Stablecoins: These cryptocurrencies are a threat to the financial system – Times of India


Sheffield: cryptocurrency November has been an exceptional year, reaching a combined value of over $3 trillion (£2.2 trillion) for the first time ever.
The market seems to have benefited from having time in the hands of the public during the pandemic lockdown. In addition, large investment funds and banks have stepped in, at least with the recent launch of the first bitcoin-backed ETF — a listed fund that should make it easier for more investors to gain exposure to this asset class.
Simultaneously there has been an explosive increase in the price of stable coins like tie rope, USDC and Binance USD.
Like other cryptocurrencies, stablecoins run on the same online ledger technology known as blockchain. The difference is that outside the crypto world their value is pegged 1:1 to a financial asset, usually the US dollar.
Stablecoins enable investors to hold money in their digital wallets that are less volatile than bitcoin, giving them one less reason to need a bank account.
As for the whole movement that is about a declaration of independence from banks and other centralized financial providers, stablecoins help facilitate this.
And since the rest of the crypto goes up and down simultaneously, investors can better protect themselves in a falling market by transferring money to stablecoins than selling their ether for bitcoin.
A large portion of the buying and selling of crypto is done using stable coins. They are particularly useful for trading on exchanges such as Uniswap where there is no single company in control and there is no option to use fiat currencies.
The total dollar value of stablecoins has risen from a low of $20 billion a year ago to $139 billion today. In a sense this is a sign that the cryptocurrency market is maturing, but it also has regulators concerned about the risks that stablecoins can pose to the financial system. So what is the problem and what can be done about it?
Initially launched in mid-2010, stablecoins are centralized operations – in other words, someone is under their control.
Tether is ultimately controlled by the owners of the crypto exchange bitfinex, which is located in the British Virgin Islands. USDC is owned by a US consortium that includes payment provider Circle, bitcoin miner Bitmain and crypto exchange Coinbase.
Binance USD is owned by another crypto exchange, Binance, which is headquartered in the Cayman Islands.
There is a philosophical contradiction between the decentralized ideal of cryptocurrencies and the fact that such a significant portion of the market is centralized. But at the same time, there are serious questions about whether these organizations have enough financial reserves to be able to maintain their 1:1 fiat ratio of stablecoins in the event of a crisis.
These 1:1 ratios are not automatic. They depend on stablecoin providers having a stock of financial assets equal to the value of their stablecoins in circulation, adjusted with the supply and demand of investors.
The providers promise that they hold 100 percent of the value of their stablecoins, but this is not quite accurate – as can be seen in the chart below.
As of March 2021, Tether holds 75 percent of its reserves in the form of cash and equivalents. The USDC holds 61 percent as of May 2021, so both are somehow less than 100 percent. A large proportion of the assets of both operations are based on commercial paper, a form of short-term company debt. It is not cash equivalent and creates a solvency risk in the event of a sudden drop in the value of these assets.
So what can derail the machine? There is currently almost unlimited money in circulation, interest rates are still at record lows and the US government has voted to accept another USD 1.2 trillion economic stimulus package, with the money supply going short any time soon. Not likely to happen. The only element challenging this abundance of money is inflation.
There are several possible inflationary scenarios, but the market still considers the “Goldilocks” scenario to be the most likely, with inflation and growth moving together at high but manageable levels.
In such a situation, the central bank can allow inflation to run at the level of 3 per cent-4 per cent.
But if the economy overheats, it can lead to high inflation and an explosive state of economic downturn.
A lot of money will be moved from riskier assets and bonds to safe havens like the US dollar. The value of those riskier assets, including commercial paper, will fall off a cliff.
This would seriously damage the value of stablecoin providers’ reserves. Many investors may be nervous about holding their money in stablecoins and try to convert their money to US dollars, and stablecoin providers may be unable to give their money back to everyone in a 1:1 ratio. This could drag down the crypto market and potentially the entire financial system.
Regulators are certainly concerned about the stability of stablecoins. A US report published a few days ago by the President’s Working Group on Financial Markets said they potentially pose a systemic risk, not to mention the danger that a large amount of economic power could be in the hands of one provider. can be focused.
In October, the US Commodity Futures Trading Commission fined Tether $41 million for claiming to be 100 percent backed by fiat currency between 2016 and 2019. Governor of the Bank of England Andrew Bailey It said in June that the bank was still deciding how to regulate stablecoins, but they had some “tough questions” to answer.
Overall, however, it looks like regulators’ response is still likely. The President’s Working Group report recommended that stablecoin providers be forced to become banks, but submitted any decision to Congress. With many large providers and such a growing international market, my concern is that stablecoins may already be effectively too large and isolated to control.
It is possible that as more stablecoins enter the market, the risk will decrease. For example, Facebook/meta has well publicized plans for a stablecoin called Diem. At the same time, the central bank’s digital currency[CBDC]Will place fiat currencies on the blockchain when it arrives.
For example, the Bank of England is to consult on the digital pound, while the European Union and China in particular are also leading the way here. Perhaps a more diversified market will reduce the systemic risk of stablecoins.
For now, we wait and see. The speed at which this alarming risk has unfolded is certainly a concern.
A 2008-style crisis in digital assets cannot be ruled out unless governments and central banks take steps to regulate.