Why regulators should treat stablecoins like banks
T12 YEARS after the birth of bitcoin, governments still struggle to deal with cryptocurrencies. Britain has banned Binance, a crypto exchange, and European Union regulators want transactions to be more traceable. On August 3, Gary Gensler, chairman of the US Securities and Exchange Commission, said the cryptocurrency markets were “rife with fraud, scams and abuse” and called on Congress to confer on his agency new regulatory powers. The price of bitcoin, the world’s largest cryptocurrency, is spinning with every word from regulators.
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Governments have an obligation to tackle the deception, tax evasion and money laundering that plague the crypto world. Police seizures of bitcoin suggest they are becoming more and more zealous. The most difficult issue they face is whether cryptocurrencies threaten the financial system. If bitcoin crashes, our crypto stress test suggests its holders would lose hundreds of billions of dollars but the fallout would be manageable. Yet there is another danger posed by “stablecoins,” a special type of cryptocurrency that attaches its value to conventional money.
Promises of stability often lead to financial crises. Because banks offer deposits that are redeemable on demand and are superficially risk-free, but backed by longer-term, less liquid, and riskier assets, they are vulnerable to rushes. Stablecoins are similar. The largest, Tether, has issued $ 62 billion in tokens which it says are redeemable for a dollar a piece. But among token-backed assets in March, only around 5% were cash or T-bills, according to Tether’s public disclosures. He says he will update the numbers soon and is “fully backed by reservations.”
Most of the assets were riskier, about half of which were commercial paper. The growth of Stablecoins from $ 14 billion in August 2020 to over $ 100 billion today has given them a significant financial footprint. Extrapolating Tether’s disclosures implies it owns more than $ 30 billion in commercial paper, making it likely the seventh-largest investor in the asset class, not far from funds managed by Vanguard and BlackRock, according to JPMorgan Chase . With an estimated leverage of 383 to 1, Tether would not be able to honor all of its tokens after losses of just 0.26%, a cushion that regulators would never allow in a bank.
Few stablecoins say a lot about their balance sheets. Tether’s disclosures about its asset allocation are meager and well below the standards expected of a bank. In February, Tether was among the defendants who agreed to a $ 18.5 million fine with the New York Attorney General, who said that in 2017, Tether misled the market over his we dollar and that it had not accurately disclosed the transfer of $ 625 million of its assets to Bitfinex, an online trading platform. Tether says the funds have been returned and that he has a “total commitment to transparency.”
No wonder Mr. Gensler calls cryptocurrencies a Wild West. Some policymakers have compared stablecoins to the “free banking” era, when banknotes issued by individuals of uncertain support and value circulated in the American economy in the 19th century. A more useful comparison is with money market funds, which were created in the 1970s to circumvent rules limiting the interest banks could pay depositors. After promising to keep the value of their stocks at one dollar, money market funds exploded in 2008 in the global financial crisis. US taxpayers have stepped in to prevent a discount on their assets and a crash in the commercial paper market, on which the real economy depends. A stable coin collapse might look like this.
Regulators must act quickly to subject stable coins to banking-type rules on transparency, liquidity and capital. Those who do not comply should be cut off from the financial system, to prevent people from drifting into an unregulated crypto-ecosystem. Policymakers are right to sound the alarm bells, but if stablecoins continue to grow, governments will need to act faster to contain the risks.
It can be tempting to ban stablecoins, especially if central banks are launching their own digital currencies, in the same way that private banknotes have been replaced by government monopolies on physical cash. Yet, it is possible that regulated private sector stablecoins end up delivering benefits, such as simplifying cross-border payments or allowing self-executing “smart contracts”. Regulators should allow experiments the purpose of which is not simply to evade financial rules. But first they must prevent the repackaging of risks that the world is familiar with. ■
This article appeared in the Leaders section of the print edition under the title “Unstablecoins”