Stablecoins: Types, Risks & Regulation

Recently, Finance Minister Nirmala Sitharaman stressed balanced regulation of stablecoins to protect monetary stability. Effective oversight can foster financial innovation & strengthen the digital economy.

What are Stablecoins?

Stablecoins are a type of cryptocurrency whose value is pegged to another asset, such as a fiat currency or gold, to maintain a stable price.
Objective: To provide an alternative to the high volatility of popular cryptocurrencies like Bitcoin, which can make these digital assets less suitable for common transactions.
They are not generally used for transactional purposes, but instead by crypto investors to park their profits without converting them back into real money.
As per Standard Chartered Bank, the size of the stablecoins market could increase tenfold to $2 trillion by 2028.

Fiat Currency is a government-issued currency that’s not backed by a physical commodity such as gold or silver. It’s backed by the government that issues it.

Types of Stablecoins

Fiat-collateralized Stablecoins: These are pegged to a specific asset, such as a fiat currency.
- The entity behind the stablecoin maintains a reserve of the asset or assets backing the stablecoin, supporting the value of the digital currency.
Non-collateralized (algorithmic) Stablecoins: They use software algorithms to automatically adjust the supply of the stablecoin based on demand, aiming to maintain a stable price.
Crypto-Backed Stablecoins: They are collateralized by other cryptocurrencies.

Significance of Stablecoins for India

Financial Inclusion: Stablecoins can expand financial access for unbanked Indians via smartphones and digital wallets. This helps bridge gaps in formal banking.
Cheaper Remittances: India received ~$130 billion in remittances in 2024. Using stablecoins can reduce transfer costs from 6% to 2%, saving households nearly $5 billion
Rupee Stability: Stablecoins pegged to the rupee can reduce dependence on the U.S. dollar and help build long-term trust in India’s domestic digital currency system.
Tech Development: With 11% of the world’s blockchain developers, India can leverage stablecoins to promote Web 3.0 innovation and attract international fintech investment.
CBDC Synergy: Combining stablecoins with the RBI’s e-Rupee can improve interoperability, speed up public adoption, and strengthen India’s digital financial infrastructure.

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Risks Associated with Stablecoins

Market Risk: Past failures, such as TerraUSD in 2022, have shown how the sudden collapse of stablecoins can wipe out user savings and disrupt broader cryptocurrency markets.

Regulatory Gaps: India treats cryptocurrency as a Virtual Digital Asset, but lacks specific laws for issuing, auditing, or safeguarding users of stablecoins.
Policy Concerns: Privately managed stablecoins might reduce the RBI’s control over liquidity and weaken the effectiveness of its monetary policies.
CBDC Competition: Private stablecoins may compete with the e-Rupee for retail transactions, potentially dividing adoption and reducing the public’s preference for sovereign digital currency.
Operational Risks: Algorithmic coins depend on automated supply formulas that can be vulnerable to market shocks. Centralized issuers may also inflate or misrepresent their actual reserves.

Are Stablecoins Regulated in India?

India does not currently recognise stablecoins, treating all cryptocurrencies as Virtual Digital Assets under Section 2(47A) of the Income Tax Act, 1961.
In 2023, VDAs were brought under the Prevention of Money Laundering Act, 2002, to curb misuse and enhance oversight.

How have other Countries treated Stablecoins?

USA GENIUS Act: The USA has allowed banks and tech giants to issue stablecoins. These coins, backed by US Treasury Bills, expand global demand for US debt, reducing borrowing costs and reasserting dollar dominance in a digital age.
European Union MiCA (Markets in Crypto-Assets Regulation) Act: It mandates that only authorised e-money institutions or credit institutions can issue e-money tokens.
Hong Kong Stablecoin Ordinance: All stablecoins must be backed by high-quality, liquid reserve assets, with the market value of the reserve pool at par with the value of the stablecoins in circulation.

Way Forward

Introduce Regulation: Create a clear legal framework that requires 1:1 reserve backing, regular audits, and complete transparency from all stablecoin issuers.
Strengthen Oversight: Empower the RBI and SEBI to jointly oversee reserve management, transaction reporting, and compliance for stablecoin operators.
CBDC Development: Enhance the e-Rupee by adding programmability and interoperability to increase reliability and promote wider public acceptance.
Promote Innovation: Integrate stablecoin and blockchain pilot projects into the RBI’s FinTech Sandbox to assess efficiency in remittances and digital trade.
Global Coordination: Collaborate with partners like the UAE and Singapore to harmonise cross-border digital payment systems.

“Innovation and oversight go hand in hand.” With proper regulation, stablecoins can boost financial inclusion, strengthen the e-Rupee, and enhance India’s global digital finance footprint.

Reference: The Hindu | Cryptocurrency | Virtual Digital Assets.

PMF IAS Pathfinder for Mains – Question 376

Q. “Stablecoins offer opportunities for technological innovation and financial inclusion but pose regulatory and operational risks.” In this context, analyse the opportunities and challenges associated with stablecoins in India. Suggest measures to integrate them safely with the e-Rupee. (250 Words) (15 Marks)

Approach

Introduction: Write a definition-based introduction and mention the current context.
Body: Analyse opportunities, challenges associated with stablecoins in India, and suggest measures to integrate them safely with the e-Rupee.
Conclusion: Emphasis on a comprehensive conclusion by mentioning the future course of action.