What stands behind stablecoins?

The appearance of stablecoins on the cryptocurrency space marks a new milestone in the development of the crypto industry, since at a very volatile market, this asset gives what users want so much – stability. These are stable currencies that are listed at Coinmarketrate.com , are becoming increasingly important and are likely to continue to gain popularity, no matter how much central banks oppose it.

Investors seem to rely on them as a safe haven (when recessions prevail in the cryptocurrency world), and their weight (capitalization) increases, which can also pose certain risks for money markets.

For this reason, central bank has placed these assets in the category of high risk, and this raises certain suspicions. Let’s figure out together what are stablecoins? What is behind them, and what are the risks?

And so…

The US Federal Reserve has defined stablecoins with the support of traditional currencies as an asset that tries to reproduce the behavior of money issued by the central bank, stabilizing the value of the digital currency. How do they do it? The creators promise to support these stablecoins with assets or cash denominated in dollars, euros, etc. So, presumably, there is an equal amount in other assets behind each stablecoin, which supports the value of each coin.

These assets are associated with the value of a “fiat” currency, with support such as gold or real estate, or with another cryptocurrency. There are also stablecoins that are not linked to any other currency, but are controlled by algorithms to maintain a stable price (at the moment they are less relevant). The main motivation for creating a stablecoin is to try to shelter investors during instability.

At the moment, the most important group of stablecoins are the so-called “secured” ones, which are associated with another external value, be it a fiat currency, another cryptocurrency or other assets, for theoretical stability. There was an assumption that stablecoins would displace cryptocurrencies, but for now they act as an additional asset. Cryptocurrency investors regularly use stablecoins as a portfolio diversification, and an intermediate way to convert their investments into dollars, euros, or vice versa.

Is this safe haven really safe?

To know if stablecoins are safe and stable, it is important to know which assets support the price of these stable currencies. Many of their creators claim that each token is backed by a dollar (for example, each USDT is equivalent to one dollar).

The Fitch rating agency recently published a study that examines the assets underlying stablecoins. For example, according to Fitch, pegged assets range from precious metals to secured loans, which can be more volatile than short-term securities such as commercial paper (CP).

In addition, the financial agency Bloomberg published that the reserves of stablecoins include billions of dollars in the form of short-term loans to large Chinese companies. However, from Tether, they assured that they have no debts from the real estate giant Evergrande, which is experiencing serious difficulties with paying coupons on its debt to investors.

The reserves of stablecoins are very diverse

Both USDCoin and Tether focus on investment grade quality: the minimum credit quality of Tether is “F3” or equivalent (the third level of short-term assets based on Fitch parameters), and USDCoin may contain corporate bonds with a rating of “BBB+” or higher.

However, in the period from June to August 2021, USDCoin significantly changed its securities portfolio, transferring the vast majority of its assets to cash equivalents. However, as can be seen from other cases, the money markets have almost completely dried up.

The Fed experts also warned users that these assets only create an image of security (the alleged provision of dollars, euros …), which may not be real:

“Stablecoins are riskier because the value of collateral for these assets, (for example, US Treasury bonds), may fluctuate or even not exist, despite the promises made”. Wait, but what about the USDT backed by the US dollar? Does it no longer exist?

Without access to the central bank, there is no safe asset

Andres Velasco, dean of the School of Public Policy, pointed out in an article published this summer in Project Syndicate that stablecoins are a kind of private digital money supposedly backed by safe and liquid assets. But, like many other liquid assets, stablecoins are vulnerable to panic. If their monetary price should remain fixed, then the issuer of stablecoins should be ready to absorb the entire offer (for example, from the binding) at any time, and give their “owners” the promised dollars. But, the expert is perplexed, since the stablecoins turned out to be capable of this.

Gary B. Gorton and Jeffrey Y. Zhang Basado, in an article published last month, says that privately produced money is not an effective medium of exchange because it is not always accepted at face value and is prone to panic.

Banking panics were very common when central banks were unable to act as creditors of last resort to the same extent as they do today. Governments, by insuring deposits for a certain amount, have also made the system more robust. But stablecoins do not have such a safety net. Sudden movements can force these stable currencies to sell their collateral (bonds, promissory notes, precious metals…) at any price.

It is a very strange view in the light of the fact that even relying on, say, the US dollar, in case of its fall, it can always switch to another security, say the BTC, and not sell everything in a panic. This sounds very ridiculous after the assurance that central banks are very firmly on their feet today.

Velasco notes in his article:

“History shows that the only way to make a safe asset really safe is to give its issuers access to a lender of last resort who will support all relevant obligations without asking questions (this lender is the central bank).

Banking panic was a common occurrence in the US before the introduction of deposit insurance with the support of the US government. Argentina did not have access to a dollar lender, and therefore its currency had to collapse sooner or later”.

Wow! An interesting statement. It turns out that the Central Banks live according to the precepts of V. And. Lenin: “Whoever is not with us is against us.”

Growing capitalization

Despite everything, stable currencies are growing and strengthening. According to Fitch estimates, stablecoins account for 3% to 5% of the entire US banknote market. Their total market capitalization was more than $120 billion. Their potential to “move” the market is increasing.

The International Settlement Bank demanded that this market be considered as a system, and that the same control be implemented as for other organizations falling under this definition.

The rating agency warns that the rapid growth in the issuance of stable currencies over time may have consequences for the functioning of short-term lending markets (promissory notes, promissory notes …). According to the note, possible proliferation risks in assets associated with stablecoin reserves may increase pressure to regulate this sector.

According to Coinмarketrate.com although there are a large number of stablecoins on the market, only six of them have a capitalization above $1 billion. Nevertheless, according to the rating agency, the capitalization growth of these assets as of September 30 of this year increased by 420%.

On the other hand, Fitch criticized the “limited transparency” of stablecoins: Tether, for example, reports quarterly, and USDCoin – once a month. The information is summarized and, in the case of Tether, is mandatory, although this does not apply to other stablecoins for which it is voluntary.

“The information in the portfolio as a whole is limited, and it cannot be directly compared.

The risks are mainly associated with secured stablecoins, which, among other things, vary depending on the size, liquidity and risk of your assets, as well as on the transparency of the operator and management.

Since stablecoins will not have short-term access to the emergency windows of the central bank, regulators should provide a clear legal framework and warn investors not to allow the next liquidity crisis to be caused or exacerbated by satablecoins,” the agency complains.

Conclusion

Today, Bitcoin is not so easy to “run into”. And there’s no point anymore. Then why are stable coins being attacked in such a way by regulators and banking?

In light of recent events, when, under the guise of digitalization, central banks want to impose a new format of money – CBDC, as not only an innovative financial instrument, but also as a means of total control, uncontrolled Central Bank stablecoins are like a bone in the throat.

These assets are able to fully meet the needs of users, without the need to abolish the fiat currency. Neither are able to give stability, which is almost the main criterion.

And risks… risks will begin when their collateral, such as dollars or euros, is threatened by inflation or other financial vicissitudes.