Written by: Aiying
Recently, a research report from JP Morgan has attracted widespread attention. The report points out that with the increase in regulatory efforts, especially the MICA Act introduced in Europe (European MiCA Act 10,000-word research report: a comprehensive interpretation of the profound impact on the Web3 industry, DeFi, stablecoins and ICO projects), stablecoin issuers such as Tether may face major challenges. This legislation requires that 60% of stablecoin reserves must be kept in European banks. For Tether, meeting these strict requirements may require large-scale adjustments to its reserve management strategy. This not only involves the reallocation of funds, but may also affect Tether's dominant position in the market. If Tether cannot adapt to these new regulations, its market share may be threatened, and it may even face more regulatory pressure and market turmoil.
Meanwhile, just last week, the ongoing bankruptcy liquidation of Swiss bank FlowBank triggered a chain reaction in the crypto industry. Anchored Coins AG was due to the bank's failure to meet minimum capital requirements and concerns about possible over-indebtedness. The company that issued the euro-pegged stablecoin AEUR deposited part of its reserve funds with this bank. When FlowBank entered the liquidation process, Anchored Coins' funds were frozen, causing the company to suspend the issuance and withdrawal of AEUR. As the case develops further, AEUR holders may face the risk of not being able to redeem in full. This incident echoes the concerns expressed by Aiying in her article last week, "From the Federal Reserve's review of the crypto-friendly bank Customers Bank, to the intertwined impact of the cryptocurrency industry and the banking system", currently in all regions, whether it is Hong Kong, Singapore, Europe, etc., stablecoin issuers must ensure that sufficient reserve funds are deposited in bank accounts. If it is 100% reserve, then the risk is all on the bank. If the bank has liquidity problems one day, then it will be unlucky together. If it is less than 100%, then the stablecoin issuer is actually acting as a "shadow bank", adding another layer of leverage on top of the leverage of the bank's reserve ratio money multiplier, which is equivalent to further amplifying the bank's own liquidity risk factor.
Due to the risk preference issues of the banking system, they are biased or disgusted with crypto institutions. Therefore, the cash of these stablecoin issuers, OTC institutions, custodian institutions, etc. is basically concentrated in a few bank accounts that can be opened, and many of them are unknown small banking institutions. Therefore, when the liquidity crisis comes, these banks' risk-bearing ability is very poor, and it is very likely to bring the stablecoin market back to the pre-liberation era overnight.
Therefore, in order to deal with the fact that the world that most people think is ruled by elites is actually a makeshift team, rules need to be formulated to combat human weaknesses to balance the risks brought about by the rapid expansion of crypto assets. Circle recently released a white paper proposing a new solution called the Token Capital Adequacy Framework (TCAF). This framework is designed to address the unique risk issues currently encountered by stablecoins in the market, such as market volatility, technical failures, and operational errors. Aiying believes that it is more meaningful for reference. The following is a summary of the white paper:
1. TCAF Framework
Circle proposed in its white paper that the traditional banking regulatory framework is mainly designed for traditional financial institutions, which often rely on fixed risk ratios and pre-set risk weights. However, these methods do not fully reflect the actual risks faced by the stablecoin industry. Therefore, a new scheme called "Token Capital Adequacy Framework" (TCAF) was proposed. Circle recommends using TCAF, a more flexible and dynamic risk management framework tailored for stablecoins and other digital assets, to better cope with the challenges brought by these emerging financial products.
1. Dynamic risk management
A key feature of TCAF is its dynamic risk management capability. In simple terms, TCAF does not conduct risk assessment according to fixed standards, but constantly adjusts according to the actual market situation. For example, it will use stress testing to assess whether the stablecoin reserves are sufficient to cope with extreme market fluctuations. This stress test is like simulating the worst market situation to see whether the issued stablecoin can still maintain its value stability under such circumstances.
In addition, TCAF will adjust capital requirements in real time according to changes in the market environment. If market risks increase, such as a large-scale sell-off or technical problems in the blockchain network, TCAF can respond quickly and require issuers to increase capital reserves to ensure the security of stablecoins. This flexible adjustment mechanism enables TCAF to respond more effectively to uncertain market conditions and emergencies, and avoid the rigidity and lag caused by fixed standards.
2. Comparison with traditional methods
In contrast, traditional banking regulatory frameworks mostly use fixed-ratio risk standards. For example, banks need to hold capital at a fixed ratio to cope with potential risks. Although this approach is simple and clear, it lacks flexibility in the face of a rapidly changing market environment. Fixed-ratio standards may not reflect new risks in the market in a timely manner, especially in the field of digital assets, where risks are often more sudden and complex.
TCAF makes up for the shortcomings of traditional methods by introducing dynamic adjustments and stress testing. It can adjust capital requirements in real time according to actual risk conditions to ensure that stablecoin issuers are always at a safe capital level. This dynamism makes TCAF more adaptable to market changes and reduces the impact of risk accumulation and sudden events.
3. Technical and operational risk management
In addition to market risks, TCAF also pays special attention to technical and operational risks. In the field of digital assets, technical risks are a very important factor, such as the performance of blockchain networks, network security issues, smart contract vulnerabilities, etc. If these risks are not properly managed, they may cause the value of stablecoins to fluctuate significantly and even affect the stability of the entire market.
TCAF incorporates these technical risks into its capital requirements. Specifically, issuers are required to regularly assess the performance and security of their blockchain networks and adjust capital reserves based on the results. If potential security vulnerabilities or performance bottlenecks are found in the network, TCAF will require issuers to increase capital reserves to ensure that there are sufficient funds to cope with possible losses even in the event of technical problems.
In addition, TCAF also requires issuers to have strong operational risk management capabilities. Operational risks include a series of problems from management systems to personnel operations, such as data leakage, operational errors, etc. By closely monitoring and managing these risks, TCAF helps issuers maintain the security and reliability of stablecoins at the technical and operational levels.
2. Five goals of the TCAF framework
The design goal of TCAF (Token Capital Adequacy Framework) is to help stablecoin issuers better manage risks and provide regulators with more effective supervision tools. The five major goals of this framework start from different angles and comprehensively cover all key aspects of stablecoin risk management. The following are the five major goals of the TCAF framework:
1. Distinguish between “potential” and “eliminated” risks
The first goal of TCAF is to help issuers distinguish which risks are still "potential risks" and which risks have been effectively controlled and "eliminated" through management measures. This distinction is important because it allows issuers to focus on managing those risks that may still pose a threat to stablecoins without wasting resources on those that have been resolved.
Specifically, TCAF identifies the risk points that still exist in the market environment, technical operations and external threats through continuous risk assessment and monitoring. For these potential risks, TCAF will require issuers to take further measures, such as increasing capital reserves or improving technical systems. For risks that have been successfully eliminated, TCAF will exclude them from further risk management measures, making the entire management process more efficient.
2. Assist supervision and simplify processes
The second goal of TCAF is to help regulators better manage operational risks while keeping the supervisory process simple and efficient. Traditional banking regulatory frameworks often involve complex processes and large amounts of paperwork, which not only increases costs but can also lead to inefficiencies.
TCAF makes it easier for regulators to monitor issuers’ risk management status through simplified reporting and dynamic adjustment mechanisms. For example, TCAF has introduced automated risk assessment tools that can provide regulators with the latest data on issuers’ capital status in real time. This simplified process not only reduces the complexity of supervision, but also improves the speed of supervision, allowing regulators to respond to market changes more quickly.
3. Standardized approach applicable across regions and institutions
As regulatory environments and market conditions vary across regions around the world, TCAF’s third goal is to provide a standardized risk management approach that can be used across regions and institutions. Traditional regulatory frameworks are often difficult to apply across borders because regulations and market practices vary from country to country.
TCAF has designed a set of flexible standards that allow regions to adjust according to their own actual conditions, while maintaining consistency in core principles. This standardized approach allows stablecoin issuers to maintain a consistent level of risk management when operating globally, while also making it easier for regulators around the world to coordinate and cooperate to ensure the security of cross-border capital flows.
4. Provide incentives and accountability mechanisms
Finally, the fourth goal of TCAF is to encourage better risk management practices through incentives and accountability. For issuers that perform well in risk management, TCAF may provide incentives such as reduced capital requirements or greater market access opportunities.
At the same time, TCAF has also established a strict accountability mechanism for issuers that fail to effectively manage risks. Through regular reviews and assessments, TCAF will impose stricter regulatory requirements on these issuers and may even impose penalties on them. This two-way effect of incentives and accountability mechanisms is intended to drive the entire industry towards a more standardized and secure direction.
Whitepaper: https://www.circle.com/blog/beyond-basel-a-new-capital-risk-framework-for-stablecoins
