How to Assess Regulatory Risk Posed to Stablecoin Users

hi uh my name is Tammy and today I am going to get use this opportunity to give a introduction about a stable coin risk assessment framework that I am currently working we are currently working on is the is the sound it's perfect okay so um in the next 20 to 25 minutes we're going to talk about the goals and motivation um how the framework work and then we're going to Deep dive into the method we use to measure stable coin risk to uh regulator RIS to stable coin users and before Deep dive into the topic we would like to talk a little bit about ourselves first so uh and this project is for public good it's completely independent from our full-time job I receive a a grant from E Foundation ESP to kick off the research and later I team up with Alexandra on the uh regulatory risk assessment uh Alexandra is a legal professional from a major protocol Foundation sheet stable con regulatory research for race and protection DB at Cambridge Center for alternative finance and about myself I am working in the protocol Specialist Team uh specialized in blockchain analytics at the crypto exchange and I was a credit risk modeler in banking for a couple of years before that so I know I think everyone must be really familiar uh with the two most significant uh stable coin event in the last two years yes the one on the left hand side it is the uh four of Terror Us's value was down from $1 to 10 cents in just a couple of days in May 2022 and then on the right hand side is the Silicon Valley Bank collapse so it started from some usdc holders got worried about the usdc reserve got stock in SB and then later other stable coin especially the one who um has exposure directly or in digr to USC also lost their pack so um later stable con this stable comprise uh recover in three days uh after FDIC announced that they're going to enable withdraw for all deposit so why do I mention these two events there are many very amazing in depth stable corn risk uh research available around but for common user the the metric they use the most are um circulating Supply one and um market cap and on Dune analytics sometime you can see price volatility liquidity uh unique number of addresses but if you look at the Terra case the reason before before it collapse it was the third largest St coin in the world with a market cap of 18 billion in April just before May and then its collapse is because it has a fundamental flaw in its design um it is under colorized by default and then it used Luna to back the stable Co which has a circular value and it can be uh down to zero and for the usdc it's one to one Reserve B but the reason that it went temporary depack is because um it is exposed to the custodian risk um where cash exist as banking notes so therefore if we combine all the metrics that I just mentioned they are just not good enough for stable coin user to assess and understand stable coin risk so that's why we have Stu stable coin risk assessment framework our goal is to build a um risk ass framework to analyze St con R from different angle um it should be easy for user to understand and all information should be able to derive from public available information um and then the main motivation at this framework is to encourage more risk driven decision rather than Trend driven or uh return driven many existing analysis focus on the uh depa event but within there are are also other event that could potentially cause a negative impact on stable coin user which is not only the user who holds stable coin but also the user who borrow a land stable coin for example or provide liquidity uh provide St uh provide liquid uh provide liquidity to the pool so this is the event uh we summarize one is when price become too volatile over time can be either too high or too low in this case for example um loss May incur when stable coin user has to buy at a higher price to um repay their landing position and then secondly is price significant lower than the Pet Value in this case the stable Co may or may not be able to recover to its pet position for the later case then the user will take a haircut into uh at their stable cor holding and then the third one is a complete failure of the project um that's what happened to Terra and then the last one is the staple coin value is still there but the user is not able to assess the stable Co and it is often associate with uh user being censored by centralized party or authorities so the framework is further break down the risk assessment into eight categories asset backing stability mechanism isurance and Redemption liquidity governance smart contract Oracle and Regulatory risk definitely the asset backing stability mechanism insurance and Redemption are the three key pillar for stable con risk assessment but I'm sure there are many talks here talk about this issue so today we are going to f uh focus on regulatory RIS and here it is why uh we are going to dig into some of the example or the event happened in the past to Showcase why regulator risk to stable coin users is important ah before that um the challenge of having single rating our framework is not going to produce a single rating because we believe um it is not time yet it can be misleading if the user is unaware about how the single rating is produced and what it is represent the challenge is that for example um it's difficult to assign weights on different risk categories because it is based on um the person who create the rating own objective and then for now the industry is still quite young compared to trap five so there's not enough data for a good probability of theack model and also not only theact matters as I mentioned there are also other events that's very important so our approach is use the framework to allow user to use the framework to analyze and compare risk among stable coin and user themselves to decide the importance of each category based on their own objective and risk appetize the first event I'm going to go through is The Bu USD unwind um in February 2023 New York d FS ended minting of B USD at pxel and then later in the same year Finance stopped supporting BD then you can see on the right hand side the supply of uh BD job sharply since February last year what happened to the users a user were able to redeem BD at one to1 as a reserve were not impacted something worse to mention is that pxel H is um bankruptcy remote but user were not able to trade B USD on binance anymore and then the second one uh it is FTX collapse in December 2023 IRS demanded 24 billion US dollar from FTS for unpaid tax after their collapse um the impact to uses some remaining assets was used to pay bankruptcy lawyer and they they managed to negotiate down to a lower value but of which 20 200 million was paid before client compensation in this scenario it is not exactly stable coin but what happen if FTX has its own stable Co and then is reserve is it possible for Reserve be impacted in the same way then is the bance enforcement in November 2023 Finance was fined for 4.3 billion for various wrongdoing um coo see this step done and was sentenced Jael no direct impact to the user as binance has the money to pay several country including Australia and Cyrus revoke or suspended binance operating license but what happen if Finance didn't have the money to pay then the last one is um we saw a rise of Y baring stor then you can see from August 2023 there's a sharp rise in uh circulating Supply um not much happening yet but they are definitely the category that easier to be identified as security for example pxel live D usdl is not available in the US market uh at the moment so in some regulat action is closer than you thought it will directly or indirectly impact stable coin users if you assuming all other aspects or Cil coin functions as expected the primary risk of Regulation actions to c one user Still Remains that is what St conin holding been impacted or will their stable conin trading activity be impacted yeah thank you Tommy um just picking up on this point just like users and customers are asking this one questions will my stable coin Holdings will will my position be impacted will the regulatory or enforcement actions um in any way impact my trading Activity The Regulators they have to ask themselves a question is my regulation structured in such a way that that the stable coins provide customer protection sufficient Lev of disclosure enough information about the project whether the Redemption mechanism is structured in a COR correct way is the right to withdrawal preserved uh both in the primary and secondary Market um oh um yeah and I think for a leg regulator a massive concern is that some of these projects they operate on such a scale that they in a way resemble um operations such of the banks central banks um and money insurance is predominantly an area of central bank so the The Regulators going of just turn the Blind Eye into this especially in the EU uh there are sort of this super issuers where which trading volumes daily trading volumes it's over 2 million transactions um they have to come up with a plan or how to minimize their activity so that it does not uh resemble or competes uh with the of the banks um yeah then going step further uh from a financial stability perspective the war that such projects failure uh will have the domino effect and could impact U Regional and supranational financial stability um right so moving to the key stable coin regulatory Frameworks let's just have a brief look at the current regulatory responses to to to stable coin activities starting with the US uh I think one major regulation that we should mention on top is F21 act um which is worth of noting as it's passed with an overwhelming by partis and support uh it's a market structure Bill uh and kind of fills in the regulatory GBS that people have been asking and asking to be filled so it defines permitted uh payments stabit coins and it also specifies how the stable coins can be traded through cftc and SEC register intermediaries uh there's also a payment stable coin act which uh imposes requirements for 100% Reserve backing uh it outright bonds algorithmic stable coins establishes FDIC conservatorship for installement issuers uh we also have Clarity for payment stable coin act uh which would Encompass permitted payment stable coins um maybe just to briefly touch upon the the the Banning of the algorithmic stable coins uh We've also seen this uh being introduced by the maker regulation so the question now from the user perspective is is it going to have an effect on me as a consumer already holding these assets uh am I going to be forced to liquidate my position or convert the stable coins to vatb stable coins uh and if there is a rush to sell uh is this going to cause an price stability instability of the um of the token right so picking up on the Mika regulation we've recently seen two chapters of Mika come to effect uh just last week um however chapters on enforcement and supervision are coming in force only in December this year uh and I think for this moment it's important to know that um there's no consistent Market approach as to uh whether the exchanges are the listing the projects uh we have so far seen a few listing from the e EA based operations but not all exchanges are are going this way um so as of today there hasn't really been a significant price um impact resulting from such the listing but um I suppose we'll see if this remains in December as well um it is likely that the nonm register stable coins will just fade away from the EU but I think we'll be happy to see uh this being challenged oh and for the for the Hong Kong one something worth to mention is that it has its own uh uh regulatory crypto regulatory framework under development but we shouldn't forget the fact that it's closely linked to a policy maker uh from mainland China so that's something that you need to consider as well um I think we just missed one point that I wanted to pick up on don't know where is f um that I think we can see kind of two Trends emerging from the customer protection perspective um so certain Regulators incline towards regulating the stable coins within the payment system regulation like UK Singapore which sort of offers great greater protection for the user um like it offers the stability and reliability of the payment infrastructure um and some Regulators are approaching this from the activity based service provider view uh on the issuers which this may prove more flexibility uh in terms of the Project's business models and I think it's also worth noting that there there are certain regulations that we probably see being enacted which may further impact the price of stable coins volatility on the market such as staking uh I think there's a question if there are certain jurisdictions in which skaking has been outright bonded um there's regulation regarding Pro reserves how is this um attested and uh just a point on legal treatment of tokenized deposits and whether certain Regulators will see will perhaps see stowable coins um considered as such um yes so just moving to potential regulatory action there are certain regulatory responses um instruments if you will that Regulators are attributed with um from the top the most probable ones um restricting traving activities on crypto centralized crypto platform um that would be limiting trading pairs uh imposing trading cups Bing certain stable coins Um this can protect users from fraudulent activities Market manipulation but may also limit access to certain stable coins users ability to buy sell and the question I think remains um is this going to affect liquidity Market access uh is this going to lead to higher transaction costs um the regulator may also restrict operation um basically just outright Bond menting of new stable coins um restrict Redemption um limits could be placed on the Redemption of stable coins uh for fiat currency and this can potentially affect users ability to exit their position um we regulator may also impose substantial fines of non-stable coin issuers and I think the most recent case we've seen was the charaps uh case where um SEC has imposed a final 4.5 billion uh US Dollars and I think what's interesting there was that the the director of the of the project was fined uh 2, sorry 200 million us doar uh in liability um there there's also a possibility of uh the reserves being seized at castal institutions this is somewhat uh of an more extreme option uh if massive legal legal violations are are detected um I think can skip to the next one oh so our approach to measure stable co uh regulatories to stable coin user to establish a semianalytical approach that can objectively help stable coin users to better understand regulator R so it's going to be uh we were going to have a stable con level assessment Crossover with the regional level assessment so this is the risk Matrix we identify at stable coin level first it's stable coin type whether it is custom cial or non-custodial custodial means um uh Reserve uh with custodian of chain and then the insurance and Redemption process are managed by centralized party and for non-custodial it is normally referred as the decentralized stable coin that people have been talk about we believe regulatory rat is different for these two different type of stable coin but it does not means that non-custodial stable coin is exempt from a regulator race because as we mentioned trading activity can also be restricted at different jurisdiction and then the second one it is the operation location where does the stable coin project is registered it is very likely linked to whether the project team is going to be sued or whether there's actions happen going to be enforced on them and then who is the issuer who is responsible for the issu and Redemption and what authorities have a say to those issues and then the next one is the reserve custodian location where uh where are the reserve assets C uh custodian and then the next one is if Reserve bankruptcy remote if the company goes bankrupt other creditor if other creditor have a claim on the stable coin Reserve then we manage Identify two quantitative factors for um regulator risk one is the percentage of the stable Gun Supply at Key centralized exchanges so this is the portion of the stable coin Supply at Central exchanges How likely it will proxy How likely trading activity can be restricted by regulator in key jurisdiction like EU UK K Us in Singapore and then the last one will be the portion of the real world asset in reserve by region so for example holding of US Treasury will have a connection to the US laws and regulations at the risk Matrix level at uh for the risk Matrix at Regional level we will the main goal is looking at the vibe of the regulatory landscape of a specific jurisdiction it is a very objective view it's very complex to analyze but um so we come up with three different um factors one is who are the key authorities and then whether the regulatory history is rich in the past not only on stable coin but also on other crypto project and crypto company and then the third one is whether stable coin regulat framework what is the progress of stable Co regulatory framework it might be the indication over uh whether there's a room uh whether it become more restricted for the stable con to be operated in the area but it it is quite difficult to say because it's a case by cases here is a case study will come up wish to use the uh risk metric that we identify We compare usdc usdt and die then you can see that uh usdc and usdt are both custodial stable coin and D being identified as non-custodial for usdc uh the operation location is us usdt is British virsion Island and then for die is on chain issue is C uh coinbase and circle for USD highly linked to uh us uh usdc at Biff and then die uh is Makow Reserve location uh usdc is um definitely at us usdt um yeah what's the guy's name uh somebody caner caner F Ro yeah claim uh they are the custodian of the usdt asset and then for that is a very complex case um it's a part on chain and part real world asset so it need more in depth analysis for their real world asset portfolio whether the reserve bankruptcy remote for usdc uh they are not and USD I assume they are not but it hasn't been mentioned and then for die it is on uh it is yes for onchain asset and for real world asset it's uh it's by case if for example if it's been set up as a SPV it is very likely that is a um bankruptcy remote but again it needs more and uh indepth analysis on their real world asset portfolio percentage of Supply at centralized exchange usdt has the highest percentage in terms of portion with centralized exchange um this can be an indication that when there's a regulatory actions on restricting unregulated State born activity at centralized Exchange in certain jurisdiction the one with the higher portion in the centralized exchange is going to be uh impacted more and then for usdc majority of their real world asset Reserve are in 100% of them are in US in US city according to their report mostly are us and then for die I saying I get the data from The Dun Dodge board about 11 about 22% at least 22% are in us for the regional level uh risk analysis uh with us it has Rich regulatory history it has regulatory action in the past not only on centralized exchanges but directly on crypto projects as well they have a regulative framework propose uh uh stable coin Bill proposed and then for EU and UK most of the action that happened in the past are around centralized exchanges or centralized crypto platform the Mika is in application and then the framework proposed in the UK are under development um it's a similar case for Singapore to wrap up a regulatories is extremely complex and challenging to be assessed systematically and it require ongoing effort for regulator and then the IND uh the industry to establish and refine standards and guidelines which also creates uncertainties the key concerns for stable coin users are the first one is a direct impact stable coin value get hold or get lost or the indirect impact stable coin activity are restricted so uh we believe that it is the stable coin and crypto industry uh should be actively participate in the discussion of the developing of um St coin regulatory framework so thank you very much for coming to follow us for more updates on the stable con for other risk categories please follow the St update at tamama Tami on X and then you can follow Alla on Linkin and uh Twitter um we have a previous presentation on the other risk Cy and can be found there and then I'll share the slide on on Twitter as well the working paper for St assessment framework is the draft is done it's under review H and then it will be live soon thank you