Why Yellen, Powell Cast a Wary Eye on Stablecoins

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Bitcoin is exciting: its price swoops and dives. Such volatility has made regulators around the world look closely at Bitcoin and other cryptocurrencies with a value that bounces around. But two of the world’s most powerful financial regulators, U.S. Treasury Secretary Janet Yellen and Federal Reserve Chair Jerome Powell, are focused as well on a more boring but more useful form of crypto, stablecoins. They fear that their very usefulness could create risks for consumers and potentially even for the financial system; Yellen is pushing financial regulators to “act quickly” in drafting stablecoin rules. Others see stablecoins as the thing that will force central banks to dive into the digital coin business themselves.

1. What are stablecoins?

Digital assets sometimes referred to as coins, sometimes as tokens, that are designed to keep their value. That is, to experience only the kind of volatility seen in traditional currencies, which have price swings that are generally far smaller than those of Bitcoin. The most popular stablecoin, Tether, for instance, always trades for about $1.

2. How do they do that?

In one of two ways. Collateralized stablecoins are pegged to another asset, like the U.S. dollar, and their issuers back up the value of their coin by holding on to that asset. Other stablecoins are pegged to the price of crypto assets like Ether or, in certain DeFi (decentralized finance) apps, collections of coins put up as collateral. Some employ algorithms to manage supply and demand of the coin so what’s in circulation matches what’s held in reserve.

3. How many stablecoins are there?

There are dozens of stablecoins in use, with a combined market value that topped $100 billion in May, and more are coming. Most of those with large followings are tied to the U.S. dollar. Facebook led a consortium that made waves with plans for a stablecoin that was first to be called Libra and then Diem, but the idea has lost momentum in the face of regulatory opposition.

4. Why are the coins popular?

Stablecoins can be a bridge between two worlds that weren’t designed with mixing in mind -- cryptocurrencies and traditional finance. That makes them useful as a way to lock in gains from crypto trading or as a safe harbor if investors think a downturn is coming. They also make it easier to move funds onto crypto exchanges. Many exchanges don’t have the relationships with banks needed to offer regular currency deposits or withdrawals, but can and do accept stablecoins such as Tether. Finally, stablecoins can streamline, speed up and make cheaper purchases and money transfers by using a different technology, called blockchain, instead of the traditional payments infrastructure.

5. What are the different stablecoins like?

Here are some examples:

  • By far the most popular is Tether, with a $62 billion valuation. Tether says that its tokens are backed 1:1 by U.S. dollars, securities and commercial paper -- short-term corporate loans. Doubts about that have dogged it for years. Bitfinex, the crypto exchange that operates Tether, agreed in February to pay $18.5 million to settle a suit brought by New York State Attorney General Letitia James charging that it hid the loss of commingled client and corporate funds and lied about reserves. Her investigation revealed that Tether was at one point only 74% backed by cash and short-term securities.
  • USDA, or USD Coin, is the second-biggest stablecoin. It’s supported by two crypto heavyweights, Circle Internet Financial Inc., and Coinbase Inc., and it has a market value of $26.4 billion, according to CoinMarketCap.com. It’s backed 1:1 by U.S. dollars, and its reserves are attested by accounting firm Grant Thornton LLP monthly.
  • TrueUSD is another collateralized stablecoin that holds greenbacks for 100% of coins it issues and is independently audited by an accounting firm. In June, TrueUSD said that Signature Bank will integrate it for settlement by commercial clients.
  • Dai is a stablecoin pegged to the value of the dollar but backed by coins including Ether that users put up as collateral. Dai has one of the more complicated price stability mechanisms in the market, and a $5.5 billion market cap.

6. How do stablecoin companies make money?

Interest and fees. Companies that issue stablecoins can make money by investing the standard cash the users turn in into various short-term government and other securities to earn interest. With billions invested, such interest can add up.

7. Why are Yellen and Powell worried?

Yellen convened a group of financial-market and bank regulators to discuss rules for stablecoins on July 19. Lawmakers and regulators have expressed alarm both in public and private that some consumers won’t actually be protected should one of the stablecoin firms not have the backing they purport to have. They also say the growing size of stablecoins has created a situation where huge amounts of U.S. dollar-equivalent coins are being exchanged without touching the U.S. banking system, potentially blinding regulators to illicit finance. “They are like money funds, they’re like bank deposits and they’re growing incredibly fast but without appropriate regulation,” Powell said in testimony before Congress. Money-market funds needed swift action by the Fed during both the 2008 financial crisis and the 2020 Covid-19 market crash to keep the uninsured investment pools from possible collapse.

8. What do stablecoins have to do with central bank crypto?

A number of central banks had been exploring the idea of issuing their own digital currencies. The debate over Diem and stablecoins in general led to an acceleration in that work, as bankers feared that a coin used by Facebook’s two billion users could undermine their ability to manage their own currencies and economies. Some of the islands in the Eastern Caribbean, including Grenada and St. Kitts and Nevis, that share a central bank have already launched their own digital currency, which is now being tested by consumers and merchants. But the first major central bank to roll this out on a big scale is likely to be the People’s Bank of China, which has begun trials with a digital yuan. The Fed has already been working on a digital-currencies report that Powell said could be released as soon as September. Among other things, that document will include a discussion on the risks and benefits of stablecoins, he said.

9. What are stablecoins’ risks to consumers?

That depends on which stablecoin you are talking about. Those tied to digital assets like Ether could crash if it does. Collateralized stablecoins run a risk of fraud, that the reserves they claim are backing the asset are fictional. And like any asset, digital or tangible, there is the risk of secondary-market manipulation that could skew coin values and threaten to break any underlying peg. Lastly, regulators could decide that stablecoins are securities and must be registered in jurisdictions like the U.S. or the European Union, or be excluded from those markets.

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