What you need to know about “stablecoins”, the “bridge” between crypto-currencies and traditional money

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(NEW YORK) – In the booming cryptocurrency arena, a new line of financial products has emerged that has caught the attention of investors and regulators – so-called ‘stablecoins’, which are backed by cash or other reserve asset.

Stablecoins seek to offer the best of both worlds: the stability of a traditional government backed currency as well as the privacy and convenience offered by crypto transactions. They are often traded to investors who may not have a stomach for the volatility associated with Bitcoin, Ethereum, and other popular cryptos – which are known to vary greatly in value on a daily basis.

The current stablecoins market is worth some $ 113 billion, US Securities and Exchange Commission Chairman Gary Gensler said earlier this month in a speech at the Aspen Security Forum. He added that in July, almost three-quarters of the exchanges on all crypto trading platforms took place between a stablecoin and another token.

Even social media giant Facebook is trying to join in on the action, seeking to launch its own stablecoin-like project after its initial cryptocurrency Libra efforts failed.

As their popularity increases, stablecoins have also recently come under renewed scrutiny from authorities and regulators. Federal Reserve officials reflected on threats posed by “new financial arrangements such as stablecoins” at a recent meeting, according to a reading released earlier this week, raising concerns about the lack of transparency and regulatory.

Last month, Treasury Secretary Janet Yellen also called on regulators to “act quickly” by forming new regulatory frameworks for stablecoins, warning of their “potential risks to end users, the financial system and the community. national security “.

Here’s what experts say investors should know about the new class of crypto that has been in the headlines in recent weeks.

What are stablecoins?
Stablecoins are essentially cryptocurrencies backed by a reserve asset, usually a traditional currency such as the US dollar. Stable coin valuations are therefore supposed to be less volatile than other digital currencies, as they are directly pegged to a fixed currency and not a virtual one.

“Think of stablecoin as a cryptocurrency with no or with limited volatility. That’s the best way to think about it, ”Haran Segram, a finance professor at New York University’s Stern School of Business, told ABC News, adding that they are sometimes seen as“ the bridge between fiat currencies and cryptocurrencies ”. Fiat currencies are traditional currencies like the dollar, backed by the government.

“Stable coins are backed by other central bank currencies,” Segram explained.

Bryan Routledge, associate professor of finance at Carnegie Mellon University’s Tepper School of Business, added that this makes stablecoins more useful as everyday currency.

“For example, the price of Bitcoin is just incredibly volatile,” he told ABC News. “It makes it more difficult to use as currency.” In 2021 alone, Bitcoin’s value has fluctuated 100% – starting the year at a price below $ 30,000, peaking at over $ 63,000 in April, before falling back to $ 30,000. in July. Bitcoin was trading at just over $ 46,000 on Friday.

“When I tell you that a latte costs $ 2.50, you know what that means – but if I quote the price of a latte in Bitcoin, it’s really hard to follow because one day it ‘is the equivalent of $ 2.50, the next day it’s the equivalent of $ 25, ”he added.

The attachment of cryptocurrencies to a fixed exchange rate against the U.S. dollar, as stablecoins attempt to do, makes them “more useful as currency,” according to Routledge.

“It’s a stablecoin because they call it a stablecoin”
While this may appear to be an overall positive development for everyday crypto investors, experts and authorities have warned of the hidden risks associated with the largely unchecked stablecoins market.

Segram noted that one of the most popular stablecoins is Tether, which claims to be backed by the US dollar.

“The problem was, research was done on this and then they found out that one unit of this stable coin was backed by US $ 0.74,” Segram said. “So things like that, what people say it’s a stablecoin, maybe it’s not really a stablecoin.”

“This is something that investors and your audience should be aware of,” he told ABC News. “Because people don’t know exactly what’s going on in the background, and I really encourage your readers to be aware of that.”

New York Attorney General Letitia James’s office conducted an investigation into Tether which said there were times when Tether did not have access to banking services and “did not hold any reserves to support outstanding ties. at the rate of one dollar for each tie, unlike his representations. Under an agreement with James’ office, Tether is prohibited from doing business with New Yorkers, but is admitted no wrongdoing and promised increased transparency. The Hong Kong-based entity, however, maintains on its website that Tether tokens are “100% backed by Tether Reserves” at an equal Tether token conversion rate. to one US dollar.

“Under the settlement, we do not admit any wrongdoing,” Tether said in a statement posted on its website in response to the investigation. “The amount of settlement we have agreed to pay to the Attorney General’s office should be seen as a measure of our desire to put this case behind us and focus on our business.” The company added that it was pleased with the “loyalty” shown by customers, saying the fasteners’ market capitalization rose from $ 2 billion to a surplus of $ 34 billion in the past two years, as the investigation was ongoing.

“Tether is complicated because it’s an international company,” Routledge added regarding who regulates it. “Cryptocurrencies, one of their charms or weaknesses, is that they sort of fall outside of anyone’s direct jurisdiction.”

For most stable parts, “it’s a stable part because they call it a stable part,” Routledge added.

Despite assurances of cash reserves, there is a risk that some stablecoins will operate on the assumption that the likelihood of having to liquidate all at once is slim if confidence remains high.

“If everyone thinks Tether is going to be a stablecoin, it will work like a stablecoin and the few people who have to exchange it at the ‘Tether store’, to be familiar, would,” he said. “The problem with this policy is you can get what the forex economists would call a speculative attack, which is, we don’t think Tether has enough money, and I think everyone thinks it is. that, they’re all going to show and demand these currencies – it’s kind of like a race to the bank.

“That’s what makes stabilization really difficult, because your credibility as a stable coin is what makes it stable, and that’s inherently unstable,” he said.

Why the Fed and Yellen are so concerned about stablecoins
Yellen’s calls for swift action to create regulatory frameworks for stablecoins have been echoed by other lawmakers.

Stablecoins were also recently debated by Fed officials, who “highlighted the fragility and general lack of transparency associated with stablecoins,” at their last Federal Open Market Committee meeting. “The importance of monitoring them closely and the need to develop an appropriate regulatory framework to deal with any financial stability risks associated with such products.” “

Segram said that while stablecoins can “regulate themselves to a certain extent by being transparent with the public, I think Yellen is calling for more top-down regulation rather than letting it be voluntary.”

This could mean that the reserve currency is kept in an independent place or that the receivables are regularly audited, he added.

Segram added that the Fed, meanwhile, may have other concerns about the growth of stablecoins.

“If stablecoins become popular, the central bank loses control,” Segram said, noting that there had been discussions of a stable-type “central bank digital currency” to be issued by the Federal Reserve.

A central bank digital currency would give the Fed more control “over how we deal with demand, supply and all other means,” Segram said.

Routledge added that the Fed might also be concerned about a “bank run” if many assets are passing through a specific stable coin.

“If for some reason this stablecoin takes a shock, it can be a systemic event for the financial system,” he added. “That’s what’s on the Fed’s radar.”

SEC Chairman Gensler, meanwhile, signaled that a regulatory crackdown could loom during his remarks earlier this month in Aspen.

Gensler said that the use of stablecoins on crypto trading platforms “can make it easier for those seeking to circumvent a multitude of public policy objectives related to our traditional banking and financial system: anti-money laundering, compliance. tax, sanctions, etc.

“It also affects our national security,” he added. Gensler said he looked forward to working with regulators and lawmakers on these issues.

Despite the risks, Segram sees cryptocurrencies as the future, which may partly explain why regulators are sounding the alarm bells and why there is so much talk about a potential central bank digital currency. Large US companies, including Amazon and Walmart, recently announced that they are hiring cryptocurrency experts, and a growing number of companies have started accepting crypto as a form of payment.

China’s central bank has already launched its digital yuan, he added, saying the United States will most likely do so at some point if it does not want to lose its status as “the world’s reserve currency.”

“If a stablecoin is issued by a private authority, it is not 100% foolproof,” he said. “In a democracy like ours, or other democracies where there is some political stability and monetary stability, a central bank digital currency might be the way to go.”

“I think of stablecoin as sort of a link between fiat currencies and cryptocurrencies, it takes that to another level,” he said.

Copyright © 2021, ABC Audio. All rights reserved.

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