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Blogroll Stablecoins Posted by Ben Regnard-Weinrabe, Heenal Vasu, Allen & Overy UK LLP; and Hazem Danny Al Nakib, Swisscom Blockchain, Ben Regnard-Weinrabe , Hannah Pack , Hazem Danny Al Nakib , Heenal Vasu , Allen & Overy
Ben Regnard-Weinrabe is a partner, Heenal Vasu a senior PSL, and Hannah Pack a Trainee Solicitor at Allen & Overy UK LLP. Hazem Danny Al Nakib is a Senior Advisor at Swisscom Blockchain AG. their Allen & Overy memorandum.
With the value of cryptocurrencies fluctuating on an almost daily basis, there has been an increased focus on creating a cryptoasset which can be transferred digitally but also crucially benefits from stability and trust. Such an asset is known in the industry as a “stablecoin”, and over recent months, this latest innovation has seen a significant growth in adoption.
A stablecoin is generally understood to be a cryptoasset pegged in value to fiat currency or other assets. It is designed to avoid the volatility inherent in other cryptocurrencies whose price is entirely market driven. While the price fluctuations of other cryptoassets make them perhaps more attractive for speculation, the relative stability of stablecoins offers the possibility of cryptocurrencies being adopted for use in everyday transactions and of becoming a digital form of cash. This would allow a much wider pool of users access to the benefits of digital currencies, for example greater speed and certainty of settlement across a blockchain. In this way, stablecoins offer a bridge between the traditional financial markets and the emerging opportunities offered by cryptocurrency technology.
Over the recent months there has been a proliferation in private companies taking the lead in developing stablecoins, for example, the “MUFG Coin”, a stablecoin that MUFG plans to roll out which will be pegged 1:1 to the Japanese yen, and the “Circle USDC”, a U.S. dollar-pegged stablecoin. The potential advantages need to be balanced, however, against regulatory and policy goals covering matters such as consumer protection, financial services regulation, market integrity and financial crime, and careful thought needs to be given to how to structure a stablecoin accordingly. Types of Stablecoins
There are three principal models used with the aim of enabling stablecoins to achieve their characteristic price stability. These are set out below. Model I: Fiat/commodity-collateralised
This is the simplest stablecoin model, under which the stablecoin is (wholly or partly) ‘backed’ by an asset such as a fiat currency, gold or other commodity collateral. A central entity guarantees the issuance and redeemability of the stablecoin by reference to the asset which it holds as collateral. This approach can be problematic, as it requires a degree of centralisation and trust in the issuing party which, in turn, imposes a potentially significant level of counterparty risk for the holder of the stablecoin, particularly if the holder has no security over or other rights to the collateral. Model II: Crypto-collateralised
In this model, the collateral backing the stablecoin is itself a cryptocurrency.
It appears from current market practice that the crypto-collateralised model is sometimes operated through paired coin systems, [1] where issuers issue: a stablecoin; and another token, used to pay an accrued fee to redeem the locked-up or pledged This redemption fee is likely to be determined by an algorithm which is designed to maintain a price band for the stablecoin.
The crypto-collateralised model has the benefit of decentralisation, as the collateral is held in a smart contract which does not require trust in a central party. However, the stablecoins in this model might need to be overcollateralised in order to account for the price volatility of the cryptocurrency collateral. Model III: Non-collateralised
Using this model, stablecoins are not backed by any outside collateral but by a type of self-sustaining economic system. The value of the stablecoins is maintained through the use of a system which, for example, expands and contracts the supply of the coin based on an algorithm. This operates in a similar manner to the way in which central banks maintain the value of fiat currencies, but can be done in a decentralised manner. Public vs. Private Stablecoins
Stablecoins can also be categorised into public and private stablecoins. Private stablecoins are those issued by commercial enterprises and public stablecoins are issued by central banks. Stablecoins also offer the possibility of developing an international coin, pegged to a basket of fiat currencies or commodities. This would reduce volatility even further by hedging against fluctuations in the value of national currencies, and has the potential to dramatically increase the efficiency of cross-border settlement. Private Stablecoins
Private companies have to date been the front-runners in developing stablecoins, primarily due to the barriers facing central banks seeking to offer d...