‘THT’, a Thai Bhat denominated algorithmic stable coin launched on the South Korean block-chain platform Terra has caught the eye of the Bank of Thailand (BOT), which is the central bank and monetary regulator of Thailand. The BOT has issued a press release in March 2021 making illegal any activity involving THT (such as the creation, issuance, usage or circulation of any material or token for money). But why do central banks fear algorithmic stable coins?

How does it work?

We first need to understand how THT works. THT has been valued at one THT to one Thai Bhat. THT is not backed by Thai Bhat but rather only mirrors the price and fluctuation of the Thai Bhat by a set of algorithmic adjustment using Terra’s native token ‘Luna’. So let imagine a three way price peg between the Thai Bhat, THT, and Luna. If the price of Thai Bhat increases, then the price of THT should also proportionally increase. To increase the price of THT, the system automatically starts to mint Luna and starts purchasing THT for the newly minted Luna at a price greater than the THT to Luna price, thereby contracting the supply of THT and increasing its value to mirror the value of the Thai Bhat. Similarly, if the price of the Thai Bhat decreases, the system automatically offers newly minted THT for Luna at a price lower than the THT to Luna price thereby decreasing the value of THT. The system works within certain thresholds of price fluctuation set, and as long as there is a demand of THT and Luna, the system would work in an efficient manner.

Is there a real threat?

So can THT actually replace the Thai Bhat in a Thai Bhat denominated transactions? Well THT being a crypto-currency is more efficient to handle and transfer. As the peg to Thai Bhat is almost assured, THT can act as an efficient medium of exchange. But it is a farfetched thought that THT would actually destabilised the Thai Bhat system or even replace the Thai Bhat. Well for one the total number of Luna in circulation as on May 11, 2021 is 955.08 million which is native token used to stabilise THT and other stable coins on the network.  The total Thai Bhat circulating until February 2021 is 2,171,418 million.  It’s not even a close match. THT would only be the domain of the tech savvy and so called risk takers and will not find general acceptance so soon. As far as Anti-Money Laundering (AML) regulations are concerned, the position so far as Bitcoins or other crypto-tokens already operating in Thailand, and the THT would be the same.

Why the fear of algorithmic stable coins?

Well for one, governments are not able to regulate algorithmic stable coins in any manner as in the case of asset collaterised stable coin. As on date, for regulatory purposes many jurisdictions are trying to categorise stable coins collaterised by fiat currency or other assets as "assets" themselves or “commodities” rather than currencies themselves. But algorithmic stable coins do not strictly fall in these categories because they are not backed by either fiat currency of any asset other than crypto-tokens. As algorithmic stable coin rely solely on crypto-tokens to mirror the prices of a fiat currency, they are as such beyond the regulatory domain of a Central Bank or regulator. This can be seen, in the consultation paper released in January 2021 by the Her Majesty's Treasury (UK), where there is a discussion on a proposed regulatory regime for asset backed stable coins in the UK. However, algorithmic stable coins are excluded from the proposed regulatory regime. The reason given in the paper for the exclusion is that, the UK Government judges that the algorithmic stable coins closely resemble unbacked exchange tokens and may pose similar risks in relation to their ability to maintain stability of value, so may not be suitable for retail or wholesale transactions. At the same time somewhere in the footnotes, the paper does not rule out that in the near future such algorithmic stable coin entities may have to make consumer disclosures via the financial promotions regime as applicable in the UK may also subject to AML/CTF regulations. The paper calls for suggestions from the public on how algorithmic stable coins are to be regulated.

Is it all a game of power?

“Fear is the path to the dark side”, this infamous Star Wars quote fairly applies the current situation. The governments fear algorithmic stable coins because it challenges one of its fundamental sources of a government’s authority. Historically governments have enjoyed monopoly over issuance of money which we know as fiat money. Much of the so called fiat money is backed by nothing or almost nothing. So the value of fiat money depends mainly on “acceptance” of it as money. This acceptance is enforced on people by way of laws. The very reason people follow these laws is because of the concept of sovereignty or the authority of a government to rule its people. So an algorithmic stable coins which is not issued or regulated by a central bank or the government or is not even collaterised by a regulated assets like fiat money or gold is seen as a challenge to the very authority of the central bank or the sovereignty of the government.

So are countries not regulating algorithmic stable coins?

Well technically they are. For example, in the U.S., in a speech made at Chainalysis Blockchain Symposium, Kenneth A. Blanco, the Director of the US Treasury, Financial Crime Enforcement Network (FinCEN) highlighted that accepting and transmitting activity denominated in algorithmic stable coins are covered under “money transmission services” under the U.S. Banking Secrecy Act, 1970 thereby obligating administrators of algorithmic stable coins to register as “money services businesses” with FinCEN. In Japan, item (ii) of paragraph (5) of Article 2 of the Payment Services Act (Act No. 59 of 2009) defines a ‘Crypto Asset’ to be property value which can be mutually exchanged with other crypto-tokens with unspecified persons acting as counterparties, and which can be transferred by means of an electronic data processing system. The definition seems to also cover algorithmic stable coins and therefore would mandate entities providing algorithmic stable coins services in Japan to register and follow other applicable regulations.

Is outright banning the only way out?

Central banks may have many arguments against algorithmic stable coins. The first argument is that algorithmic stable coins fluctuation control mechanism is unreliable. But one may use that argument even against Fiat money. A political or economic crisis would mean that your hard earned fiat money is not as valuable as it used to be. Case in point is the recent Myanmar Kyat devaluation against the US Dollar or that of the Venezuelan Bolivar.  

The second argument is that algorithmic stable coins may not be accepted as a medium of exchange internationally. But then, then we have seen the Nigerian currency crisis where the Nigerian Government rationed the supply of foreign exchange in Nigeria harming a number of local businesses involved importing goods into Nigeria. As algorithmic stable coins are not collateralised on fiat currency therefore they would technically not be affected by a devaluation of the fiat currency.

In fact, the native token can be used to stabilise the stable coin once the fiat currency surpasses the devaluation threshold set by the block chain. In addition, algorithmic stable coins can be exchanged for native tokens or with other currency denominated stable coins on other block-chain networks and therefore are more freely exchangeable with minimum transactions fees. In fact these transactions fees for stable coins are much lower than the fees charged by banks for foreign exchange transactions in many countries.

The third argument is that it would destabilise the monetary of system of country. As already pointed out, as on date the scale of algorithmic stable coins do not have the scale and accessibility to dent any monetary system in the world. They would, at most can exist in parallel, and provide an additional options to people.

Also, as the value of algorithmic stable coins is stable, there would be no issue in ascertaining the value of a transaction vis-à-vis a fiat currency. This would let lenders finance such transaction or governments to tax the same (like customs or VAT or GST), just as transactions denominated in a fiat currency.

Although the algorithmic stable coins may be risky to a certain extent and may raise a concern for compliance AML regulations, but an outright ban may serve no purpose. It would be best let market forces decide the faith of algorithmic stable coins. If they meet the users’ expectation they will flourish and if they fail they will die of natural causes.

DISCLAIMER: The above article is published only for informational/academic purposes and does not amount to any legal opinion or financial advice on the subject matter. Readers are therefore advised get themselves independently acquainted with the risks, legal issues, and any other financial information pertaining to subject matter of this article.