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Stablecoins: These cryptocurrencies threaten the financial system, but nobody can get a grip on them

By Jean-Philippe SerberaSenior Lecturer, Sheffield Hallam University Sheffield, November 14th (The Conversation) Cryptocurrencies had an exceptional year, reaching a total value of more than $ 3 trillion for the first time in November. The market  -pears to have benefited from the public’s free time during the pandemic lockdown. Large mutual funds and banks have also stepped in, not least with the recent launch of the first Bitcoin-backed ETF – a publicly traded fund that makes it easier for more investors to invest in this asset class.

In addition, the value of stablecoins such as Tether, USDC and Binance USD has skyrocketed. Like other cryptocurrencies, stablecoins move on the same online ledger technology known as blockchains. The difference is that their value is tied 1: 1 to a financial asset outside of the crypto world, usually the US dollar.

Stablecoins allow investors to keep money in their digital wallets that is less volatile than Bitcoin, which gives them one less reason to need a bank account. For an entire movement that involves declaring independence from banks and other centralized finance providers, stablecoins are helping make this easier. And since the rest of crypto tends to go up and down together, investors can better protect themselves in a falling market by converting money into stablecoins than, for example, selling their ether for Bitcoin.

A significant portion of the buying and selling of crypto is done with stablecoins. They are especially useful for trading on exchanges like Unisw – where no single company is in control and where there is no option to use fiat currencies. The total dollar value of stablecoins has grown from a low of $ 20 billion a year ago to $ 139 billion today. In a way, this is a sign that the cryptocurrency market is maturing, but it also worries regulators about the risks stablecoins could pose to the financial system. So what’s the problem and what can be done about it? Stablecoins were first introduced in the mid-2010s and are centralized operations – in other words, someone is in control of them. Tether is ultimately controlled by the owners of the Bitfinex crypto exchange, which is based in the British Virgin Islands. USDC is owned by an American consortium consisting of the payment provider Circle, the Bitcoin miner Bitmain and the crypto exchange Coinbase. Binance USD is owned by Binance, another crypto exchange based in the Cayman Islands.

There is a philosophical contradiction between the decentralized ideal of cryptocurrencies and the fact that such an important part of the market is centralized. The serious question that arises is whether these organizations have enough financial reserves to be able to maintain the 1: 1 fiat ratios of their stablecoins in the event of a crisis.

These 1: 1 ratios are not automatic. They rely on stablecoin providers to have reserves of financial assets equal to the value of their stablecoins in circulation, which adjust to the supply and demand of investors. The vendors promise they have reserves equal to 100 percent of the value of their stablecoins, but that’s not entirely true – as can be seen in the gr -hs below.

Tether holds 75 percent of its reserves in cash and equivalents as of March 2021. USDC holds 61 percent as of May 2021, so both are well below 100 percent. Much of the assets of both companies are based on commercial p -er, a form of short-term corporate debt. This is not a cash equivalent and represents a solvency risk in the event of a sudden decline in the value of these assets.

What could the machine derail? There is currently almost unlimited money in circulation, interest rates are still at record lows and since the US government has just accepted another stimulus package worth $ 1.2 trillion, the supply of money is unlikely to be significantly reduced anytime soon. The only element that could question this abundance of money is inflation.

There are several possible inflation scenarios, but the market still believes that the most likely scenario is the “Goldilocks” scenario, with inflation and growth rising together to high but manageable levels. In this case, the central banks can run inflation at a level of 3 to 4 percent.

But overheating of the economy could lead to an explosive situation of high inflation and economic recession. Much money would be moved from risky assets and bonds to safer havens like the US dollar. The value of these riskier assets, including commercial p -er, would fall off a cliff.

This would seriously damage the value of the stablecoin providers’ reserves. Many investors with their money in stablecoins could panic and try to convert their money into US dollars, for example, and the stablecoin providers may not be able to return their money to everyone at a 1: 1 ratio. This could drag down the crypto market and possibly the financial system as a whole.

Regulators are certainly concerned about the stability of stablecoins. A US report by the President’s Working Group on Financial Markets, released a few days ago, stated that they pose a potential systemic risk, not to mention the risk of a huge amount of economic power being concentrated in the hands of one provider.

In October, the US Commodity Futures Trading Commission fined $ 41 million for claiming that it was 100 percent fiat currency between 2016 and 2019, but that it had some “tough questions” to answer.

Overall, however, the regulatory response  -pears to be hesitant. The report by the president’s working group recommended forcing stablecoins providers to become banks, but delegated all decisions to Congress. With several large providers and such a burgeoning international market, my concern is that stablecoins are already effectively too large and uneven to control.

It is possible that the risks will decrease as more stablecoins hit the market. Facebook / Meta, for example, has publicized plans for a stablecoin called Diem. Meanwhile, Central Banks Digital Currencies (CBDCs) will add fiat currencies to the blockchain when they arrive. The Bank of England, for example, should consult on a digital pound, and the EU and especially China are making progress here. Perh -s the systemic risks of stablecoins will be reduced in a more diversified market.

We’ll wait and see for now. The speed with which this worrying risk has emerged is certainly worrying. Unless governments and central banks step up regulation, a 2008-style digital asset crisis cannot be ruled out. (The Conversation) RUP RUP

(This story was not edited by Devdiscourse staff and is automatically generated from a syndicated feed.)

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