May 18, 2022

Breakingviews: Stablecoin panics may be a feature not a bug

by Breakingviews.

Stablecoins are failing to live up to their name. TerraUSD, one of the many cryptoassets whose value was supposedly pegged to the U.S. dollar, imploded last week. And tokens issued by $80 billion behemoth Tether, also linked to the greenback, briefly traded at 95 cents. Wobbly “safe” assets may be a feature, not a bug, of the cryptocurrency world.

Granted, the two cases are different. Terra, which had $18 billion of digital coins in circulation in early May, utterly failed. Its value relied on trading incentives that became self-destructive. Tether, which claims to be backed by real-world financial assets, allowed holders to swap tokens worth $7 billion for cash over six days.

Nonetheless, it’s a reminder that crypto’s safe havens are risky. Traders depend on stablecoins to move and lend money with confidence. Crypto derivatives are often denominated in Tether, which is also often used as collateral. Its collapse would inflict widespread losses. Little surprise regulators in the United States and elsewhere are concerned.

One fix is for stablecoins to hold $1 in a bank account for every digital token of equivalent value in circulation. That would be a major improvement for Tether, which in December had less than half its reserves in bank deposits and U.S. Treasury bonds. The rest was in riskier assets like commercial paper, corporate bonds and digital tokens. Switching to 100% cash would make future wobbles less likely.

It’s doubtful that Tether’s management, including Chief Financial Officer Giancarlo Devasini, would countenance that. Ditching racier assets would mean less income. Assuming Tether earns a conservative 1% yield on its reserves, it pockets $800 million of revenue per year. That would all but vanish if Devasini put the assets in a bank instead.

Nor would that solve regulators’ worries. With minimal interest income, a fully cash-backed stablecoin might have to charge transaction fees to cover its costs, potentially sending users elsewhere. In the crypto world, there’s always a new, unregulated coin offering suspiciously juicy rewards. Terra’s popularity owed much to the 20% interest users hoped to earn through an associated product.

It’s therefore hard to imagine a safe but costly token being the only game in town. Other upstart “stablecoins” could win fans by taking more risk. The upshot is that Terra’s blowup, and Tether’s wobbles, could be a recurring theme.

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