1. The Stablecoin Ecosystem – an introduction
The European Parliament, on 13 September 2019, issued a note wherein it observed that the introduction of a privately governed currency (here, Libra) could fundamentally challenge the current EU financial framework, conflict with EU law and tax requirements, and violate consumer rights. Towards the end, the note concluded that as the first case study of blockchain banking, Libra’s adoption and use, if Facebook’s plans go ahead, would need to be closely monitored from a legal and institutional perspective, as it could have a serious impact on the integrity of existing financial governance schemes, and undermine the orderly functioning of financial markets.
The past year has seen the introduction of a stablecoin by the name of Libra into the public domain. Libra is a blockchain based cryptocurrency that has sought to alter the landscape of traditional banking. The core mission for Libra, it is maintained, is to enable a simple global currency and financial infrastructure that empowers billions of people. Libra has presented itself to be an organisation that wishes to come to the aid of the “unbanked” who number at 1.7 billion adults globally. These persons are believed to be outside of the financial system with no access whatsoever to a traditional bank. Impediments such as insufficient funds, high and unpredictable fees, physical distance from the banks, lack of necessary documentation to have a bank account etc. that the unbanked are faced with are sought to be made redundant by Libra. Libra is born out of a belief that the world needs a reliable digital currency and infrastructure that together can deliver on the promise of “the internet of money”.
A stablecoin is a type of virtual currency or cryptocurrency for which mechanisms are established to minimize price fluctuations and ‘stabilize’ its value. Stablecoins on first blush present numerous opportunities like faster and cheaper payments, both domestic and cross border. A stablecoin could be collateralized by a Fiat Currency, by commodities, cryptocurrency or non-collateralized and controlled by algorithm. This collaterization lends an intrinsic value to the currency and to reduce the price volatility to provide a stable value amount. In case of Libra, it is indicated to be backed by a basket of bank deposits and short- term government securities for every Libra that is created.
The potential of stablecoins in the payment ecosystem lies rooted in the solemn promise that the blockchain technology holds in the payments ecosystem, which is firstly, its capability to deliver on financial inclusiveness, in terms of persons and also in terms of services (additional financial services like credit, saving, insurance etc); and secondly to remove any cross border barriers owing to faster and inexpensive payment systems.
2. Legal and tangential issues around implementation of a stablecoin
In current times, stablecoins like Libra have been received with a lot of scepticism and sometimes, also a lot of criticism has been meted out from the central banks across the globe. The core issue that is seen with the implementation of Libra is use of blockchain. Cryptocurrencies on the other hand have not been welcomed by the central banks either and the permutation of blockchain and cryptocurrency lends instability to this arrangement. The instability is anticipated to further compound with the element of risk ultimately resulting into concerns of national security, data privacy, consumer protection and as per some also threat to monetary sovereignty of nations. The major concerns stated by the G7 Working Group in their report of October 2019 are discussed below:
Legal certainty– The Working Group notes that a well-founded, clear and transparent legal basis in all relevant jurisdictions is a prerequisite for any stablecoin arrangement and is a core element of payment, clearing and settlement arrangement. The central argument of the Working Group has been that the underlying technical and contractual arrangement are not static but vary according to the peculiarities in design, characterization and market mechanisms. This tends to hit at the very argument of stablecoins being a stable form of currency. Further, it has to be borne in mind that in so far as the legal characterization of a stablecoin is concerned, it is relevant to concretise as to whether the true legal nature of a stablecoin is that it is money-equivalent; (ii) contractual claim; (iii) property right; (iv) a security or financial instrument; or (v) represent an interest in a fund or collective investment vehicle. This categorisation is crucial to ascertain the laws applicable to stablecoins. Likewise, percolating a layer in cross-border payments would demand ascertaining as to which law would be applicable to the working of the elements of stablecoins and which courts will have the jurisdiction to adjudicate disputes should they arise. The Working Group emphasises that the legal basis for the rights and obligations of the concerned parties and the finality of settlement must always be in the clear.
Sound governance– The Working Group underscores the fact that any stablecoin project must be established on sound governance practices prior to live operations in order to promote the safety and efficiency of payments and related services.
Financial integrity – Money laundering, terrorist financing and other forms of illicit finance may thrive in the new environment if the stablecoins are not effectively regulated and supervised. This has been the central argument of the Working Group. It is suggested that in order to mitigate these risks, the providers of stablecoins and other supporting entities should comply with the highest international standards. It is pertinent to note that it has been mentioned that the G7 supports the Financial Action Task Force (“FATF”) framework in this regard.
Safety, efficiency and integrity of payment systems- Financial markets rely on dependable clearing and settlement arrangements to allocate capital and to manage liquidity. The Working Group has stated that effective regulation and oversight of stablecoin arrangements is critical to achieve the public policy goals of payment system safety and efficiency. Thus, regulatory and policy frameworks are expected to remain technology-neutral and not hinder innovation, while ensuring that it is safe and robust.
Cyber security and operational resilience- Cyber and other operational risks could materialise in a stablecoin ecosystem’s different components, including the technical infrastructure for the transfer of value. For consumers, some crypto asset wallets and trading platforms have proven susceptible to fraud, theft or other cyber incidents. In this background, it is the view of the Working Group that public authorities should require that operational and cyber risks from stablecoins be mitigated through the use of appropriate systems, policies, procedures and controls. Therefore, it is pertinent to note that the stablecoins may be subject to laws, regulation and guidance and may also fall within the scope of international standards on operational risk.
Market Integrity- Market integrity as a concept is the one that seeks to define fairness or transparency of price formation in financial markets, which is a critical foundation of protection for investors, consumers as well as competition. Since stablecoins aim to reduce the volatility of their prices relative to fiat currencies, it is expected that there could be fewer opportunities for manipulation than in other crypto assets. As per the Working Group, a stablecoin arrangement must ensure fair and transparent pricing in both primary and secondary markets.
Data Privacy, Protection and Portability- It is accepted that policy issues around personal and financial data protection is becoming increasingly important as more data is collected and used in the provisions of financial services. Coupled with the use of machine learning and AI, the authorities will apply appropriate data privacy and protection rules to stablecoin operators, including how data will be used by the parties in the ecosystem and shared between the relevant parties simply because the users of stablecoin may not have clear information about such use of their personal and/ or financial data.
Consumer/ investor protection- As is true of any technology in its nascent stages, in the matter of stablecoins as well, additional work may be required to ensure that consumers and
investors are informed of all material risks as well as their individual obligations. The Working Group recommends that it will be the responsibility of the regulator to ensure that all actors involved in an ecosystem guarantee basic consumer and investor rights. Moreover, in the event that a stablecoin is considered to be a security or a financial instrument, it is trite that the relevant parties shall be subject to and be required to adhere to the relevant capital market laws and frameworks.
Tax Compliance – Stablecoins may pose tax challenges within a country and also in cross border scenario. Thus, a stablecoin project will be expected to comply with applicable tax laws and mitigate potential avoidance of tax obligations.
National security– Various countries have expressed serious concerns about the national security implications of stablecoins (most recently, Libra) and other cryptocurrencies. It has been observed that the likelihood of illegal funding of terrorism, cyber-crimes, tax evasion, extortion, ransomware, illicit drugs, incidents of money laundering and other illegal activities is very high due to volatility of the entire cryptocurrency ecosystem.
Global Scale Risks to Global Stablecoins
The Global Stablecoins (“GSCs”) present additional risks and challenges, and will require cross-border and cross-agency collaboration. The onus will also be on the public authorities to coordinate across agencies, sectors, and jurisdictions to support GSC innovation while mitigating the highlighted risks. If stablecoins reach a global scale (for instance, as envisaged in Libra), the Working Group in its report states that GSCs could pose risks and challenges to:
Monetary policy transmission: GSC project will need to assess the impact of the stablecoin’s ability to displace or substitute value of native fiat currencies in each jurisdiction, a GSC could have a broad impact on interest rates and credit institutions.
Financial stability: GSC project will need to assess how GSCs will operate as a whole (as part of a system or when interacting with other GSC or fiat systems) and on an individual level (e.g., how the stablecoin is pegged, what assets it is secured to, etc.) to ensure financial market inefficiencies are not further amplified.
The international monetary system: GSC project should consider the effect that a GSC cross- border payment system will have on the ability of domestic authorities to control their native currency.
Fair competition: GSC project should ensure support for competition and interoperability with other payment systems in the larger ecosystem.
The existing frameworks applicable to GSCs are- the Committee on Payments and Market Infrastructures, the International Organisation of Securities Commission, the Basel Committee on Banking Supervision and the Financial Action Task Force. It is pertinent to note that a number of international bodies have begun to develop new policy recommendations specific to stablecoin arrangements. One such international body, the Financial Stability Board ( “FSB”), an international body that monitors and makes recommendations about the global financial system on 18 October 2019, published a paper titled “Regulatory issues of stablecoins” and paper was delivered to G20 Finance Ministers and Central Bank Governors for their meeting in Washington D.C in mid-October. In cooperation with the standard- setting bodies, FSB plans to assess and provide a consultative report on the key regulatory issues that exist around GSCs to the G20 Finance Ministers and central bank Governors.In the report, the FSB will:
a. Take stock of existing supervisory and regulatory approaches and emerging practices in this field, with a focus on cross-border issues and taking into account the perspective of emerging markets and developing economies.
b. Based on the stocktake, consider whether existing supervisory and regulatory approaches are adequate and effective in addressing financial stability and systemic risk concerns that could arise from the individual components of a stablecoin arrangement or their interaction as an ecosystem as a whole.
c. Advise on possible multilateral responses, if deemed necessary, including developing regulatory and supervisory approaches to addressing financial stability and systemic risk concerns at the global level.
The consultative report will be provided in April 2020, with a final report being released in July 2020.
3. Acceptability of digital currency -as it stands- across the world and the points of
divergence with the regulators
In October 2019, the G7 Working Group on Stablecoins released its report on the impact of global stablecoins. In the report, the Working Group acknowledged that stablecoins have numerous features of cryptoassets and that stablecoins seek to do better in terms of stabilizing the price of the currency by linking its value to a pool of assets and hence capable of serving better as (i) a means payment and store of value; and (ii) by contributing to the development of global payment arrangements that are faster, cheaper and tend to be more inclusive than the existing arrangements. However, it was also observed that stablecoins as an initiative is still a technology that is in its nascent stages and remains largely untested. Finally, the Working Group concluded that prior to the commencement of any global stablecoin project, a hosts of risks and issues associated with stablecoins like legal, regulatory, oversight, operational and public policy must be addressed.
On 05 December 2019, referring to the G7 report of October 2019, the Council of the EU and the European Commission published a joint statement on stablecoins acknowledging that technological innovation can produce great economic benefits for the financial sector, promoting competition and financial inclusion, broadening consumer choice, increasing efficiency and delivering cost savings for financial institutions and the economy at large, however that it was to be ensured that no global “stablecoin” arrangement should begin operation in the European Union until the legal, regulatory and oversight challenges and risks have been adequately identified and addressed.
Any organization monitoring the trends in technology and innovation, would accept that the concept of cryptocurrencies is the future of digital payment systems. Blockchain technology is evolving and fast emerging in today’s time. However, there have to be inbuilt safeguards that alleviate the concerns regarding such technological innovations. With specific reference to Libra, regulators and authorities across the world have flagged security issues and concentration of power in a few hands i.e. the members of the Libra Association- like Facebook. This is viewed as concentration of power in hands of private businesses. Further apprehensions are around transition of payments from a centralized regime to a decentralized regime managed by a conglomerate of corporates. To these conglomerates, Libra is a progressive force to reckon with inasmuch as is seeks to lower the entry barriers set by banks in the quest of an individual becoming one where a private corporation backed global financial network supporting a global currency managed by a brand new corporate-formed non-profit central bank.
Since Libra seeks to transcend national boundaries, the regulators are concerned as to how legal remedies would be effected between two persons belonging to countries having varying levels of legislations, controls, mechanisms and compliances in place. This would call for agreements and negotiations at international levels to be entered into. In the backdrop of the above, in October 2019, Libra saw crucial partners like Mastercard, Visa, eBay, Paypal, Stripe and Mercado back out. Most recently, in January 2020, Vodafone, decided to step out of the currency project. The list of 29 partners in the Libra Network has been reduced to 21 in under a year. A short case study below seeks to shed some light on how Data Protection Commissioners world over have received the stablecoin, Libra.
Case study: Libra- a data protection perspective from world regulators
Right from the declaration by Facebook in June 2018 that Libra will be launched, the concerns of the regulators have been around the conundrum of centralization v/s decentralization. Since both centralization and decentralization have their own unique sets of characteristics, it is expected of Libra to be able to balance out the positives from both the centralized and the decentralized system. Libra will start as a permissioned blockchain to which only a specific group of organisations will have access. In order to be open in its true sense and to always operate in the best interests of its users, Libra’s ambition is to bloom into a permission-less system, which will be explored only post half a decade of the public launch of the Libra Blockchain and the ecosystem.
It can be argued that if the blockchain is indeed open and the government agencies can look into the system and identify the users or the transactions, the probability of either of the two i.e. governmental interference in transaction or monitoring/ surveillance of the users will be very high. Hence, serious privacy concerns arise. So, Libra, in its current form leaves us with another thought to ponder upon- whether it is a trade-off between national security concerns and privacy of individuals.
Insofar as Libra’s commitment to protection of users’ personal data is concerned, the Libra Association has maintained that Calibra (the Libra wallet), customers’ account information and financial data will not be used to improve ad targeting on the Facebook, Inc. family of products.
In a joint statement on 05 August 2019, a group of data protection officials voiced concerns about Facebook’s proposed digital currency project Libra. The statement was signed by amongst others, FTC Democratic commissioner Rohit Chopra, U.K. Information Commissioner Elizabeth Denham, EU Data Protection Supervisor the Late Giovanni Buttarelli, Canada Privacy Commissioner Daniel Therrien, Australian Information and Privacy Commissioner Angeline Falk.
The joint statement sought that the Libra Network satisfactorily addresses the following questions:
1. How can global data protection and privacy enforcement authorities be confident that the Libra Network has robust measures to protect the personal information of network users? In particular, how will the Libra Network ensure that its participants will: a. provide clear information about how personal information will be used (including the use of profiling and algorithms, and the sharing of personal information between members of the Libra Network and any third parties) to allow users to provide specific and informed consent where appropriate; b. create privacy-protective default settings that do not use nudge techniques or “dark patterns” to encourage people to share personal data with third parties or weaken their privacy protections; c. ensure that privacy control settings are prominent and easy to use; d. collect and process only the minimum amount of personal information necessary to achieve the identified purpose of the product or service, and ensure the lawfulness of the processing; e. ensure that all personal data is adequately protected; and f. give people simple procedures for exercising their privacy rights, including deleting their accounts, and honouring their requests in a timely way.
2. How will the Libra Network incorporate privacy by design principles in the development of its infrastructure?
3. How will the Libra Association ensure that all processors of data within the Libra Network are identified, and are compliant with their respective data protection obligations?
4. How does the Libra Network plan to undertake data protection impact assessments, and how will the Libra Network ensure these assessments are considered on an ongoing basis?
5. How will the Libra Network ensure that its data protection and privacy policies, standards and controls apply consistently across the Libra Network’s operations in all jurisdictions?
6. Where data is shared amongst Libra Network members: a. what data elements will be involved? b. to what extent will it be de-identified, and what method will be used to achieve de- identification? c. how will Libra Network ensure that data is not re-identified, including by use of enforceable contractual commitments with those with whom data is shared?
4. FinTech in the DIFC – pioneering efforts in the GCC region
The GCC nations are highly adaptive to the technological changes and have embraced FinTech and Blockchain technologies. FinTech is bringing advanced technologies into the financial sector, improving its performance and delivering value to
Amongst the Middle East countries, the United Arab Emirates (“UAE”) has been a pioneer in FinTech initiatives. The Dubai International Financial Centre (“DIFC”) has led the FinTech revolution in the Middle East from the front. From securing the highest number of investment deals to surpassing the registration of 100 FinTech startups in a short time, DIFC has increasingly encouraged and nurtured FinTech startups. Another feather in the cap has been the setting of its accelerator called the DIFC FinTech Hive. DIFC has signed MoUs with 14 different FinTech hubs to reinforce the same.
The FinTech Hive at the DIFC is a 12-week programme, which provides technology companies with mentoring and support from Middle Eastern and global financial institutions and insurance companies. The programme included 22 participants from the FinTech, Insurtech, Regtech and Islamic Fintech sectors
While FinTech may be at an early stage but a broad spectrum of FinTech technologies solutions is being offered, viz. Payments and remittances, Digital Banking, Online lending, crowdfunding, Insurtech, Blockchain/ Cryptocurrencies, Reg-tech, Artificial Intelligence (“AI”) etc. nations. For instance, in December 2018, the UAE and Saudi Arabia started developing FinTech for cross-border settlements, including a digital currency project. For the joint digital currency, the UAE and Saudi central banks have launched a distributed ledger PoC system to facilitate cross-border settlements. The digital currency is expected to be backed by fiat currencies of the two nations.
The FinTech ecosystem of DIFC has more than doubled in size from over 80 to 200 companies since the start of 2019 while the number of licensed FinTech firms operating in the DIFC increased from 35 to more than 80 in the first half of 2019. DIFC has also witnessed some of the key international FinTech firms that have made DIFC their regional base include Dublin- based software company Fenergo, InsurTech leaders Charles Taylor and Swedish crowdfunding platform, FundedByMe.
The government of the UAE is promoting and endorsing in particular the blockchain adoption all across the country. The Emirates Blockchain Strategy 2021 mentions that it aims to shift 50 percent of the transactions of the government on the blockchain by the year 202113. It is also understood that the Dubai Financial Services Authority (“DFSA”) is currently considering a licensing regime for cryptoassets. With respect to stablecoins specifically, the DFSA Regulations would apply where the activity amounts to “providing money services” specifically, money transmission, which means “(a) selling or issuing payment instruments; (b) selling or issuing stored value; or (c) receiving money or monetary value for transmission, including electronic transmission, to a location within or outside the DIFC.
Separately, the ADGM Financial Services Regulatory Authority (“FSRA”) published rules and accompanying guidance on June 25, 2018, as amended, to create a comprehensive regime for operating a cryptoasset business. This regime covers brokerage, custody, exchange and related activities in respect of specific ‘Accepted Crypto Assets’ which meet specified criteria and are deemed acceptable to the FSRA. In connection with the aforementioned, the FSRA has recently issued detailed regulatory guidance specifically in relation to stablecoins, covering how they fit in between its payment services rules and specific cryptoassets rulebook16.
The FSRA’s position is as follows:
(i) It permits only those stablecoins which are fully collateralized 1:1 with fiat, and backed only by the same fiat currency it purports to be tokenizing – therefore other types of stablecoins (such as commodity or crypto-collateralized or non-collateralized stablecoins) may not be permitted. (ii) Such ‘fiat tokens’ are to be treated as a mechanism for issuing stored value (e.g.,e-money) – similar to the DIFC. (iii) Issuers of fiat tokens for the purposes of facilitating or effecting payments are treated as money services businesses (i.e., a payment services-type license is required) and will also have to satisfy various cryptoasset-specific rules of the FSRA, including detailed technology standards and acceptance criteria in respect of the stablecoins. (iv) FSRA license holders must (a) consider which additional FSRA requirements may specially apply to the use of stablecoins, including, for example, what particular risk disclosures may be relevant to investors, and (b) apply the client money rules in the FSRA conduct of business rulebook in respect of fiat tokens.
Case Study- Emcredit
In May 2019, Dubai approved the launch of XPOS by Pundi X and Ebooc for Blockchain POS System. The manner in which the arrangement will work is that Pundi X and Ebooc will jointly implement XPOS terminals and XPASS cards throughout Dubai so that everyone in the city has access to blockchain-based transaction payments. XPOS will enable merchants to accept cryptocurrency payments whereas XPASS cards will allow consumers to store the cryptocurrencies to be used at XPOS terminals.
With this, the Dubai government became the first authority in the world to approve a means for its residents to make cryptocurrency payments by approving the XPOS devices effectively translating such a development into a major achievement for blockchain adoption. Again, Dubai has set a precedent that other leading cities in the world should look to emulate.
It is a step towards the widespread adoption of blockchain technology and cryptocurrency as an accepted means-of-payment and is aimed at primarily the broader public sector in the Gulf state, which comprises locals, regional immigrants, and international expats.
A digital stablecoin-equivalent of the UAE dirham (AED) will be available on the device, and cryptocurrencies like Bitcoin, Litecoin, or even Pundi X’s native PXS token are unavailable for making purchases for now. However, this may soon change if Dubai introduces crypto- regulations in the near future.
5. Insights into the way forward
The recent development of so-called “stablecoins” attempts to overcome the volatility drawback of existing crypto-assets by claiming to exhibit a stable value through algorithmic money) or collateralised stablecoins. In fact, some stablecoins, to the extent that they have an identified issuer, are not crypto-assets according to the definition used in this paper and might qualify as e-money under some national legislation. So far, stablecoins seem to be used mostly by crypto-asset traders to hedge against market movements and have demonstrated different levels of price volatility depending on their business models.
A short case study of the European Central Bank will help us in gauging where the stablecoins stand in the repertoire before banks and regulators.
Case Study: European Central Bank
While the European Central Bank (“ECB”) is not opposed to stablecoins, the President of the ECB, Christine Lagarde, supports the bank’s active involvement in the development of a central bank digital currency (“CBDC”) to address the demand for faster and cheaper cross- border payments. It was mentioned that ECB will continue to assess the costs and benefits of issuing a central bank digital currency that would ensure that the general public remains able to use central bank money even if the use of physical cash eventually declines. Currently, the ECB is working on all aspects of CBDC, with in-depth analysis of costs and benefits of such a new form of central bank money.
At a press conference in Frankfurt, Germany Christine Lagarde, presented ECB’s plans for a new task force of the bank for a digital Euro. The President of the ECB plans to establish a task force by mid-2020 to accelerate the development of a digital Euro and define its objectives.
Noting the interest shown by central banks in Canada, Britain and elsewhere, President Lagarde said:
“My personal conviction is that given developments we see, not so much in bitcoin but in stablecoins projects… we’d better be ahead of the curve because there is clearly demand out there that we have to respond to.”
While many countries like China, Russia, and EU, amongst others are exploring CBDC, the private actors are determined to make stablecoins a success. However, in order to reap the benefits of stablecoins, close international cooperation is a necessity. It has been recommended by the Working Group that that public sector authorities should engage with these groups by defining their regulatory expectations with GSC arrangements. Moreover, the relevant stakeholders and international organizations should jointly develop roadmaps in an effort to improve the inclusiveness and efficiency of payment systems and financial services. The Working Group mentions that these roadmaps could include recommendations to:
(i) support initiatives to improve cross-border payments;
(ii) promote financial inclusion; and
(iii) improve coordination between domestic and international authorities.
To facilitate such engagement, the Working Group has, in its Report developed concepts for how stablecoin arrangements may be defined; detailed the regulatory, oversight, and policy issues associated with stablecoin initiatives, including how this issues may be amplified or new issues may arise if stablecoins reach a global scale; and reviewed existing regimes that may be applicable to stablecoins and noted groups that are currently assessing whether there may be regulatory gaps around GSCs.
In the event a provider of stablecoin can demonstrate the successful fulfilment of the expectations through the roadmaps through joint efforts by relevant stakeholders, the regulators over the world may be willing to consider stablecoins as a form of payments.
By Tripti Dhar Partner, Reina Legal LLP