Circle Proposes New Capital-Risk Framework for Stablecoins

The
rise
of
tokenized
finance,
particularly
stablecoins
and
other
stable
value
tokens,
has
introduced
new
dynamics
and
challenges
for
financial
institutions
in
managing
and
assessing
their
capital
needs.
According
to
Circle’s
blog,
three
of
Circle’s
top
financial
leaders—Chief
Economist
Gordon
Liao,
Treasurer
Dan
Fishman,
and
Chief
Financial
Officer
Jeremy
Fox-Geen—have
proposed
a
risk-based
capital
framework
tailored
to
these
digital
assets.

Understanding
the
Token
Capital
Adequacy
Framework
(TCAF)

The
proposed
framework,
named
the
Token
Capital
Adequacy
Framework
(TCAF),
aims
to
adapt
to
the
distinct
characteristics
and
risks
inherent
in
stable
value
tokens.
The
paper,
titled ‘Risk-based
Capital
for
Stable
Value
Tokens,’
demonstrates
how
a
risk-based
capital
framework
can
establish
a
foundation
for
safety
and
soundness
in
tokenized
finance.

Capital,
fundamentally,
is
the
difference
between
a
financial
institution’s
assets
and
liabilities,
serving
as
a
buffer
against
potential
losses.
In
traditional
banking,
capital
adequacy
is
designed
to
help
institutions
weather
financial
shocks,
maintain
customer
confidence,
and
prevent
runs.
Circle’s
executives
argue
that
stablecoins
and
other
stable
value
tokens
require
more
specialized
capital
standards
due
to
their
tokenized
nature,
which
presents
unique
characteristics.

Key
Features
of
TCAF

The
TCAF
provides
a
robust
methodology
to
assess,
manage,
and
allocate
capital
for
stable
value
tokens,
enabling
them
to
better
withstand
potential
shocks
and
maintain
stability.
Unlike
traditional
banks,
stable
value
tokens
are
transferred
on
programmable
blockchains
or
distributed
ledgers,
creating
unique
financial
and
operational
risk
profiles
that
traditional
Basel-style
capital
requirements
cannot
adequately
address.

Moreover,
existing
capital
frameworks
that
rely
on
fixed
ratios
do
not
account
for
the
reserve
differences
with
stable
value
tokens,
nor
do
they
cover
risks
such
as
susceptibility
to
coordinated
runs
and
technology-driven
operational
risks.

TCAF
Highlights

• Developed
  to
  assess
  and
  manage
  capital
  needs
  based
  on
  quantitative
  assessment
  of
  market,
  credit,
  and
  operational
  risks
  specific
  to
  tokenized
  assets.
• Designed
  to
  be
  adaptive;
  applicable
  to
  various
  token
  backings
  such
  as
  fiat,
  crypto
  assets,
  and
  synthetic
  assets;
  and
  to
  operate
  independently
  of
  reserve
  and
  liquidity
  standards.
• Emphasizes
  risk
  sensitivity
  and
  stress
  testing
  over
  fixed-ratio
  methods,
  such
  as
  those
  adopted
  in
  the
  European
  Union’s
  Markets
  in
  Crypto-Assets
  (MiCA)
  regulatory
  framework.
• Requires
  internal
  stakeholder
  input
  in
  determining
  non-financial
  risk,
  helping
  to
  ensure
  accountability
  and
  better
  risk
  management.

Reshaping
Operational
Risk
Frameworks

The
TCAF
can
also
be
applied
by
banks
to
manage
operational
risks,
such
as
losses
from
failed
or
inadequate
internal
processes
or
from
external
events
like
cybersecurity
incidents.
A
risk-sensitive
capital
framework
with
sufficient
internal
accountability,
as
proposed
by
TCAF,
provides
a
foundation
for
rewriting
capital
standards
for
operational
risks
more
broadly
for
both
banks
and
non-banks.

Recent
cybersecurity
events
for
financial
firms
underscore
the
need
to
re-evaluate
operational
risks
and
provide
a
stronger
feedback
loop
between
technology
decisions
and
balance
sheet
allocations.

For
a
detailed
understanding,
read
the
full
paper
on
[Circle’s
blog](https://www.circle.com/blog/beyond-basel-a-new-capital-risk-framework-for-stablecoins).

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source:
Shutterstock