Products based on distributed ledger technology (DLT) have recently gained in popularity. The services on offer range inter alia from the trading of Bitcoins, Ethereum and other traditional cryptocurrencies to decentralized finance products (DeFi) to non-fungible-tokens (NFTs). Those investors that are still holding out on investments in cryptocurrencies often argue that the volatility and therefore the risk associated with cryptocurrencies is simply too high. So-called stablecoins have been introduced to the market in order to offer the technical advantages of decentralized products while at the same time mitigating the associated volatility and also acting as an alternative to the exchange of crypto assets to fiat-money for value-preserving purposes. Stablecoins offer an easy first access to the crypto market and may even be used for investment purposes, if they are utilized in e.g. DeFi-lending projects. That being said, the payment purpose is usually what’s being focused on with stablecoins. The main purpose of a stablecoin is the representation of the value of a technical figure in crypto tokens, that generally is determined outside of its DLT infrastructure. Most stablecoins reference the value of the US dollar, but there are also stablecoins that reference the value of other national currencies or the value of e.g. gold.

How Do Stablecoins Achieve the Connection to Stable Values?

Stablecoins are supposed to be less volatile than traditional cryptocurrencies because of their connection to external values. They are suited as a means of payment thanks to this characteristic, should both parties of an exchange contract agree to accept them as such. The most common mechanisms to connect a stablecoin to an external value are on the one hand the escrow of real assets by the stablecoin issuer and on the other hand algorithmic hedge approaches. The best known example for an escrow with real assets is probably the stablecoin USDT, which is issued by Tether Ltd. The company promised to put one US dollar for every issued USDT in escrow to achieve a continuous connection of USDT to the value of the US dollar. It is however rumored that as things progressed, the escrow-pool has been filled with securities and other fixed assets. It is right now unknown, if there really is a sufficient amount of US dollars in escrow to actually match the amount of USDT in circulation. The stablecoin project Terra for example chose an algorithmic approach. With this approach, the stakers are asked when validating a new block to provide information regarding the current market price of the represented national currency. The value of the stablecoin is than subsequently determined from the average of the provided market prices. Those stakers that provided as their price the subsequently determined average price are rewarded by the system with additional block rewards in the form of new tokens. Stakers will therefore try to provide the current value of the represented national currency, since this is the only information available and therefore their best bet. Terra is therefore neither dependent on data outside of their own blockchain nor on the escrow of assets.

How Are Stablecoins Qualified Pursuant to German Supervisory Law?

According to German supervisory law, stablecoins can qualify as financial instruments. Especially a qualification as a unit of account or as a crypto asset in accordance to the German Banking Act (KWG) respectively the Investment Firm Act (WpIG) is conceivable. According to the administrative practice of BaFin, units of account are units of value that are comparable to foreign exchange but not denominated in a legal tender, comparable to complementary currencies and which are used in regional or private payment systems as a means of payment. They do not necessarily have a central issuer. Crypto assets on the other hand are defined as digital representations of value that are neither issued nor guaranteed by a central bank nor any other public authority and that do not possess the legal status of currency or money, but are accepted by natural or legal persons as a means of exchange or payment on basis of an agreement or actual practice or which serves investment purposes and which can be stored, traded and transferred electronically. The qualification as a crypto asset does also not call for the existence of a central issuer. All so far existing stablecoins have been created by private projects. Central banks or other government agencies have not yet issued a stablecoin. The main purpose of stablecoins is the aim to provide the crypto market with a compatible unit, which is suited to be used as a means of payment and also as a way to secure value. Even though the majority of stablecoins reference legal tender, they do not themselves possess the status of legal tender or money. According to BaFin, the qualification as a unit of account requires that the respective instrument is used as an alternative means of payment. Should therefore in a specific case the value securing aspects of a stablecoin be the main purpose, the qualification as a unit of account may be precluded. The stablecoin may nevertheless qualify as a crypto asset, because the legal definition also includes assets that are not alternative means of payment but which serve investment purposes. Stablecoins which e.g. represent the value of a specific amount of precious metals in order to achieve a stable exchange rate are potentially interesting for investment purposes. They can be used as a safe haven which secure value without the necessity of exiting the crypto market.

Attorney Lutz Auffenberg, LL.M. (London)

Rechtsreferendar Gabriel Aslan

I.  https://fin-law.de

E. info@fin-law.de