The financial landscape is undergoing a profound transformation as digital markets capable of instant trade settlement emerge. In a recent commentary from the C.D. Howe Institute, authors Peter MacKenzie and Mark Zelmer advocate for Canada to implement a two-track regulatory framework to navigate this shift effectively. This approach aims to balance innovation with security in an era where traditional finance is rapidly digitizing.
The Rise of Tokenized Trading Platforms
Last month, the New York Stock Exchange announced plans to develop a blockchain-based platform enabling 24/7 trading of tokenized stocks and exchange-traded funds. Tokenization involves converting conventional financial assets into digital tokens on a blockchain, facilitating trades settled with stablecoins or tokenized bank deposits instead of traditional payment systems. NASDAQ is pursuing similar initiatives, signaling that tokenization and instant settlement are becoming mainstream in global finance.
This evolution points toward a future where financial operations occur around the clock, settle instantly, and utilize programmable digital money. The transition demands careful regulatory consideration to prevent fragmentation and ensure stability.
Proposing a Dual Regulatory Framework
MacKenzie and Zelmer propose a two-track regulatory system tailored to different digital assets. Track 1 would govern "pure payment" stablecoins—digital tokens fully backed by high-quality liquid assets under the oversight of the Bank of Canada. Track 2 would cover tokenized bank deposits, which would remain supervised by the Office of the Superintendent of Financial Institutions and its provincial counterparts.
The rationale for this separation is clear: regulation should not treat a stablecoin designed for payments as equivalent to a stock or ETF. Similarly, tokenized bank deposits must retain all the benefits and protections Canadians currently enjoy with their bank accounts, ensuring consumer confidence and financial integrity.
Reconsidering Interest Payment Prohibitions
Policy-makers are urged to reconsider the prohibition of interest payments in the proposed "Stablecoin Act." Issuers may find alternative ways to pass value to holders, such as rewards programs or fee waivers, akin to historical incentives like free toasters. This prohibition adds unnecessary complexity and could limit the competitive appeal of Canadian dollar stablecoins compared to U.S. alternatives.
For instance, the U.S. GENIUS Act also bans interest payments, yet platforms like Coinbase offer yields exceeding four percent on U.S. dollar stablecoins held with them. This disparity highlights the need for regulatory flexibility to foster innovation while maintaining safeguards.
The Role of a Central Bank Digital Currency
Regulation alone is insufficient to ensure a stable digital financial ecosystem. Canada should anchor its stablecoin system to a central bank digital currency. Historical lessons underscore the risks of allowing multiple currencies with varying values to circulate simultaneously.
Before the introduction of paper money, a wide variety of coins complicated trade and caused confusion. During America's "Free Banking Era" from 1836 to 1865, state banks issued competing currencies that traded at discounts, counterfeiting was rampant, and financial panics were common.
While modern technology reduces informational barriers—real-time exchange rates are easily computed—the lack of fungibility in money introduces settlement risks and liquidity fragmentation. The de-pegging of TerraUSD in 2022 demonstrated how instability in one stablecoin can trigger broader financial turmoil. Even minor frictions, multiplied across millions of daily transactions, could significantly hinder economic activity.
Preventing Fragmentation with a CBDC
Privately issued stablecoins, backed by different reserves and operating on disparate platforms, risk recreating historical fragmentation in digital form. A central bank digital currency could mitigate this by providing a neutral settlement layer between competing stablecoin issuers and the public. It would facilitate conversions between stablecoins and central bank money without necessarily involving commercial banks, enhancing efficiency and reducing systemic risks.
As digital trading and money markets evolve, Canada's adoption of a two-track regulatory framework, complemented by a CBDC, could position the nation as a leader in safe and innovative finance. This strategy ensures that the benefits of digitalization are realized while safeguarding against the pitfalls of an uncoordinated monetary landscape.
