to disrupt the payment sector. Stable coins are a broad topic ranging from the Euro or the US dollar on blockchain to Facebook’s Libra initiative. They can simply remain a “stable” coin or — if E-Money rules apply — turn into the digital Euro on a blockchain system.

Such statements coming from central bankers are impressive since central bankers are often criticized for being conservative and very cautious with respect to financial innovations.

However, the authors argue that stable coins are a nascent appearance and are largely untested. Various challenges have to be taken into account to exploit the full potential of stable coins.

Challenges for public policy and regulation

The report defines the following rules for stable coin projects with a global character to be addressed in order to be compliant:

  • Legal certainty: The legal basis of the stable coin should be clear and transparent in all relevant jurisdictions.
  • Sound governance: A sound governance has to be established before starting a stable coin’s Operation.
  • Financial integrity: The highest international standards with respect to anti money laundering (AML) and counter-terrorism financing (CTF) have to be applied.
  • Safety, efficiency and integrity of payment systems: Safety and efficiency of payment systems have to be ensured by effective technology-neutral Regulation.
  • Consumer/investor protection: Consumers and investors have to be informed of all material risks and their individual obligations.
  • Fair competition in financial markets: Competition in financial markets should not be undermined and interoperability with other payment systems has to be supported.
  • Financial stability: Financial stability has to be ensured with global stable coins. Risks related to credit risks, maturity and liquidity mismatch, or operational risks, which could lead to bank runs, have to be addressed.

Complying with these rules, stable coins can exploit its full potential and should be approved by regulators.

How to regulate stable coins?

The G7 clearly states that “no global stable coin project should begin operation until the legal, regulatory and oversight challenges and risks outlined above are adequately addressed, through appropriate designs and by adhering to regulation that is clear and proportionate to the risks.” Furthermore, the G7 Working Group encourages public authorities to coordinate across agencies, sectors and jurisdictions to ensure a consistent worldwide response to mitigating risks. In other words, it is stressed that a national regulation for stable coins is not enough to properly regulate global stable coins. Technology-neutral regulatory guidelines should be developed.

How should central banks react?

The G7 encourages the public sector to “redouble its efforts to reduce frictions in international payments and support measures to improve financial inclusion”. This mainly means that it encourages central banks and other public institutions to develop strategies, how to improve the efficiency and how to lower the costs of payments and financial services. The possibility to issue an own central bank digital currency (CBDC) should be assessed by central banks, even if central banks in the end decide not to issue an own digital currency. One message is clear: Central banks should hurry and develop concepts how to increase the efficiency of worldwide payments. It is remarkable that this report clearly states concrete claims. Central banks should start acting now — this is a key message.

What about Libra?

Even if not mentioned in the main text, Libra of course belongs to the class of global stable coins. Therefore, Libra has to fulfill the rules outlined in the report in order to start operating. The Libra Association responded to the report by publishing a Statement, which confirms that “the Libra Association is committed to building a system that replicates or exceeds current standards for consumer protection, financial stability, and global cooperation to prevent money laundering and illicit finance while preserving national sovereignty over monetary policy.” The Libra Association intends to comply with the G7 rules, such as privacy, fair competition and consumer rights.

From our perspective, the G7 report is a big step forward since it is now clearly stated, which rules global stable coins have to comply with. If analyzing these different rules, it does not seem to unrealistic that Libra in the end indeed fulfils all the necessary requirements to start its operations. And — as indicated by the answer from the Libra Association — the Libra Association also intends to comply with the rules.

What about traditional currencies the on blockchain?

If for example in Europe E-Money rules can apply to a blockchain-based stable coin that is pegged to the Euro then the “Euro stable coin” is elevated to the status of “the Euro”. Put differently, a Euro-pegged stable coin plus the required licenses from the government (i.e., E-Money license) result in “the Euro”; but not stored in legacy systems but rather on a state-of-the-art DLT platform. The Euro on the blockchain will be very important for the European industry (e.g. engineering, mobility): Companies denominate their invoices in Euros and also their accounting systems operate in Euro. A world, in which BMW, for example, sends an invoice in Bitcoin, is at this point in time not imaginable. This is why stable coins could also take the form of traditional currencies. This is also why people now start talking about “the digital Euro”. What they mean, is the Euro on a blockchain system in compliance with e.g. the E-Money regime.

Conclusion

Stable coins will be relevant means of payment used for worldwide transactions soon. We welcome that supranational institutions, such as the G7 Working Group on Stable Coins and central banks, recognize stable coins as a serious alternative for worldwide payments and analyze challenges, which have to be addressed by regulators. Stable coins have great potentials, mainly to increase payment efficiency. Further, a Euro-backed stable coin is valuable for the whole (German) industry and can alongside with smart contracts automate payments for example for machine-to-machine payments.

Remarks

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Jonas Gross is a project manager and research assistant at the Frankfurt School Blockchain Center (FSBC). His fields of interests are primarily cryptocurrencies. Besides, in the context of his PhD, he analyzes the impact of blockchain technology on monetary policy of worldwide central banks. He mainly studies innovations as central bank digital currencies (CBDC) and other crypto currency projects as “Libra”. You can contact him via mail (jonas.gross@fs-blockchain.de), LinkedIn (https://www.linkedin.com/in/jonasgross94/), Xing (https://www.xing.com/profile/Jonas_Gross4) or follow him on (Twitter Jonas__Gross).

Prof. Dr. Philipp Sandner is head of the Frankfurt School Blockchain Center (FSBC) at the Frankfurt School of Finance & Management. In 2018, he was ranked as one of the “Top 30” economists by the Frankfurter Allgemeine Zeitung (FAZ), a major newspaper in Germany. Further, he belongs to the “Top 40 under 40” — a ranking by the German business magazine Capital. The expertise of Prof. Sandner, in particular, includes blockchain technology, crypto assets, distributed ledger technology (DLT), Euro-on-Ledger, initial coin offerings (ICOs), security tokens (STOs), digital transformation and entrepreneurship. You can contact him via mail (email@philipp-sandner.de), via LinkedIn (https://www.linkedin.com/in/philippsandner/) or follow him on Twitter (@philippsandner).

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