Circle Proposes New Capital Risk Framework for Stablecoin

Circle, the issuer of USDC stablecoin, recently released a white paper titled "Risk Capital of Stable Value Tokens", proposing a new risk-based capital management model for stablecoins and other digital cash tokens. The authors believe that in order to mitigate the unique risks faced by stablecoins, equivalent tokens of other legal currencies and their issuers, there needs to be sufficient capital reserve requirements for stablecoins. These requirements should exceed the current established capital standards under the Basel banking regulatory framework. According to the authors, these unique risks include but are not limited to token price shortages due to market trading and prevalence in secondary markets, digital token "runs" caused by excessive selling off, operational risks and technological risks.

These unique challenges distinguish stablecoin issuers and their issued digital assets from traditional banks. The authors suggest that one way to address this issue is through what they call a Token Capital Adequacy Framework (TCAF). Circle's paper explains that current banking regulations use fixed ratio risk standards and risk weights which may not necessarily reflect true levels of risk. Using long-term government bonds as an example, they point out that despite high interest rate risk associated with them, their weighted risk is low under current bank standards. TCAF addresses this problem by adopting a dynamic risk-sensitive model which first stress tests reserves then takes into account stakeholder opinions. The TCAF model also considers technical risks such as blockchain network performance and network security. The paper further notes that TCAF's dynamic approach could lead to higher or lower capital requirements than current bank standards depending on changes in the risk environment.

The newly proposed model by Circle has five objectives: Firstly it aims at distinguishing between emerging 'disappearing' risks factors versus those successfully mitigated or no longer posing threats known as 'already disappeared' ones; It also seeks complementarity helping regulators adequately deal with operational hazards while remaining simple enough avoiding bloated costly departments found within conventional banking industry; Fourthly, TCAF's main goal is to provide a set of risk management standards applicable across various jurisdictions and institutions; Lastly but equally important, the model aims at providing incentives and accountability measures to alleviate negative risk externalities.