Coinbase Legal Chief Urges Regulators to Fill Stablecoin Protection Gaps

stablecoins

While lawmakers and regulators focus on stablecoins’ potential to destabilize the broader economy and the financial system on which it’s built, Coinbase Chief Legal Officer Paul Grewal said they should be taking a harder look at another set of uncertainties that require an immediate response.

Speaking Wednesday (Aug. 3) at a panel at the Philadelphia Fed’s annual FinTech Conference, Grewal said that successful regulation of the dollar-pegged cryptocurrencies, which are cropping up more and more in serious conversations about the use of digital assets for payments, needs to focus on filling in the holes in what we know about the participants in the $153 billion stablecoin market.

That starts with “understanding what reserve assets stand behind a given stablecoin, and having certain requirements, for example, regarding the composition of those reserve assets,” he said,  Seeking Alpha reported.

Only then can informed decisions about “additional regulation to clarify the standards and requirements attached to these stablecoins” be made, he added. “What visibility do regulators, members of the public, auditors, others have to the composition of these assets that fundamentally guarantee the safety and security of the assets?”

What’s Behind Them?

While that issue has been brought into sharper focus since a week-long run led to the $48 billion collapse of the Terra/LUNA algorithmic stablecoin ecosystem in early May — which turned out to have been backed by an incentivized arbitrage scheme that failed abruptly beginning May 7 — it has been a matter of concern within the cryptocurrency industry for years.

Read more: TerraUSD’s Price Collapse Shows Vulnerability of Dollar-Pegged Cryptos

There have been calls in the Senate and House to mandate that all stablecoins be 100% backed by currency and treasuries, but crypto is hard to keep out of borders. And several new algorithmic stablecoins are being launched.

See more: Unbacked Stablecoin’s Collapse Lost $48B; Crypto Says ‘Let’s Launch Two More’

After TerraUSD broke its peg and fell to near-zero, two major stablecoins, Tether’s $66 billion market cap USDT, and Circle’s $54 billion market cap USDC, were left with about 80% of the market.

Questions have been asked about the make-up of Tether’s backing reserves for years, which it claimed was backed 100% by cash until a lawsuit by the state of New York forced the company to reveal that less than 3% of that reserve was in cash, and the majority — 65% —was in unspecified commercial paper, which is short-term corporate debt of uncertain liquidity. Tether then set about changing that, and recently put that number at less than 25%.

Read more: Is Tether Stablecoin Due for $80B Day of Reckoning?

But even that is not formally audited, which is why calls have been made recently for formal audit requirements and allowing regulators access to confirm that information.

Circle was discovered to have about 9% of its reserves in commercial paper last year, but quickly reduced that to zero, leaving just dollars and treasuries.

Other payments regulations have gone further, notably Kenya’s M-PESA mobile money system, which requires backing reserves to be kept in the custody of an outside trustee rather than the system’s owner, Safaricom.

Cybersecurity Risks

Another problem that has become more urgent in the wake of a series of hacks on decentralized finance (DeFi) bridge platforms used for cross-chain payments is the question of the cybersecurity of stablecoins.

“What risk management programs do [stablecoin issuers] have in place?” Grewal asked. “What cybersecurity standards are being applied? Is the code that is being used to run a particular blockchain subject to sufficient testing, quality assurance, security measures to ensure that these assets are fundamentally safe for all participants in the system?”

Based on exploitation of flawed code — often hastily written and unreviewed updates — just four of the cross-chain bridge hacks have led to well over $1 billion in losses this year — the most recent the $190 million Nomad hack Monday (Aug. 1).

See more: Hack of Crypto Payments Bridge Turns into $190M DeFi Free-for-All

While stablecoins don’t necessarily have that problem — they tend to be on major blockchains — they do use bridge programs to make their stablecoins work together on different blockchains, and many have been stolen in the bridge hacks.

Until that potential vulnerability is understood, it’s hard for regulators to write the rules needed to keep what could turn into a major new payments rail secure.

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