You don’t have to dig deep to find reasons to question the stability of stablecoins. Take Tether, the most widely circulated stablecoin, which is designed to be worth precisely $1. (Hence “tether.”) Right on the company’s home page, under the headline “100% Backed,” there is this: “Every Tether token is always 100% backed by our reserves, which include traditional currency and cash equivalents and, from time to time, may include other assets and receivables from loans made by Tether to third parties, which may include affiliated entities (collectively, “reserves”).
Backed by “traditional currency”? Great. “Cash equivalents”? Well, probably OK. “Other assets and receivables from loans made by Tether to third parties”? Those are of questionable value. Loans to “affiliated entities”? Even sketchier.
Gary Gorton, an economist who is a finance professor at Yale School of Management, is known for diagnosing the instabilities in the financial system that led to the global financial crisis of 2008-09. He cited Tether’s disclosure language on April 15 in a video talk in which he said stablecoins amount to a form of “wildcat banking.” Here’s how Wikipedia defines wildcat banking, a term that dates to the period from 1836 to 1865: “Operating primarily as banks of issue rather than deposit banks, wildcat banks circulated currency that was formally redeemable in gold or silver coin, but practically based on other assets such as government bonds or real estate notes.”
“The essential feature of holding price at 1:1 means you need a credible mechanism for assuring the reserves are actually there,” Gorton said. Stablecoins are crypto currencies that live on the blockchain. But while the blockchain guarantees who owns a particular coin, it doesn’t guarantee that the coin is backed by anything real.
As reported by Bloomberg’s Olga Kharif on March 30, a Cayman Islands-based accounting firm, Moore Cayman, provided an assurance that Tether’s assets exceed its liabilities, but didn’t specify what the assets were. “The assurance is not an audit,” the story noted. In February, without admitting or denying any wrongdoing, the officials who control Bitfinex and Tether, with which it’s affiliated, agreed to pay $18.5 million to settle allegations that it hid the loss of commingled client and corporate funds and lied about reserves.
Gorton, who spoke as part of a series hosted by economist Markus Brunnermeier of Princeton University, said that stablecoins need to submit to regulation to assure holders of their value. “I don’t think in their current form they’re going to work,” he said.
Coinbase Global Inc., the crypto trading platform that went public this week, is part of a consortium that issues another popular stablecoin, USD Coin. The Coinbase website says, “Centre, the consortium that mints USDC, collectively holds US$1.00 for every single USDC.” But the user agreement says, “USDC is fully backed by U.S. Dollars or equivalent assets” (emphasis added). And a disclaimer says, “As with any asset, the value of Digital Currencies can go up or down and there can be a substantial risk that you lose money buying, selling, holding, or investing in digital currencies.”
In December, President Trump’s Working Group on Financial Markets released a statement on stablecoins saying, among other things, that they should focus on “ensuring a 1:1 reserve ratio and adequate financial resources to absorb losses and meet liquidity needs.” On the other end of the political spectrum, Rep. Rashida Tlaib, a liberal Democrat from Michigan, introduced a bill that month that would require every stablecoin issuer to have a banking charter.
The prices of Tether and USD Coin have been reasonably stable to date. But without assured backing, stablecoins are vulnerable to panicky runs by holders who try to pull their funds out before others can, Gorton says. Runs on commercial banks pretty much ended in the U.S. after the creation of the Federal Deposit Insurance Corp. in the Depression, but stablecoins have no such backing. “Stablecoins are just reliving all of history here,” Gorton said. “It’s going to be a fun 10 years.”
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