The Financial Security Board, the Federal Reserve System, and the Biden administration have, as of recent, bought to fore the concerns regarding stablecoins. The three administrative bodies have the opinion that stablecoins are unique cryptocurrencies that could potentially pose a non-negligible threat to the global financial security.
The global financial regulation authorities have, as of current, way too many enemies. Bitcoin and Libra are a few of the top names that come to mind. Facebook’s digital currency that was dead on arrival is a new addition to the list. Now, the global financial regulation authorities have to deal with stablecoins as well.
It is noteworthy that stablecoins have been targeted in a report published by The Financial Stability Board (FSB), on the dangers of crypto assets. This report was published on 16th January.
Across 2021, stablecoins have been steadily growing. This was despite concerns regarding standards of governance and risk management, sufficiency and quality or risk assets, and regulatory compliance. With the arrival of 2022, stablecoins are being blamed for putting global financial stability in danger.
How will stability exist in a volatile world?
Stablecoins have newly earned the status of a villain in the finance world. This development is surprising by itself, because, the electronic currency had initially been created to put a check over Bitcoin’s volatility. The purpose of creating stablecoins was to rightly introduce some stability in the Bitcoin hemisphere.
Stablecoins are those cryptocurrencies for which the price is never going to vary. This is because a base reference such as US dollar is used for indexing stablecoins.
For instance, let’s consider Tether, which is the most widely used stablecoin alongside being the most famous stablecoin as well. Tether invariably has a value that is equivalent to one US dollar.
With the promise of stability that they promote; stablecoin in general and Tether in particular have come by as a bridge among paper currencies, such as yuan, euro, dollar, etc, and the cryptocurrencies.
Let us consider one of the ways how stablecoins is put to use by crypto investors. If one invests in Etherium and Bitcoin, then, one is in a position to avoid the yo-yoing prices by exchanging their currencies for Tether, Binance USD or USD coins. Each of the latter is stablecoins. This way, an investor can know the exact dollar-value of their portfolios.
A few of the platforms even request users to first change their cryptocurrencies into stablecoins, before they are changed into other traditional currencies including US dollars.
For guaranteeing their value, the creators of stablecoins invariably ensure that the number of dollars in reserve is the same as the number of stablecoins in circulation. Just as an instance, as per a statement released by the founders of Tether in December 2021, Tether had USD 78.2 million in the bank. This was to cover the 78 million coins of the Tether cryptocurrency that were in circulation.
Do we see a systemic risk coming?
The information in the previous paragraph implies that today, the market value of tethers is similar to that which banks have. This is a direct result of the value rising at a lightning-fast rate.
The market value of all stablecoins stood at USD 157 billion. This was a remarkable increase, because the figure stood at USD 5.6 billion at the beginning of 2020.
In particular, as the value of Tethers hit new benchmarks, financial authorities from all across the world have broken into a cold sweat.
In the United States, a meeting took place in August where the Federal Reserve discussed the threat of stablecoins. Herein, the Federal Reserve considered that how can they be sure that the creators have the necessary reserves. Was Tether headed for failure?
The stature of stablecoins grows. This is one of the key signs of democratization of investment in cryptocurrencies. The number of people who intend to exchange Monero and Bitcoins increases by the day. Correspondingly, the volume of transactions also increases and so does the number of stablecoins in circulation.
So, this goes to show that the insiders are not the only party that owns the stablecoins now. Nowadays, businesses and investment funds also own stablecoins, and so do banks. It is easy to see stablecoin increases the connectedness with the traditional financial systems.
Now, let us consider the situation wherein the stablecoins were to fail. Initially, this would pose losses for the stock market investors. The impacts over the traditional financial markets would, correspondingly, be more widespread still. These are among the most important fears harbored by the US Federal Reserve and the FSB.
Nevertheless, as of current, the risk is relative. Stablecoins are financially influensive to a significant extent. But the central banks, still, withhold the capacity to make up for the losses in case a problem arises, without having too much of an effect over their balance sheets.
But, if the stablecoins such as Tether continue to grow at the same rate as they have been growing in the past few years, they’ll attain systemic proportions. This implies that they will be too big to fail.
Let us suppose that stablecoin creators maintain sufficient reserves. Odds of failure will not arise in this case.
But, there is another aspect that has become a matter of concern for the financial authorities. Regarding the composition of reserve assets, stablecoin issuers are not subject to a consistent set of standards. Furthermore, disclosure practices also lack consistency.
As of current, the FSB should ask these stablecoin creators to make promises at face value as audits on their reserves. The stablecoin creators just need to promise. Leading organizations and international standards need not be involved in the processes.
It was just three years back that Tether was under suspicion for being nothing but a big scam or fraud. But three years later, Tether has become central to the entire cryptocurrency space.
Nowadays, we are seeing that stablecoins are putting in more and more efforts to bring transparency to their operations. They don’t just have reserves in dollars but also in short-term investments that allows them to make payments.
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