The legal limbo of stablecoins
The plumbing matters more than the peg: Part 2
For stablecoins to become mainstream payments instruments requires they be compliant, but that’s just table stakes. The competitive edge for issuers is to build them with the right balance of identity and privacy standards.
Compliance is one of several aspects to building a sustainable, far-reaching financial infrastructure using stablecoins. This series of articles, “The plumbing matters more than the peg”, examines the components to realizing this goal, including reserves management, liquidity, and resilience; Part 1 already looked at the scope of opportunities for stablecoins in payments.
Part 1: Stablecoins and the real world of payments
Legal status
The good news is that many jurisdictions have legislation and regulations regarding stablecoins. This is a big change compared to about eighteen months ago, when there was little or none. However, whether it’s the US or Hong Kong, Europe or Singapore, London or Dubai, stablecoins are not legally operating at the same level as cash.
While both sides to a transaction can increasingly treat certain regulated stablecoins as money for booking and settlement, stablecoins do not have general legal-tender status.
Accounting standards view stablecoins as an intangible property or a financial asset, which requires a capital charge, whereas cash would not. More jurisdictions are interpreting their accounting standards to accept stablecoins as cash equivalents, which eliminates one barrier to their adoption. Even so, stablecoins still present merchants with an accounting nightmare: they have to track fiat fair-value receipts, and recognize any gains or losses on fiat conversion, creating additional paperwork than if they just held cash or fiat e-money.
Tax authorities mostly treat them as property or financial assets, not as cash.
Even if a regulator defines a stablecoin as a payments token, not a security, the taxman may still consider the transaction to be fair game. Spending via a bank deposit doesn’t trigger a capital-gains tax, but paying with a stablecoin still can. And tax authorities are not accepting tax payments in stablecoins, an important indicator of whether the state regards them as ‘money’.
Finally, we don’t know yet how courts and law enforcement will treat redemption at par from a clearly liable but troubled issuer; precedents around money-market funds have not been tested in a stablecoin case.
For a licensed entity to book, pay tax, and legally enforce stablecoins as a normal payment obligation depends on accounting, tax, and legal changes. Some of these shifts are in progress, others have a long way to go.
This restricts stablecoins to a narrow set of applications. As a counter-example, look at China’s eRMB. Because it’s recognized by the state as legal tender, the eRMB can be used for paying taxes and receiving government services. Stablecoins can’t worm their way into everyday life without that recognition by the state. Corporate treasurers, projected by the fintech industry to be the biggest adopters of stablecoins, confine their use to niche flows related to on-chain liquidity and collateral. They aren’t being used for general payments, let alone for mass-market invoicing or payroll.
One last challenge to settling the legal status of stablecoins is their global nature.
Global 24/7?
Even when regulators agree on sensible rules, they still only operate within their own jurisdiction. Correspondent banking evolved to meet this reality; hence the duplicative compliance checks. Crypto rails have been built to operate globally, 24/7, with little regard for regulation. Backfitting this infrastructure is easier if there is either a very big market (the US) or a bloc that offers a single license, such as in Europe’s MiCA regime.
But in Asia or Latin America? Regulation is fragmented across two dozen jurisdictions. Licensing timelines can stretch beyond two years – or longer, as many authorities struggle to recruit and keep talent with real experience in both banking and payments, and in technology.
Stablecoins sit at the intersection of securities law, payments regulation, banking supervision, and cutting‑edge cryptography. When regulators have limited opportunities for staff to be seconded into actual payment operations, or lose their qualified people to the private sector, the result is often cautious, reactive policymaking.
The good news for the industry as that authorities in hubs like Hong Kong and the UAE see licensing stablecoin operators as vital to their ambitions to lead in digital assets. They have either published comprehensive rules, or have established principles-based frameworks to focus on KYC and AML outcomes.
But central banks lack an established body for networking and trading policy ideas, so harmonization is a long, painful process. The closest thing to a coordinating body is the Bank of International Settlements, which sponsored mBridge – which, when it launched, caused a furor in the US, which saw it as BIS enabling China to work outside the framework of SWIFT-enabled correspondent banking. Don’t expect the BIS to be an active coordinator for stablecoins.
Transparency
Transparency is the another sticking point. This one is a head-scratcher for people in the crypto industry. They live with a kind of raw transparency, in which every transaction is visible. It’s the wallet addresses that are cryptographically hidden. But the kind of visibility available in crypto does not map to TradFi, which means transparency around stablecoins has to be shoehorned into legacy infrastructure.
In the SWIFT world, banks can see each counterparty and maintain audit trails for who owns which account at every hop. With stablecoin flows, the bank only sees a transfer from or to a crypto exchange or wallet provider, and cannot readily map the full chain of wallet owners touching the asset. That opacity clashes head‑on with AML, KYC, sanctions, and fraud obligations, especially in an era when billions of dollars have been lost to cybercrime and where blockchain transactions are irreversible.
When a Visa or Mastercard payment goes wrong, the card network can reverse the transaction and often eat the fraud cost (hence justifying high issuer fees); on a public blockchain, there is no global dispute‑resolution layer.
Regulators and compliance teams are right to be wary: faster, irreversible money is great if you trust every actor in the system and can identify them; it is terrifying if you cannot. Perhaps there is a world in which TradFi could embrace crypto’s market transparency as a massive efficiency gain, but the more likely outcome is that stablecoins have to be designed around traditional compliance.
Privacy and identity
What might such a solution look like, one that enables the widespread adoption of stablecoins as a superior mode of payment, while preserving both the privacy demanded by crypto natives and the traditional safeguards against crime?
Today, many stablecoin systems rely on denial lists (blocking known bad actors) whereas banks operate on white lists, where only pre‑vetted clients can transact. Bridging that gap requires a new layer of decentralized identity and permissioned privacy that lets multiple participants, not just the issuer, onboard and vouch for clients.
For banks and regulators, the core question is: who is this wallet? If a central securities depository, a custodian, or a bank can attach a verified identity to an on‑chain address using robust KYC/KYB processes, then stablecoin transfers can be treated much more like account‑to‑account transfers in today’s system. Technologies like zero‑knowledge proofs hold out the promise of allowing parties to demonstrate compliance with certain rules (for example, that a user is not on a sanctions list, or that a transaction is below a threshold) without revealing all underlying personal data.
Some central‑bank digital currency experiments hint at this direction. In places like Hong Kong and mainland China, pilots such as eHKD and eCNY have been used to explore what happens when identity frameworks like iAMSmart or national ID systems are intertwined with digital money. Those projects raise uncomfortable questions about authoritarian overreach and surveillance, but they also provide technical templates for embedding identity at the protocol layer. For stablecoins, the challenge is to borrow the good parts – strong identity, clear liability, auditable records – while avoiding the worst: centralized, granular tracking of every transaction.
Compliance is the price of admission; without it, no major bank or regulator will allow stablecoins to carry significant flows. Identity and privacy standards are the negotiation: can we use technology to prove that the industry can know enough about its users to satisfy AML and systemic‑risk concerns, while avoiding building panopticons?
This is a hard nut to crack, but it is achievable. Remember, it’s the plumbing, not the peg, that matters most. Our final article in this series will look at other aspects to stablecoin plumbing that still need attention: liquidity and resilience.