How stable are stablecoins?
Stablecoins – cryptocurrencies that are pegged to the price of other assets – are open, global, and accessible to anyone on the internet, always operative and most importantly, do not suffer from the high volatility of broader crypto.
They are also becoming an important pillar the in crypto economy infrastructure and stability. Their supply has increased 6x since September 2020 and their combined market cap now more than $125B, mainly to provide liquidity to crypto exchanges, NFTs and DeFi protocols. But their future potential lies in digital wallets, with the ability to bring blockchain-based payments, to non-crypto users.
But are these stablecoins really stable? What do regulators have to say and how will they interact with Central Bank Digital Currencies?
Not all stablecoins are equal
There are three main categories of stablecoins:
- Fiat-backed: are pegged to traditional fiat currencies to ensure stability. Most notable examples include Tether and USD Coin, issued by Circle and Coinbase.
- Crypto-backed: are pegged to other cryptocurrencies. The main player is MakerDAO.
- Algorithmic: rely on algorithms to match the demand for the currency and its market supply, like a decentralized central bank. Terra Money is the biggest player in this category.
Each is worth a deep dive in its own right, but here we’re mostly looking at fiat-pegged stablecoins, the category with the biggest adoption and applicability for payments outside the crypto ecosystem.
Are stablecoins really stable?
Stablecoin, or better “asset-referenced tokens” as defined by the MiCA proposal for EU regulation of crypto assets and blockchain regulation, are, in the case of fiat-backed, pegged 1 to 1 to selected currencies. The only thing that truly matters for a stablecoin is how well it maintains this price parity, its stability.
The first point of attention is the quality of the reserves. Tether has a controversial history of lack of transparencyon the quality of its reserves and even Circle, the issuer of USDC, isn’t winning the stablecoin transparency race. There are concerns that stablecoins could trigger credit market contagion in cases of liquidity crises due to their high use of short-term investable assets, like commercial papers. In the long term, transparency and regulatory approval will be pivotal.
The regulators are coming
Stablecoins are not money, they are assets, securities, since they lack legal tender functionality. And in the view of the SEC, they should be regulated accordingly. Policymakers worry that the growth of cryptocurrencies, especially stablecoins, could lead to central banks losing control. Bank exposure and adoption in payments are still limited, so the risk is not systemic yet, but this is rapidly changing. Stablecoins tend to be privately issued.
Stablecoins and Central Banks
Can stablecoins and Central Bank Digital Currencies (CBDCs) coexist, or are stablecoins just a temporary bridge towards central bank digital currencies?
Every nation is choosing its path. China is leading the pack on CBDC and is banning crypto and stablecoins, warning of the risk to consumers. The US meanwhile is very behind on CBDCs, with the FED still divided on the matter, and could bet on stablecoins instead. Circle’s USDC would be the obvious candidate.
The Euro zone is moving forward and started an investigation project in July. We will probably see the consolidation of a handful of dominant stablecoins, then evolving towards CBDCs. But the infrastructure on which these will run will be interesting to see.
Visa and Mastercard
Traditional card networks, like Visa and Mastercard, are striving to ensure their role as payments rails, claiming their blockchains will be ready to support transactions whether for stablecoins or CBDCs. Visa just announced it is working on an interoperability platform for CBDCs and stablecoins, which would allow it to seamlessly make a cross border payment where the recipient receives a different CBDC, or permissioned stablecoin. Mastercard instead released last year a virtual sandbox tool for central banks to test CBDCs settlement using Mastercard infrastructure.
In all, we’ve catalogued 54 stablecoin startups and projects, from those backed by currencies, to others linked to metal and commodities. As with many things in the crypto world, the area’s potential is undeniable, while many question marks still remain.