Hey all, Liam here. 

Stablecoins are getting another facelift — or, rather, haircut. 

Late last week, the US Securities and Exchange Commission announced that broker-dealers needn’t treat dollar-pegged cryptocurrencies with the same risk profile as before. 

Instead, Commissioner Hester Peirce clarified that the SEC would not object if a broker-dealer applied a 2% haircut to stablecoins.

It’s a key regulatory change that will likely make stablecoins far more attractive for traditional financial firms. 

“This move will open the floodgates for embedding stablecoins in institutional finance,” JP Richardson, the CEO of the NYSE-listed crypto wallet provider Exodus, said.

To make sense of this critical change, let’s define our terms. 

Broker-dealers play two roles in financial markets. 

They help match investors with purchases and charge a commission for that activity. As dealers, they may hold a large inventory of a specific stock, bond, commodity, or stablecoin and sell it directly to investors. They make money by selling those assets back to investors for more than they purchased them. 

When handling financial assets, be it cryptocurrencies, cash or gold, regulators assign risk to each asset. Depending on the level of risk, the SEC encourages broker-dealers to maintain a liquidity cushion commensurate with that risk. 

This means that the riskier an asset is perceived to be, the larger the liquidity cushion, or haircut, that is required. 

Previously, the SEC didn’t provide any guidance on the riskiness of stablecoins, so many conservative broker-dealers simply took a 100% haircut on the asset if they decided to operate in this sector. 

In practical terms, a 100% haircut is like saying these assets are going to go to zero, and to keep your customers safe, you’re going to need to assume they are already worth zero. 

If a broker-dealer held $100 million in Circle’s USDC stablecoin as part of its inventory to sell or use for other investments, the SEC demanded that the broker-dealer also hold an equivalent $100 million in cash in case USDC lost its peg to the dollar, there was a bank run, or any other kind of super bearish event. 

It also means that those broker-dealers needed to hold an equivalent amount of that asset in cash or treasuries, making holding assets with this level of insurance policy hugely expensive for firms.

Now, that’s no longer the case. 

“In my view, a 100% haircut would be unnecessarily punitive given the underlying reserve assets that back payment stablecoins,” Peirce said. “A haircut of 2% aligns with the haircut imposed on registered investment companies that are money market funds, which hold similar instruments as payment stablecoin issuers.” 

That same broker-dealer now only needs to hold 2% of that $100 million in USDC, or $2 million, to meet the SEC’s new standards. 

From a balance-sheet-efficiency perspective, this is great news for these kinds of firms. 

Suddenly, they have another $98 million on their balance sheet to keep growing their business in other ways. 

Exodus’ Richardson wagers that this will also encourage firms to start building stablecoin rails for their businesses. 

This puts pressure on every major broker-dealer to build stablecoin infrastructure or fall behind the ones who do,” he said.

“Because their competitors now can, and there's no longer a capital penalty that makes it uneconomical.”

ICYMI

• Russia to begin ‘mass blocking’ of major crypto exchanges in summer, warns expert
  Russia will block citizens from trading crypto on overseas exchanges as early as this summer, industry experts warn.

• CFTC claims sole authority to regulate prediction markets
  In a court filing and a short video posted on social media on February 17, Commodity Futures Trading Commission Chair Mike Selig waded into the raging battle over prediction markets’ ability to offer sports betting across the US.

• What to expect at Trumps’ World Liberty Forum despite $2tn market meltdown and Democrat probes
  While the US president is busy steamrolling into his second year in office with a slew of new policies, his family’s crypto venture drew a star-studded crowd to an event at Mar-a-Lago, his Florida resort, on February 18.

Latest from DL Research

Story of the week

Prediction markets are bending insider trading rules. But will they break them?

Trading on insider information involves using wit and expertise to try to predict an outcome.

Insider trading, however, is a legal term for describing fraud by which you use material nonpublic information — such as a secret USDA crop report — for profit.

Yesha Yadav, a professor of law and associate dean at Vanderbilt Law School, says the distinction between legally trading on insider information and illegal insider trading is becoming increasingly blurred.

Post of the week

With the Hyperliquid Foundation dropping $28 million to join the crypto lobbying race, there’s an argument that the winner will be the outfit that doesn’t get crushed by politics first. Does anyone remember Drift?

DL News is an independent news organisation that provides original, in-depth reporting on the largely misunderstood world of cryptocurrency and decentralised finance. From original stories to investigations, our journalism is accurate, honest and responsible.

Forwarded by a friend? subscribe here.