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Stablecoins

Star marking (1-5) indicates the importance of topic for CSE
  • 24 Sep 2021
  • 5 min read

Why in News

The US is discussing launching a formal review into whether Tether and other stablecoins threaten financial stability.

  • The first stablecoin, created in 2014, was Tether.

Key Points

  • About Stablecoins:
    • A stablecoin is a type of cryptocurrency that is typically pegged to an existing government-backed currency.
      • A cryptocurrency is a form of digital asset based on a network that is distributed across a large number of computers.
    • Stablecoins hold a bundle of assets in reserve, usually short-term securities such as cash, government debt or commercial paper.
    • Stablecoins are useful because they allow people to transact more seamlessly in cryptocurrencies that function as investments, such as Bitcoin.
    • They form a bridge between old-world money and new-world crypto aslo they promise to function like perfectly safe holdings.
  • Types:
    • Fiat-collateralized Stablecoins:
      • They are collateralized by fiat money, such as the US dollar, euro or the pound, on a 1:1 ratio.
      • Examples: Tether, Gemini Dollar, and TrueSD.
    • Stablecoins Backed by Other Assets:
      • There are a few stablecoins, which are backed by a basket of multiple assets (commercial papers, bonds, real estate, precious metals, etc).
      • The value of these stablecoins can fluctuate over time subject to movement in commodity and precious metal prices.
      • Example: Digix Gold, backed by physical gold.
    • Crypto-Collateralized Stablecoins:
      • Crypto-collateralized stablecoins are more decentralised than their peers and are backed by cryptocurrencies.
      • The flipside is price volatility and to address the risk of price volatility, these stablecoins are over-collateralized.
      • Example: Dai.
    • Non-collateralized stablecoins:
      • These stablecoins do not have any backing and are decentralized in the true sense and the supply of non-collateralized stablecoins is governed by algorithms.
      • Example: Basis.
  • Concerns:
    • Related to Short term Debt:
      • Many stablecoins are backed by types of short-term debt that are prone to periods of illiquidity, meaning that they can become hard or impossible to trade during times of trouble.
    • Not all Stablecoins are Stable:
      • Not all stablecoins are really 100% price-stable. Their values are dependent on their underlying assets.
    • Asset Contagion Risk:
      • There are potential asset contagion risks linked to the liquidation of stablecoin reserve holdings.
        • A contagion is the spread of an economic crisis from one market or region to another and can occur at both a domestic or international level.
      • The risks are primarily associated with collateralised stablecoins, varying based on the size, liquidity and riskiness of their asset holdings, as well as the transparency and governance of the operator.
    • Risks to Financial Stability:
      • While stablecoins have the potential to enhance the efficiency of the provision of financial services, they may also generate risks to financial stability, particularly if they are adopted at a significant scale.
    • Lack of Accountability:
      • They are not transparent or auditable by everyone and are operated just like non-bank financial intermediaries that provide services similar to traditional commercial banks, but outside normal banking regulation.
    • Regulatory Challenge:
      • International coordination of regulatory efforts across diverse economies, jurisdictions, legal systems, and different levels of economic development and needs is another regulatory challenge.
      • There is not (yet) a uniform regulatory approach of regulators worldwide relating to stablecoins.

Way Forward

  • Stablecoins do not stand for a uniform category but represent a variety of crypto instruments that can vary significantly in legal, technical, functional and economic terms.
  • So, in order to be effective in limiting risks and not disturbing innovations the stablecoin industry must work together with the regulators to come up with a framework that helps put them at ease while protecting this nascent industry from overregulation.

Source: IE

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