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Stablecoins: Overview, CBDCs, Role in Crypto, Regulations

Stablecoins — pegged to a dependable fiat currency such as the US dollar — have become a cornerstone of the crypto ecosystem. As per industry reports, there has been an increase in the issuance of stablecoins and the market cap has grown 18 fold over the past year, surpassing $100 billion in May 2021. The stablecoin market cap is currently $112.15 billion. In particular, stablecoins such as Tether (USDT), USD Coin (USDC), and Pax Dollar (USDP) have jumped from $30 billion in circulation in January 2021 to about $125 billion as of mid-September.

On 18 October 2021, credit agency Fitch Ratings published a report analyzing stablecoins and their continued growth.  “The rapid growth in stablecoins means that these securities holdings are already relatively large,” the report observed. Fitch Ratings believe that stablecoins such as Tether (USDT) that approach a systemically important scale may reshape the short-term securities market while inviting new risks to these markets; however, the new report also accedes to the fact that it is the regulatory approach towards stablecoins that will truly determine how this sector will develop.

Stablecoins vs CBDCs

A Central Bank Digital Currency (CBDC) issued by a central bank is a digital representation of fiat currency. Similar to stablecoins, digital ledger technology (DLT) forms the basis for CBDC as well. CBDS can be divided into two categories: wholesale and retail. Wholesale CBDCs will be restricted to commercial banks, financial and clearing institutions whereas the retail form may widen CBDC access to corporate, businesses, and general consumers.

The main difference between stablecoins and CBDC would be the monetary system in which they may operate. While some algorithmic stablecoins such as DAI can be can completely decentralized with no regulatory authority or a centralized private organization controlling their monetary value, the CBDC’s monetary value may be determined by the issuing Central Bank. Unlike CBDC, stablecoins are developed without any central intervention or challenges associated with financial intermediaries. For instance, TrueUSD — a USD-backed ERC20 stablecoin that was developed on the Ethereum blockchain — will not require banks to solve issues such as double spending and price manipulation.

As CBDCs are issued by the government, CBDC holders will be assured that they will be backed — most likely by fiat currencies but may also be backed by commodities such as gold. Furthermore, similar to fiat currencies, CBDCs will be impacted by monetary policies such as quantitative easing. This may lead to an increase in the inflation rate and expose CBDC to the same socio-economic effects as fiat. Stablecoins on the other hand can be both crypto collateralized (where a reserve is made of other cryptocurrencies) or non-collateralized (which do not have any reserve but instead use central bank-like monetary policy to maintain a fixed price by controlling supply with algorithms that respond to market conditions), therefore, making them less susceptible to monetary policies.

Role of Stablecoins in the Crypto Landscape

Crypto Trading

Fiat on-ramp and off-ramp (fee charged to convert fiat to crypto and vice versa) continue to be a major hurdle for crypto exchanges and institutional traders. Stablecoins have come forth as a prime solution for exchanges and institutional traders who want the ability to reduce their risk exposure to crypto price fluctuations without fully cashing out. Some crypto exchanges that have trusted volume have stopped providing investors with any fiat on-ramps. They only accept stablecoins as a medium of exchange. Examples include exchanges such as Binance and Poloniex. 


Stablecoin payments are picking up steam. This is because using stablecoin for payment can significantly bring down the transaction fee by 2-3%, which is otherwise taken up by intermediaries and financial institutions. For example, in order to leverage this efficiency, Walmart has created its own stablecoin and is in the process of patenting it.

Decentralized Finance

Using stablecoins, not only can the investors protect themselves from the effects of market volatility but they can also be used to generate yield on their crypto assets in the DeFi market. For example, if an investor places ETH into Aave protocol to earn interest, a drop in the price of ETH would negate the yield earned; however if the same investor uses USDT instead, then the value of the underlying asset —  as well as the yield earned — would remain stable.

Regulatory Oversight Over Stablecoins is Steadily Increasing

United States

With an increase in the popularity of stablecoins, regulatory scrutiny around stablecoins is also increasing. Recently, in a hearing before the House of Financial Services Committee, Federal Reserve Chair Jerome Powell explained that stablecoins are very similar to money market funds stating that “they’re like bank deposits but they’re to some extent outside the regulatory perimeter and it’s appropriate that they are regulated – same activity, same regulation.

Stablecoins are top-of-mind for the U.S. Treasury Department, as they are set to release a report on stablecoins in late October 2021. On December 23, 2020, the U.S. President’s Working Group on Financial Markets released an initial assessment on certain key regulatory and supervisory considerations surrounding stablecoins. In this assessment, the treasury stated that — depending on the stablecoin’s design and other factors such as functions, activities, and risks attached — a stablecoin can be security, commodity, or derivative. This will bring them within the purview of either the U.S. securities law or the Commodities Exchange Act or both. Additionally, stablecoin participants have to meet all the applicable anti-money laundering and sanctions legislation obligations,

In July 2021, Rep. Don Beyer introduced the Digital Asset Market Structure and Investor Protection Act, providing some insights into how the U.S. may regulate stablecoins. The bill accords the Treasury Department the power to veto the creation and usage of all stablecoins in the U.S. under its terms. This could create hurdles for issuers as the Treasury Department may restrict the trading of any and all stablecoins as they will need approval from the Treasury. It’ll be interesting to see how that is enforced, especially in relation to algorithmic stablecoins.

European Union

Earlier this year, European Commission’s proposed Regulation on Markets in Crypto Assets (MiCA) underwent its first reading in the Council and the European Parliament. MiCA will oversee the regulation of the crypto market in the EU.

Stablecoins constitute one of the main focus of MiCA regulations. MiCA separates stablecoins into two different categories. Firstly, those stablecoins whose value is pegged to a single fiat currency can be categorized as E-Money tokens. On the other hand, stablecoins whose value can be pegged to several fiat currencies, commodities, or other crypto assets or a combination of such assets will fall under Asset- Referenced tokens. MiCA states that algorithmic stablecoins should not be considered asset-referenced tokens, although they may be subject to the requirements for crypto assets more generally.  

Asset-referenced currencies are subject to strict regulatory standards of transparency, operation, and governance. If MiCA is enforced, stablecoins will need the authorization of regulatory bodies to be traded within the EU. This authorization requirement also applies to stablecoins that are already in circulation.


The Payment Service Act (PSA) regulates stablecoins as e-money. E-money is a digital representation of a single fiat currency that represents a claim on its issuer. Issuers of digital tokens that can be classified as e-money (stablecoins) will require PSA license, as such activity would constitute an e-money issuance service. However, e-money definition does not cover algorithmic stablecoins, non-collateralized stablecoins, or commodity-collateralized stablecoins In light of the emergence of new forms of stablecoins, on December 23, 2019, MAS issued a stablecoin consultation paper seeking public consultation on scope of money, e-money, and digital payment tokens (DPTs), as well as the regulation of payment services based on these emerging forms of payment

On October 5, 2020, StraitsX — a Major Payment Institution (MPI) licensed by the MAS for e-money issuance — released XSGD. XSGD is a Travel Rule-compliant stablecoin backed 1:1 with the Singapore dollar. Under its MPI license, StraitsX can mint an unlimited amount of XSGD tokens while the corresponding fiat is held and safeguarded in segregated accounts with a fully regulated MAS approved bank.

How Can Merkle Science Help?

To enable access to potential benefits of stablecoins while mitigating the risks they pose to users, investors, and the financial system, the regulatory oversight over stablecoins is increasing.  In order to protect themselves from exposure to the AML/CFT risks, VASPs should proactively put compliance frameworks in place to monitor all transactions surrounding stablecoins and to mitigate AML/CFT risks.

Merkle Science provides a predictive crypto risk and intelligence platform, setting the standard for the next generation of financial safeguards and criminal detection. We are creating the infrastructure necessary so that a full range of individuals, entities, and services may transact safely with crypto. Merkle Science’s highly customizable platform and proprietary Behavioral Rule Engine is easy-to-use, allowing institutions to detect illicit activity beyond the blacklists and detected suspicious activity that could have previously been undetected.