As one of the fastest growing segments of the cryptocurrency ecosystem, stablecoins are digital assets designed to maintain stable values. Backed by traditional currencies like the U.S. dollar or commodities such as gold, stablecoins aim to maintain price stability amidst the volatility that often characterizes cryptocurrencies. Their increasing popularity has raised questions about their role in illicit activities, their potential for financial innovation, and the risks they pose during economic downturns.
Stablecoins were largely invented to provide a more stable price peg for crypto assets. They’re winning a lot of favor among investors and interestingly, users. In fact, they now power nearly three out of every five shady cryptocurrency transactions. Criminals, including those from Russia and many other countries, use them to launder money and evade sanctions. What’s more, interest in digital currencies is exploding. Like them or not, as they grow, their impacts on the financial system and regulatory landscape are becoming increasingly complex.
Understanding Stablecoins
For many investors, stablecoins have become a “cash-management tool.” These bonds offer competitive, fixed annual yields, often even higher than money-market mutual funds. This makes them attractive to anyone seeking easily-sold liquid assets with limited upside potential and stable returns. A dollar-pegged stablecoin, for example, keeps its value by backing itself with a reserve of U.S. dollars. Therefore, this reserve directly reflects the number of coins circulating. This institutional structure provides tremendous confidence in the value of the stablecoin. Issuers always redeem for at least one unit of reserve currency per stablecoin issued.
For all their growth and utility, stablecoins certainly have their challenges. Arthur Wilmarth, a legal scholar specializing in financial regulation, emphasizes the potential dangers:
“These issuers could be in trouble during a crisis.”
Further, this concern shines a light on the issuer’s financial health and stability, which like the seahorse itself may be very precarious in times of economic turbulence.
The Risks of Stablecoins
The risks of stablecoins go far beyond their issuers. In the event of a crisis, an issuer could potentially declare bankruptcy. Or they might just not provide the underlying assets they promised. Hilary Allen, a law professor and expert in financial regulation, points out that many crypto assets lack substantive backing:
“Most crypto assets have nothing behind them – they’re literally annotations on a database or spreadsheet.”
Allen notes that stablecoins possess reserve assets tied to these annotations:
“Stablecoins have reserve assets linked to the annotations in the database.”
Worries over the security and trustworthiness of cybercurrency only deepen. This is particularly the case when these currencies are associated with money laundering or sanctions evasion.
“They’re used for money laundering and sanctions evasion – that type of thing,” Allen adds.
Given the risk of a government bailout or other public policy interventions at taxpayer expense, it’s critical that public policy stablecoins fail.
The Future of Stablecoins
Stablecoins are especially valuable in the cross-border space, helping users avoid relying on the expensive process of transferring physical currency. As financial systems develop, many predict that a form of “global stablecoin” may come to exist—one accepted not just in one country or region, but across borders.
The holy grail would be to identify a so-called ‘global stablecoin’ – one that can be universally accepted across borders by all parties, examined by Steven Schwarz, an expert in the intersection of technology and finance.
This points to a larger, pressing need for oversight and regulation of this new industry. Without any meaningful protections, investors and consumers stand to lose a lot.
“The risk is that you may go to the issuer of the stablecoin and say, ‘Please redeem my stablecoin for the underlying reference assets.’”
Founded initially as a tech company in 2016, the Trump-backed crypto firm World Liberty Financial has recently made waves with its release of its own stablecoin, USD1. This new development begs more questions about political vs financial interests at play in the world of cryptocurrencies.
The Trump-backed crypto firm World Liberty Financial has made headlines by issuing its own stablecoin called USD1. This development raises further questions about the intersection of politics and finance in the realm of cryptocurrencies.
