Recently, the US has brought to attention the issue of conducting a formal review on Tether and other stablecoins in order to understand if they pose a threat to financial stability. The first stablecoin, which was launched in 2014, was Tether.
Understanding Stablecoins: The Basics
A stablecoin is a specific form of cryptocurrency primarily pegged to an existing government-backed currency. They are digital assets that rely on a network dispersed over many computers. Unlike other cryptocurrencies, these hold a bundle of assets in reserve, typically short-term securities. These can include cash, government debt or commercial paper.
Stablecoins are particularly useful since they facilitate smoother transactions in investment functioning cryptocurrencies like Bitcoin. They act as a bridge connecting conventional money and the new-age world of cryptocurrency. They also offer the prospect of functioning like completely safe holdings.
Various Types of Stablecoins
There are different types of stablecoins, each with unique characteristics and functions. Fiat-collateralized stablecoins use fiat money such as the US dollar, euro, or pound as collateral at a 1:1 ratio. Some examples include Tether, Gemini Dollar, and TrueSD.
Then there are stablecoins backed by various assets. These coins are supported by a diversified range of assets like commercial papers, bonds, precious metals, real estate, etc. Examples of this variant include Digix Gold, backed by physical gold.
Crypto-collateralized stablecoins offer a greater degree of decentralization and are backed by other cryptocurrencies. To tackle price volatility, these stablecoins are over-collateralized. An example of this type is Dai. Non-collateralized stablecoins do not have any backing and are decentralized in the true sense, governed by algorithms, for instance, Basis.
Concerns and Risks Surrounding Stablecoins
However, several concerns have been raised regarding stablecoins. Many of them are backed by types of short-term debt that are prone to periods of liquidity difficulties. Moreover, it is important to note that not all stablecoins maintain 100% price stability as their values depend on their underlying assets.
There are potential asset contagion risks associated with the liquidation of stablecoin reserve holdings. This refers to the spread of an economic crisis from one market or region to another and can occur at both a domestic and international level.
Stablecoins also have the potential to enhance the efficiency of the provision of financial services, but they may also generate risks to financial stability, especially if they are adopted on a large scale. They lack transparency, are auditable by everyone, and operate similarly to non-bank financial intermediaries that provide services akin to traditional commercial banks but outside normal banking regulation.
Regulatory Challenges
Regulating stablecoins is not without its hurdles including coordination of efforts across diverse economies, jurisdictions, legal systems, while also dealing with different levels of economic development and needs. Furthermore, there’s not yet a uniform regulatory approach adopted by regulators worldwide concerning stablecoins.
Way Forward
Since stablecoins don’t represent a uniform category but a variety of crypto instruments that vary significantly, it is essential to create a framework that limits risks while also fostering innovation. The stablecoin industry must collaborate with regulators to devise a framework that helps put them at ease while protecting this emerging industry from potential overregulation.