Circle, the issuer of the USDC (Circle-United States dollar) stablecoin, recently published a white paper titled: Risk-based capital for stable value tokens; We propose a novel risk-based capital management model for stablecoins and other digital cash tokens.
The authors of the paper argue that stablecoins require appropriate capital reserve requirements that go beyond the capital standards currently established under the Basel banking regulatory framework to mitigate the risks inherent in stablecoins, tokens identical to other fiat currencies, and token issuers.
According to the authors, these inherent risks include, but are not limited to, the lack of token price due to market trading, the prevalence of secondary markets, “flooding” of digital tokens due to overselling, operational risks, and technical risks.
Token Capital Adequacy Framework
These unique challenges differentiate stablecoin issuers and the digital assets they issue from traditional banks. The authors of the paper argue that the solution is to adopt what they call a Token Capital Adequacy Framework (TCAF).
The Circle paper explains that current banking regulations use fixed-rate risk criteria and risk weights that do not necessarily reflect actual levels of risk. The authors cite long-term government bonds, which have high interest rate risk but are currently rated as having zero weighted risk within banking standards.
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TCAF addresses this by adopting a dynamic risk sensitivity model that begins with stress test reserves and gathering stakeholder input. Technical risks such as blockchain network performance and cybersecurity are also considered under the TCAF model.
The paper also notes that TCAF’s dynamic approach could result in stronger or weaker capital requirements than current banking standards, depending on the risk environment.
Five Goals of the Framework
Circle’s new proposed model has five goals in mind: First, the model seeks to distinguish between “disappearing” risks, which have been successfully mitigated or no longer pose a threat, and “ongoing” risks, which are emerging.
The model also seeks to be “as simple as possible” while playing a complementary role in helping supervisors appropriately address operational risks, while avoiding the bloated and expensive risk management departments that characterize the traditional banking sector.
The fourth major goal of TCAF is to provide risk management standards that work across jurisdictions and institutions. Lastly, but most importantly, the model seeks to provide incentives and accountability to mitigate negative risk externalities.
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