Stablecoins Surge Amidst Regulatory Scrutiny

As digital currencies reshape the financial landscape, stablecoins are emerging as a pivotal player.

Earlier this month, Castle Island Ventures partnered with Brevan Howard Digital and Artemis to produce an in-depth report on stablecoins, sponsored by Visa. Based on their findings, “There are over $160 billion worth of stablecoins in circulation today, up from single digit billions as recently as 2020.”

The report argues that stablecoins have found increasing use cases, stating, “In emerging markets, adoption of stablecoins for payments, currency substitution, and access to high quality forms of yield is accelerating.”

Navigating Stablecoin Transparency, Regulation, and Market Volatility Post-TerraLuna Collapse

Stablecoins offer the promise of price stability while maintaining the innovative potential of digital assets. Their rise has not been without controversy. Notably, stablecoins face scrutiny over their transparency, regulatory compliance with KYC and AML, and underlying technical mechanisms.

In May of 2022, TerraLuna’s stablecoin, known as Terra (UST), collapsed. This catastrophic event triggered one of the most significant events in cryptocurrency history. UST was an algorithmic stablecoin designed to maintain a 1:1 peg with the US dollar through its sister token, Luna. However, when market confidence in UST began to falter, the mechanism that tied UST and Luna broke down. Luna’s price plummeted due to massive token issuance, causing a hyperinflationary spiral. This led to UST losing its peg entirely, wiping out over $40 billion in value and devastating investor confidence.

Since this event, the market has been recovering and demanding transparency. Consumer demand for stablecoins continues to increase.

The whole purpose of a stablecoin’s design is to maintain a stable value. Typically stablecoins are pegged to a traditional asset, like the US dollar, a commodity, or a basket of assets. The purpose of stablecoins is to reduce the volatility common in other cryptocurrencies. Thus making them more suitable for everyday transactions, savings, or as a hedge against market fluctuations. The report mentioned above found that over 95% of stablecoins “are linked to the US dollar.”

The referenced stablecoin findings go on to say, “The divergence that appeared throughout the cooling off period in crypto exchange volumes in 2022-23 suggests that stablecoins have meaningful usage outside of mere speculative uses.”

Balancing Innovation, Regulation, and Illicit Activity Amidst $2.6 Trillion Market Growth

Many types of stablecoins exist, including fiat-collateralized, crypto-collateralized, and algorithmic stablecoins.

The purpose of stablecoins is pairing cryptocurrency innovation with price stability. Beneath the surface lies a complex debate over how this plays out. Since their public entrance into the world of digital assets in 2014, stablecoins continue to be a vehicle for fraudulent activity.

However, the narrative is shifting.

In Castle Island’s stablecoin report it found that, “In the first half of 2024, stablecoins settled (according to our adjusted estimates) over $2.6 trillion dollars worth of value.”

USDT (Tether Tether ) is the most widely used stablecoin. USDT’s purpose is for cross-border payments, remittances, and as a hedge against currency fluctuations and inflation. However, due to its anonymity and ease of transfer, Tether has also been exploited for illicit activities, including black market transactions and money laundering.

In April of 2024, Senators Cynthia Lummis (R-WY) and Kirsten Gillibrand (D-NY) announced a press release regarding their stablecoin bill. Gillibrand stated, “Passing a regulatory framework for stablecoins is absolutely critical to maintaining the U.S. dollar’s dominance, promoting responsible innovation, protecting consumers and cracking down on money laundering and illicit finance.”

A key issue for regulators is balancing the legitimate benefits of stablecoins, with the need for stronger oversight to combat illicit use. All while promoting financial inclusion and faster transactions for users.

Stablecoins vs. Central Bank Digital Currencies

Some stablecoins are more transparent than others.

Nic Carter, one of Castle Island Ventures founding partners, said, “Each blockchain offers tradeoffs in terms of settlement assurances, fees, speed, etc.”

One of cryptocurrency’s appeals is that it is not associated with any government. When asked if a government might employ stablecoins in the form of a Central Bank Digital Currency, Carter states, “We haven’t encountered any government-backed stablecoins just yet.” He goes on to say, “My guess is CBDC’s, when they are deployed, will not use blockchain rails, because governments will want to embed more surveillance into these systems, and crypto transactions on public blockchains are less surveillable and give end users significantly more autonomy. So I am skeptical we will see a government launch on a public blockchain.”

As stablecoins evolve, their growing adoption reflects their potential to revolutionize digital finance. Balancing innovation with regulatory oversight and ensuring transparency will be crucial in shaping the future of stablecoins within the global financial system.

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