Says crypto stablecoins be like casino

Just recently, the administration of President Joe Biden, along with the Federal Reserve System and the Financial Stability Board, raised concerns regarding the issue of “stablecoins,” arguing that these sets of unique currencies pose a significant risk to the financial stability of the entire globe.

Following Libra and Bitcoin – Facebook’s digital cryptocurrencies – the world’s financial regulators now have to deal with a new foe: stablecoins. In its assessment concerning the dangers of crypto assets that was issued on February 16, the Financial Stability Board (FSB) heavily focused on these cryptocurrencies.

The growth and expansion of stablecoins increased throughout 2021 “despite concerns about regulatory compliance, quality and sufficiency of reserve assets, and standards of risk management and governance,” a statement from the global organization formed by the G20 in 2009 read, and very certain to cause harm to global financial security.

Stability in a world that’s already volatile?

Stablecoins’ role as the financial villain may appear quite strange for an e-money whose initial desire in the first place was to “put the brakes on the volatility of Bitcoin and to rightly bring a bit of stability into this sphere,” says Nathalie Janson, specialist, and economist in cryptos at Neoma Business School.

Stablecoins are cryptocurrencies whose prices never differ since they are indexed using a base reference such as the United States dollar. An apt example is a Tether (one of the most commonly used of the entire stablecoins) which has always maintained an equal value to one USD.

The promise of stability has gone a long way into making stablecoins, and more so the tethers, “the bridge between paper currencies (such as the dollar, euro, yuan, etc.) and cryptocurrencies,” says Vincent Boy, a financial analyst and crypto expert working at IG consulting firm.

Essentially, those who’ve invested in Ethereum and Bitcoin avoid yo-yoing prices by switching their currencies in USD coins, Tethers, or binance USD – all forms of stablecoins – to be aware of their portfolios precise dollar value. Other platforms even require a user to first convert their cryptos into stablecoins before converting them to dollars or other fiat currencies.

The creators of “stable” cryptos have to therefore retain the same amount of dollars in reserve as the same number of stablecoins that are in circulation to ensure their value. Tether’s founders, for example, stated in December 2021 that they had USD 78.2 million in the bank for purposes of funding the 78 million tokens in circulation.

Could there be a ‘systemic risk’ on the horizon?

All this means that “today’s tethers have a market value similar to that of a bank,” says Boy. It’s the result of a speedy rise in worth: the market worth of the entire stablecoins was standing at around €157 billion USD in December 2021, “an increase from $5.6 billion at the start of 2020”, according to the FBS.

Tethers, for instance, seem to have increased in value, something that has made financial authorities in many places across the globe become somewhat concerned. In a meeting held on August 2021, the United States Federal Reserve voiced its concerns on the dangers of stablecoins. “The questions being asked are how to be sure that [the creators] really have the necessary reserves and whether Tether is about to fail,” further stated Vincent Boy.

One of the most telling pieces of evidence is the significant rise in the popularity of stablecoins, signaling the “democratization of investments in cryptocurrency,” said Boy. As more people proceed to exchange dollars for Monero, Bitcoins, and other cryptos, the volume of transactions goes up, meaning that we are left with more stablecoins in circulation.

Now, Tethers and other stablecoins isn’t under the full control and ownership of insiders, “but also traditional investment funds, businesses, and even banks,” said Janson. This is what the Financial Security Board describes as stablecoins’ “increasing interconnectedness with the traditional financial system.”

Should these stablecoins fail, investors in the stock market would end up reporting huge losses, something that could result in significant impacts on traditional financial markets as allayed by both the US Federal Reserve and the FSB.

As things currently stand, the danger seems only relative. “The financial influence stablecoins have is significant, but the central banks have the capacity to cover losses if there is a problem without hurting their balance sheets too much,” said Boy.

But should Tether and other stablecoins continue to witness increased growth, soon, they could “reach a systemic size, meaning they have become ‘too big to fail,” added Boy.

Crystal balls and transparency

There’s no risk of failure as long as the creators of stablecoins have in place sufficient reserves. But again, this is another area that financial authorities seem worried about: “Stablecoin issuers are not subject to a consistent set of standards regarding the composition of reserve assets … and there is a lack of consistency in disclosure practices,” said the FSB.

Currently, the FSB must take these stablecoin producers’ promises at face value because audits of their reserves, when conducted, are not always conducted by major organizations or in accordance with international norms. Tether was generally suspected of being nothing more than a massive hoax just three years ago, which is hardly encouraging for a cryptocurrency that is now essential to a whole financial ecosystem.

But again, stablecoins seem to have made some significant strides towards transparency. “What we do know now is that they don’t just have reserves in dollars but also in short-term investments that allow them to make payments,” said Janson. Janson further reiterated that there are still some problems. “The authorities are obsessed by the idea of a new liquidity crisis, like the one that happened in 2008,” she added.

When the market realized the Lehman Brothers financial products were mostly based on worthless assets during the subprime mortgage era, nobody wanted to be associated with them, a move that drove banks into a major financial catastrophe.

Have you ever thought of what would happen should stablecoins face the same scenario as that of the Lehman Brothers since these coins aren’t 100% transparent regarding their reserves? “For example, some stablecoins may be tied to debt from Evergrand (the Chinese real-estate giant verging on failure), as has been suggested for Tether. In this case, the reserves could come to be worth much less, which could make it impossible to reimburse everyone if they needed to,” said Boy.

The Federal Reserve, together with the FSB and President Biden, have all advocated for strict controls. But for others, such as Janson, such measures aren’t a necessity. According to her, everything is a move aimed at preventing stablecoins from competing with cryptocurrencies that are lately being embraced by many countries. “Why would we want to treat them like banks? It would be enough to impose stricter transparency obligations, as that is the main problem,” she said.

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