Regulators across the globe are concerned about the unprecedented growth of tokenized money, stablecoins in particular, and its potential to disintermediate incumbent financial institutions , create volatility and financial stability risks.
Let’s Decrypt Stablecoins
Are the concerns over stablecoins legitimate? Let’s understand this token and its various types in detail to make an informed opinion.
So, what are stablecoins? Unlike Bitcoin and other popular cryptocurrencies, known for wild volatility, stablecoins are blockchain-based cryptocurrencies backed by safe reserves.
But, are stablecoins really stable?
Let’s have a look at different types of stablecoins classified solely on the basis of the value that underpins them.
Types of Stablecoins
- Fiat-collateralized stablecoins: These stablecoins are collateralized by fiat money, such as US dollar, euro or the pound, on a 1:1 ratio. Common examples are Tether (2014), Gemini Dollar(2018) and TrueSD.
- Stablecoins backed by other asset classes: There are a few stablecoins, which are backed by a basket of multiple assets (commercial papers, bonds, real estate, precious metals, etc). The value of these stablecoins can fluctuate over time subject to movement in commodity and precious metal prices. Digix Gold, backed by physical gold, was introduced in 2018. SwissRealCoin, launched in 2018, had a Swiss real estate portfolio.
- Crypto-collateralized stablecoins: Crypto-collateralized stablecoins are more decentralised than their peers and are backed by cryptocurrencies. The flipside is price volatility. To address the risk of price volatility, these stablecoins are over-collateralised. Dai (launched in 2017) is the most popular crypto-collateralized stablecoin.
- Non-collateralized stablecoins: These stablecoins do not have any backing and are decentralized in the true sense. The supply of non-collateralized stablecoins is governed by algorithms. Basis, introduced in 2018, is the most common stablecoin in this category.
Risks from Stablecoins
Tether, arguably the largest stablecoin issuer, disclosed in March that it held over 75 per cent of its reserves in cash and cash equivalents, most of which are in the form of commercial paper. The remaining assets include loans to unaffiliated entities (12.55 per cent), corporate bonds, funds & precious metals (9.96 per cent), and additional investments which include Bitcoin and other digital tokens (1.64 per cent).
The commercial paper holdings of Tether outnumbered leading money market funds (MMF) in the US and Europe.
In the event of a mass selloff of Tether coins along with other stablecoins, short-term credit markets will have to bear the brunt. In June this year, the crash of Iron, an algorithmic stablecoin, gave us a glimpse of the risk they run. That made Mark Cuban, an America’s billionaire entrepreneur and a victim of Iron collapse, to raise his voice for regulating stablecoins.
Fitch Ratings has rightly cautioned that potential asset contagion risks linked to the liquidation of stablecoin reserve holdings could increase pressure for tighter regulation of the nascent sector.
Clarion Call for Regulation
US Secretary of the Treasury Janet L Yellen has underscored the need to act quickly to ensure there is an appropriate US regulatory framework in place.
“You wouldn’t need stablecoins; you wouldn’t need cryptocurrencies, if you had a digital US currency,” US Fed Chairman Jerome Powell told a Congressional hearing this July.
He made it clear that the Fed is done letting stablecoins run amok. “We have a tradition in this country where the public’s money is held in what is supposed to be a very safe asset,” Powell said. “That doesn’t exist for stablecoins, and if they’re going to be a significant part of the payments universe… then we need an appropriate framework, which frankly we don’t have.”
Last year, European Commission came out with a regulatory framework proposal for crypto assets and stablecoins. The Financial Stability Board (FSB), an international body that monitors and makes recommendations about the global financial system, has highlighted the potential of global stablecoins (GSCs). FSB says, “A widely-adopted stablecoin with a potential reach and use across multiple jurisdictions (so-called ‘global stablecoins’ or GSCs) could become systemically important in and across one or many jurisdictions, including as a means of making payments.
But those who back stablecoins say with the established use cases in cross-border payments, settlements and financial inclusion, a global regulatory framework is all that is needed to harness the full potential of stablecoins.