When the oldest US money market fund “failed” in 2008, it was a key moment in the financial crisis. The Reserve Primary Fund had to break its promise to return $1 for every share to its investors following the historic bankruptcy of Lehman Brothers. Retail investors quickly discovered that the bank-like stability guaranteed by these funds did not mean bank-like protection. Stricter regulations as to which funds money market funds could invest in followed. Something this existential could happen in the $1.3 billion crypto market.
Tether, the largest stablecoin in the cryptosphere, briefly severed its one-to-one link with the US dollar last week. Unlike Bitcoin or other more esoteric crypto assets, stablecoins are meant to avoid volatility, as their name suggests. They claim to be backed by real-world assets and thus act as a vital cog in the crypto market, providing traders with a safe place to park their money between bets on more volatile digital coins. This stability is now in question and the whole crypto market is uneasy.
Tether fell to 95.11 cents on Thursday before recovering. He says he continued to redeem his tokens at $1 each from those who requested (he had over $4 billion in requests on Friday). Meanwhile, a smaller stablecoin rival called TerraUSD – which didn’t even claim the backstop of real reserves and instead relied on an algorithm-driven peg – crashed in value.
If armchair investors lose their shirts and a few crypto brethren see their egos deflated, the reaction may be a shrug. It’s not like there aren’t any warnings. But that underestimates the risks to the real economy of the $180 billion stablecoin market.
If Tether does indeed have $80 billion in assets to back its 80 billion coins in circulation, that would put it among the largest hedge funds in the world, with nearly half of its holdings in US Treasuries and another quarter in corporate debt. If a fire sale of these assets ensues as Tether attempts to maintain its dollar peg or faces a wave of redemptions, the sheer scale of these moves could make already choppy financial markets even more volatile.
It doesn’t help that there have been lingering questions about whether Tether’s assets really fully support its coins, and the related fines of two US watchdogs. Reports suggest that some corporate debt is issued by Chinese companies. Even in the face of last week’s farrago, the company staunchly refused to detail how its seemingly vast reserves are managed, saying it amounts to its “secret sauce.” Banks have discovered, the hard way, that distrust only encourages people to rush out. The faith of true believers in crypto can still be sorely tested.
This means that politicians must stop dithering and heed warnings about stablecoins from central banks such as the Federal Reserve, Bank of England and European Central Bank. Banks keep only a fraction of their assets in the form of liquid reserves to safeguard the value of deposits. In return, they are strictly regulated. Stablecoins can spark bank runs while taking advantage of the cryptosphere’s weak regulation. Real world rules are needed.
Part of the problem is trying to define what crypto assets are, and therefore which agency should have oversight; stablecoins muddy definitions further. Another problem concerns the wildly divergent attitudes of countries towards crypto: where some see a risk, others see a reward. Unless they act in concert, the action is futile, as the British watchdog found when it rejected Binance, a major crypto exchange that has since been well received by France. But turf wars are a distraction when it comes to a $180 billion market with global reach. The risk of inaction is that financial stability is threatened by the next and biggest swing in stablecoins.