Thought Experiment on Stablecoins and Wrapped Crypto Assets Regulation

Recently there was a crackdown on Bitmex for not complying with regulations in the United States (Crypto Trading Platform BitMEX ‘Attempted to Evade’ US Regulations, CFTC, DOJ Charge). This type of regulatory crackdown is inevitable in the broader crypto ecosystem and regulators will want to know the origins of crypto assets, such as if the asset was mined from a coinbase transaction.

A coinbase transaction is the first transaction in a new block. The recipient of the coinbase transaction, the miner who mined that block, has rights to the block reward and the related transaction fees.

“A coinbase transaction is a unique type of bitcoin transaction that can only be created by a miner. This type of transaction has no inputs, and there is one created with each new block that is mined on the network. In other words, this is the transaction that rewards a miner with the block reward for their work.” — CEX.IO

Eventually regulators will want to know the origins of crypto assets and if the asset was mined by the miner who has rights to the coinbase transaction or whether it was acquired elsewhere.

This will also apply to stablecoins and wrapped crypto assets depending on the model and design being followed, the difference being that wrapped crypto assets are the equivalent of their underlying token, only with a possibly different way of governing the issuance of the token.

What is a stablecoin?

A stablecoin is a class of cryptocurrency that offers price stability and is backed by reserve assets. Most use the United States Dollar (USD) as its reserve asset. At the moment, USDT has 90% of the stablecoin market share and is backed by USD bank reserves.

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The 180D volatility, measured as the standard deviation of the natural log of daily returns over the past 180 days. Sample stablecoins GUSD, USDC and USDT compared to BTC (Source: Coinmetrics)

As depicted above, Bitcoin is becoming stable over time and in the future Bitcoin will become much more stable and replace USD$ and others as a stablecoin.

What is a wrapped crypto asset?

A wrapped crypto asset is effectively an IOU that is hosted on a different blockchain. A wrapped coin can include a coin such as BTC being wrapped over to another network such as the Ethereum blockchain.

For wrapped Proof-of-Work mined crypto such as BTC, regulated institutions would be willing to acquire BTC that was mined from a coinbase transaction and pay for them with a premium, as long as it complies to given jurisdiction regulation.

This is where reporting standard Mining KYH Standard 42 — being introduced to the open source community could help. If the underlying reserve assets for these stablecoins or wrapped crypto assets can be traced to the originating coinbase transaction and indicate if it falls within a given jurisdiction, then it would become very valuable for these regulated institutions.

The reality is that it becomes very hard to regulate a wrapped crypto asset given that, at the moment, they are being wrapped and hosted on blockchains such as Ethereum which itself is also mined in a Proof-of-Work way just like BTC is.

More thought experiments should be done to help understand the complexity of stablecoins and wrapped crypto assets and the challenges they bring when trying to regulate them along with how they should be regulated.

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