Stablecoin Default Guarantees Pose Risks to the Issuing Banks, Swiss Regulator Says

• Switzerlands' financial markets supervisor proposed new requirements to help mitigate the risks arising from banks providing a default guarantee to stablecoin holders.
• In the event of irregularities at the stablecoin issuer, the bank providing the default guarantee may suffer reputational damage, the regulator said.

Stablecoin issuers operating in Switzerland create a risk for the banks they work with, the country's financial markets regulator, FINMA, wrote in guidance published on Friday.

That's because the issuers, who take deposits from the public and might otherwise be treated as banks themselves, can obviate the need for a banking license by reaching an agreement with a registered lender to repay their customers in case of default.

"This creates risks for the stablecoin holders and the bank providing the default guarantee," FINMA said in the guidance note. "In the event of irregularities at the stablecoin issuer, the bank providing the default guarantee may suffer reputational damage due to its contractual relationship with the issuer and may also be exposed to legal risks."

Concern over the backing carried by issuers of stablecoins, which are crypto tokens whose value is tied to another asset such as the U.S. dollar or gold, has proliferated for years. As far back as 2021, Tether, whose USDT is by far the largest stablecoin by market cap, published its first account of reserves to deal with queries about its funding. Circle, whose USDC is the No. 2, followed suit in 2022.

FINMA's guidance, which builds on an initial note from 2019, sets out a number of requirements to ensure adequate protection. Customers must have their own claim against the guarantee-providing bank, and the guarantee must cover the full amount of deposits and interest. In addition, the bank must ensure that the deposits it receives don't surpass the cover provided by the guarantee.

The regulator plans to ensure that the risks associated with default guarantees are addressed in future discussions.