“Same activity, same risk, same regulation.” A catchphrase that doesn’t mean much unless you’ve been working in the regulatory trenches, it emerged from the mess of the 2008 financial crisis. Before the crash, shadow banks were packaging risky mortgages and other loans into securities before selling them off. Like a sneaky virus, risk spread through the financial system undetected. The Financial Stability Board (FSB) recommended strengthening oversight of these non-banks, which were behaving like banks without bank-like supervision.
Considering the trauma of the last financial crisis, it should come as no surprise that “same activity, same risk, same regulation” is now a sacred principle. It’s invoked whenever policy makers are reckoning with financial innovations squeezing through the cracks of old laws and regulations, such as cryptocurrencies and stablecoins. When the FSB released recommendations for crypto-asset regulation, it pledged it was observing the principle. So were law makers in the European Union, who quoted the principle in the text of their crypto-asset framework.
It’s curious, then, that Canada’s approach to stablecoin oversight violates this principle of good financial-system governance. Tabled by the federal government last year to supervise a growing part of the crypto-asset economy, the Stablecoin Act regulates new technology more than it regulates new activities and risks.
Stablecoins Are a New Name for an Old Trick
In the financial sector, which has evolved over millennia, new activities are hard to come by. Evidence of grain depositories can be found in ancient Mesopotamia. Merchant bankers emerged in Renaissance Italy, followed by goldsmith bankers in seventeenth-century England. Capital markets grew with industrialization. With plenty of history to learn from, Canada’s financial system started to take shape in the nineteenth century and matured through the twentieth. After all that time, it’s common to come by new technology to perform the same old activities: taking deposits, issuing loans, securitizing debt and executing payments.
As groundbreaking as they seem, the companies that issue stablecoins aren’t doing anything fundamentally new.
Stablecoins are crypto-assets whose value is pegged to fiat currency. The issuer takes your dollars and gives you stablecoins in return. You can think of the stablecoins a bit like IOUs: whenever you want, you can get your dollars back by cashing in your stablecoins. This exchange is largely guaranteed because stablecoin issuers hold all the dollars they get in full reserve on their balance sheet as cash and cash-like assets. This guarantee is what keeps the value of stablecoins stable, making them a viable substitute for money.
If this sounds a bit like banking, that’s because it is. “Narrow banking” is when a bank holds its deposits in full reserve as cash and cash-like assets, just as stablecoin issuers do. There are few examples of narrow banks around the world today. Payment banks in India are narrow. So is the Safe Deposit Bank of Norway. The Narrow Bank of Connecticut tried to set up shop in the United States, but was denied by the Federal Reserve.
In Canada, there are no true narrow banks. In an alternate universe, there probably is. As Peter Routledge, head of the Office of the Superintendent of Financial Institutions (OSFI), once told a parliamentary committee, “there are some stablecoin arrangements that, when I look at their balance sheets, look an awful lot to me like banks.”
Same Activity, Same Risk, Different Regulatory Approach
Instead of getting Canada’s banking regulators to police narrow banks, the federal government decided the Bank of Canada should do it under a brand-new framework. The outlines of that framework are in the Stablecoin Act, which the federal government included in its recent budget implementation bill. It’s best understood as a “bank-lite” framework, which ensures the soundness of balance sheets and that stablecoin issuers are managing their operational risks.
That means the line between the Bank of Canada and OSFI is blurring, as both are now responsible for preventing bank runs from destabilizing the financial system. Under the Bank Act, OSFI ensures bank deposits are backed by adequate reserves and able to be withdrawn. Under the Stablecoin Act, the Bank of Canada will make sure that stablecoins are, too. But supervisory differences remain. There are consumer protection regulations under the Bank Act, enforced by the Financial Consumer Agency of Canada. While those will continue to apply to banks, nothing like them will apply to stablecoin issuers.
By blurring the line, the Stablecoin Act makes financial supervision more complex and challenging, making it harder to manage risk. One reason why Canada withstood the worst of the 2008 financial crisis is regulatory simplicity — that its banking system was “tightly regulated by one overarching regulator.” If stablecoins take off, what are the odds risks will sneak through the emerging cracks of fragmenting supervision and materialize before being discovered?
The stablecoin framework will be challenging for financial innovators, too. Stablecoins act more like a technology, in that they can be used to perform different activities. They can be used to build a banking business. They can also be used to build a payment business. But payment businesses have other payment-specific laws and regulations to comply with. So if a group of banks came together to issue a stablecoin for cross-border payments, would the group be subject to the Stablecoin Act or to payments law, such as the Payment Clearing and Settlement Act? Or would it be subject to the Bank Act? Would it be subject to securities law, in the way that Stablecorp, a Canadian stablecoin issuer, is today? Or would it be subject to all of these laws? That’s enough regulatory complexity to scare away most entrepreneurial talent.
The beauty of “same activity, same risk, same regulation” is that it keeps the financial system both innovative and safe. Regulations written for specific technologies, rather than for specific activities and risks, give entrepreneurs with crack legal teams the opportunity to work around the law. Sometimes that’s good, as when Uber and Lyft did it. Other times, as when shadow banks brought down the global financial system, it’s bad. Such laws also block technological innovation when there is no wiggle room for entrepreneurs to be creative, keeping the economy in the dark ages.
Copying Is Only as Wise as What’s Being Copied
There is little doubt about what influenced Canada’s approach to stablecoin oversight. The United States recently passed its own stablecoin law called the GENIUS Act. Since then, crypto-asset companies have been busy in Canada lobbying the prime minister’s office for a framework similar to the American one.
Much of Canadian financial policy making is by imitation. OSFI supervision is guided by the global standard setters in Basel, Switzerland. Canada was also inspired by others, such as the United Kingdom and Australia, to upgrade its national payment systems and regulate financial data sharing. Copying can be good. Snubbing international direction and going your own way can earn labels like “reckless” from the editorial board of the Financial Times.
But public policy by imitation can also be negative. In Canada, our version of the GENIUS Act not only violates a golden rule of financial regulation but also emulates a law explicitly designed to bolster demand for US treasuries, protecting the greenback’s status as a global reserve currency. That logic has no application in Canada.
Policy makers should have amended the laws Canada already has on the books. If stablecoin issuers are acting like (narrow) banks, banking law should have evolved to include a narrow bank charter. If stablecoins are being used to make payments, payments law should be amended and applied. If stablecoins are being listed on trading platforms as securities, securities law should come to the rescue, as it already has tried to do. Laws need not proliferate when they can evolve.
BlackRock executives recently wrote that the financial system is where the internet was in the 1990s. If that’s true, stablecoins aren’t guaranteed to succeed. They may go out with a whimper if tokenized deposits prove superior. Either way, they will pave the way for whatever is next. Canadian policy makers should be future-proofing public policy to deliver the benefits of this progress, while also managing the risks. But, by passing new laws to regulate new technologies that perform the same old activities, they’re doing neither optimally.
