So-Called Stablecoins
Stablecoins are an anonymous-ish way of making transactions. But a recent pronouncement from the Financial Action Task Force (FATF) could change that. The global anti-money laundering watchdog seems intent on making stablecoins a little less anonymous in the near future.
What is a stablecoin?
If you’ve got $10 in your PayPal wallet, then having $10 in a stablecoin wallet lets you do pretty much the same thing. Both allow you to pay other people for goods and service, split a bill, or get paid by others. Because stablecoin balances are U.S. dollar-denominated, they shelter their users from hyper-volatile cryptocurrency prices.
Whereas PayPal balances are registered on PayPal’s centralized database, a stablecoin is recorded on a decentralized ledger, or blockchain, say like Ethereum. There are different types of stablecoins. In the most popular version, U.S. dollars are kept in a bank while the stablecoin administrator issues blockchain-based tokens that are linked to those dollars. This linkage — the owner’s ability to redeem a token one-for-one into underlying dollars — is what stabilizes them at $1.
The largest stablecoins of this type are Tether, USD Coin, and Paxos. But Libra, an emerging payments platform championed by Facebook, is trying to adopt this model too.
To date, stablecoin payments networks have taken a hands-off approach to knowing who their users are. Anyone can receive $100,000 worth of Tether or USD Coin tokens into a digital wallet from a stranger and then transmit those funds to another stranger’s digital wallet. And no one along that chain of transactions needs to reveal their identity to the stablecoin system. The only point at which users must identify themselves is when they want to convert their stablecoins back into actual dollars in a bank account.
But if the FATF has its way, this privacy-friendly approach could change.
What is the FATF doing about stablecoins?
FATF is an intergovernmental body that was formed in 1989 to promulgate standards for combating the laundering of drug money. Its role grew after 9/11 when it added countering the financing of terrorism to its mandate. Once FATF issues a recommendation, the task force’s 38 member countries usually implement their interpretation of the rule on a national level.
Earlier this month, FATF issued a long-awaited report to the G20 on what it referred to as “so-called” stablecoins. The report writers consistently chose the modifier “so-called” throughout its 32 pages. The term stablecoin is “primarily a marketing term used by promoters,” they write. This comes off as arrogant. Whether the so-called FATF likes it or not, the word stablecoin has become part of the lingua franca of the cryptocurrency universe.
The FATF suggests in its report that “central developers and governance bodies of so-called stablecoins” should be treated either as financial institutions or as virtual asset service providers (VASPs). A VASP is an entity that exchanges or transfers virtual assets like bitcoin. Classifying stablecoins this way would oblige stablecoins to implement the same anti-money laundering (AML) and countering financing of terrorism (CFT) measures as banks, money transmitters, and cryptocurrency exchanges.
Specifically, stablecoin systems would probably have to abide by the FATF’s Recommendation 10, which prohibits financial institutions from “keeping anonymous accounts or accounts in obviously fictitious names.” As it stands now, stablecoin platforms have implemented customer due diligence programs (i.e. programs for identifying customers and verifying their documents) that only apply to the small minority of users who redeem their stablecoins for actual dollars. Due diligence would have to be extended to everyone who has a wallet.
So no more anonymous $100,000 Tether or USDC transactions. To get a stablecoin wallet, you gotta show your papers.
Stablecoins, privacy, and the rule of law
I often criticize the FATF and other money laundering regulators for refusing to admit the public benefits to financial anonymity. Sure, 100% anonymity is risky. Bad actors like fraudsters and extortionists rely on cloaked payments. But too little anonymity is also problematic.
We live in an age in which digital surveillance is pervasive, both by governments and corporations. People are increasingly concerned that their personal data will be compromised. Surely more regulatory space will have to be cut out for information-light payment systems. Instead, money laundering regulators around the world seem intent on shutting the window for anonymous exchange for good.
Nevertheless, I still think the so-called FATF got this one right.
Stablecoins are just one of many payment options. Reloadable prepaid debit cards, a ubiquitous payments tool popular with unbanked Americans, are another. Yet prepaid debit card issuers like Walmart (via its partner Green Dot Bank) are obligated to do customer due diligence on all of their users. Money transmitters like PayPal also have to go through the same hoops. And the same goes for banks like Chase.
Stablecoins should not be allowed to avoid verifying users when Walmart, PayPal and Chase are obliged to spend huge amounts of resources building systems for collecting customer identity and verifying it. If society is going to have a set of laws about the due diligence required of payments providers, it shouldn’t allow a select few to ignore them. This is Rule of Law 101.
There are a few legal exemptions to due diligence requirements. In the U.S., for instance, certain types of prepaid cards—nonreloadable ones—are exempt. That’s why you can go to a pharmacy and get a Vanilla prepaid card without having to show ID. Regulators see fit to exempt these cards because many people don’t have documentation; without nonreloadable prepaid cards they couldn’t make digital transactions. But this window isn’t very large. Prepaid cards are only exempt from due diligence if they have a face value below $1,000.
If stablecoins want to keep avoiding due diligence, perhaps they could qualify under this exemption. If not, it is only fair that stablecoins adopt the same customer due diligence practices as other payment providers.
Regular consumers are slowly becoming more interested in financial privacy. But they shouldn’t have to rely on systems that ignore the law. A more durable solution is to work towards changing those laws. That means changing the public opinion about financial privacy. Once institutions like the so-called FATF have been convinced that there is a civil liberties case for anonymity, perhaps payments rules can finally be modified to widen—and not shrink—the financial privacy window.
J.P. Koning
J.P. Koning is a financial writer and blogger with interests in monetary economics, economic history, finance, and fintech. He has worked as an equity researcher at a Canadian brokerage firm and a financial writer and publisher at a large Canadian bank. More recently, he has written several papers for R3, a distributed ledger company, on the topics of central bank cryptocurrency and cross border payments. He founded the popular blog Moneyness in 2012. He designs economics and financial wallcharts at Financial Graph & Art.
Koning earned his B.A. in Economics from McGill University.
