Thread by @ccatalini

1/ 🧵#Stablecoin regulation by Congress can bring clarity and consumer protection, unlocking benefits for consumers & SMEs. Faster, affordable payments await! (see papers.ssrn.com/sol3/papers.cf…).

2/ Designing stablecoins isn't rocket science, 🚀 but avoid pitfalls! ⚡️⚡️⚡️ (papers.ssrn.com/sol3/papers.cf…). State (e.g., @NYDFS) and federal regulators and agencies (@federalreserve, @USOCC, @FDICgov) can play a key role in this.

3/ #1: You need a robust reserve design that can weather market storms 🌪️ and a major run (papers.ssrn.com/sol3/papers.cf…). The plan by the now-defunct @DiemAssociation was short-term US Treasuries (90 days or less) & repos for liquidity.

4/ Diem would not have de-pegged🔗! Over months of work, @FINMA_media & a regulatory college, which convened dozens of regulators across the globe, provided feedback, asked for improvements to Diem's design, and discussed extreme events exactly like the ones we've now witnessed.

5/ As a testament to the quality of work by @FINMA_media and the bank-like review process Diem completed — same risk, same regulation! — when the US President's Working Group released its stablecoin report (home.treasury.gov/news/press-rel…)... it mirrored Diem's design.🤔

6/ So while money market funds are convenient, even if they only invest in short-term USTs, they introduce counterparty risk and can levy gates and fees in a crisis — leaving coin holders to absorb losses. 🚨 That is why we dropped MMFs from the Diem design early in our journey.

7/ 🏦 Bank deposits run into the same issues we've seen over the last days with Silicon Valley Bank, as stablecoin issuers need liquidity for mint and burn operations well above the @FDICgov insured limit. 🚨

8/ In lieu of a @federalreserve master account, stablecoin issuers should therefore use 90 days or less US Treasuries, repos, and minimal cash distributed across multiple banks. 🏦🏦🏦🏦🏦🏦🏦

9/ #2: Stablecoin issuers need to be able to absorb losses due to credit, market, and operational risk. The Basel III framework provides clear guidance for calculating 🧮 the first two (probably <0.5% capital charge), and losses are limited if USTs are short-term.

10/ Operational risk capital requirements are more significant and require carefully identifying and estimating 🔍 losses from idiosyncratic scenarios that don't exist in traditional banking.

11/ Examples range from failures in mint/burn 🔥🔥 operations to unauthorized minting, attacks on the underlying blockchain infrastructure, errors in smart contracts, AML/CFT violations, data privacy breaches, legal fines, and more.

12/ Overall, operational risk can add anywhere between 0.5% and 1.5% to the issuer's capital requirements 🪙, depending on who the issuer mints & burns with, the blockchains it operates on, and, of course, operational, compliance, and other risk controls and mitigations in place.

13/ #3: Regulation needs to address AML/CFT concerns 👮 and how KYC 🪪 has to be implemented on open networks. Diem addressed this by dropping unhosted wallets from its design, but that solution had negative side-effects on the potential for the network to democratize access.

14/ Deposit tokens similarly solve this by bringing #stablecoins within the banking framework. 🏦 However, doing so eliminates any upside in terms of increased competition and lower costs. If deposit tokens are the only path, expect no benefits to consumers & businesses.

15/ New identity protocols 🆔 and verified credentials can better address the tension between AML/CFT requirements and open networks. 🌐 Stablecoins need open networks to deliver their benefits! (annualreviews.org/doi/abs/10.114… and hbr.org/2021/08/stable…)