A currency basket to back stablecoins won't work
One of the most ambitious projects in the cryptocurrency sector, Facebook’s Libra, shows promise to set the standard for stablecoins but will fail because it is designed to be backed by a basket of currencies.
Ultimately, a basket of currencies will include a mix of national interests and involve internal and external politics. Monetary mandates are also different between central banks. For instance, the European Central Bank (ECB) is targeting inflation while the U.S. Federal Reserve Bank is currently working to solve issues around unemployment.
The Libra project also failed to take into account the regulatory hurdles they may face. Instead of collecting partners for their project before beginning its dialogue with policymakers, stablecoin issuers should remember that fiat currencies must work in tandem with existing regulations and hence, regulators.
The euro is an alternative to a basket of fiat currencies, as it represents the national interests of 44 countries but operates as a unified financial asset. The ECB regulates the currency and has incentives to be held to a higher standard as it is accountable to multiple bodies within the European Union.
The participation of institutional investors, financial intermediaries and regulators are important to establish credibility for this new asset class.
On the institutional front, investors can help to introduce sophisticated valuation models and other best practices to the sector. Extreme volatility with cryptocurrency trades are often driven by retail investors who focus on short-term trends and sentiments instead of the underlying value of assets.
In comparison, institutional investors are more likely to implement due diligence measures that look at the project’s fundamentals over a long-term period, acting as a sort of anchor on the price of an asset. As the ecosystem matures, this can help to add further stability to the space.
To get the buy-in from institutional investors, a network of licensed financial intermediaries like custodians and the surrounding regulatory framework must support this emerging market.
Counterparties that have been properly evaluated and approved by local regulators will instill confidence in investors to transact with stablecoins. Partnerships with leading digital asset custodians, for instance, can help to assure investors who own tokens that they will have a safe place to store them.
On the regulation front, policymakers can help to provide clarity at the point of on- and off-ramps between cryptocurrency and fiat. This is necessary because at the end, regulators and banks still have a say on how much fiat money flows into the cryptocurrency sector.
For instance, U.S. regulators do not segregate digital assets from existing buckets they already regulate (i.e., commodities, securities, MSBs). But Europe’s regulators treat the asset class more competitively and it is likely that they will adjust existing e-money regulations, which were developed at least 20 years ago, to include blockchain technology and stablecoins. This will create the framework for what could be considered as e-money 2.0.
As the stablecoin market evolves, the euro’s framework will emerge as better suited to be the fiat currency of choice for our global economy. The U.S. dollar still does not allow business models with multiple issuing entities while the European Union has already established what Libra is trying to promise, with 11 fiat settlement points across its economic region and counting.
While the U.S. is running with horses, European markets have already started their engines in the race to bring stablecoins to markets around the world.