This blog in Finastra written by Carlo R.W. De Meijer delivers a snapshot of the different methods used to approximate “stability” in cryptocurrencies and then evaluates the inherent risks associated with these financial instruments. The blog also provides a snapshot of the regulatory activities taking place that are specific to stablecoins – there are more of these than I knew about. The blog points out the serious need for stability given that in early 2021 there were $28 billion worth of stablecoins issued which has grown to $110 billion today.
This blog is well worth a read for anyone interested in stablecoins. The blog identifies five primary risk areas, these are my three favorites:
“Asset contagion risk
The rapid growth of stablecoin issuance could, in time, have implications for the functioning of short-term credit markets. Certain stablecoins are today’s economic equivalent of money-market funds, and in some cases their practices could lead to lower values, creating significant damage in the broader crypto market. There are potential asset contagion risks linked to the liquidation of stablecoin reserve holdings. These risks are primarily associated with collateralised stablecoins, varying based on the size, liquidity and riskiness of their asset holdings, as well as the transparency and governance of the operator.
Fewer risks are posed by coins that are fully backed by safe, highly liquid assets.
One of the most known and most widely traded stablecoin is Tether. Each Tether token is pegged 1-to-1 to the dollar. But the true value of those tokens depends on the market value of its reserves. Tether has disclosed that as of 31 March it held only 26.2% of its reserves in cash, fiduciary deposits, reverse repo notes and government securities, with a further 49.6% in commercial paper (CP).
Collateral consequences
Also further collateral consequences, particularly because the recent rise in crypto prices, has been fuelled in significant part by debt. It is questionable whether stablecoins could liquidate sufficient investments quickly to satisfy the demand if needed. The consequences of such an inability to meet a sudden wave of withdrawals could be significant in the larger crypto ecosystem.
Lack of accountability
The drawback of fiat-collateralized stablecoins is that they are not transparent or auditable by everyone. They are operated just like non-bank financial intermediaries that provide services similar to traditional commercial banks, but outside normal banking regulation. They therefor may escape accountability. In the case of fiat-backed stablecoins traders need to blindly trust the exchange or operator to trade in these currencies or try to find and examine out its financial disclosers by themselves to ensure that the stablecoins are fully backed by fiat, even if they do not release audit results.”
Overview by Tim Sloane, VP, Payments Innovation at Mercator Advisory Group