Crypto’s Conservative Coins

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Bibliographic details

• Authors: Parma Bains, RANJIT SINGH
• Published: September 1, 2022

Background and original vision

• 2009: Crypto revolution framed as decentralizing and democratizing financial services, reducing reliance on banks and governments.
• Original promise: place power "in the hands of the people" via blockchain technology.
• Reality: speculators hoarded crypto assets rather than using them for payments; thousands of volatile "altcoins" emerged, undermining use as a stable store of value or trusted unit of account.

Stablecoin mechanics and centralization

• Definition: A stablecoin is a crypto asset that aims to maintain a stable value relative to a specified asset or pool of assets (monetary units like the dollar or euro, a currency basket, a commodity such as gold, or unbacked crypto assets).
• Stability prerequisites:
  • A centralized institution issues (mints) and redeems (burns) the stablecoin.
  • A separate centralized custodian holds corresponding reserves (typically fiat currency).
• Centralizing features:
  • Stablecoin issuers hold user data.
  • Reserve managers are typically commercial banks.
  • Network administrators can change network rules.
  • Exchanges and wallets can block transactions.
  • Transparency of blockchains plus anti-money-laundering compliance can reduce privacy relative to existing payment rails.

Uses and market role

• Primary uses:
  • Permit users to remain in the crypto ecosystem without cashing out into fiat currency.
  • Purchase unbacked crypto assets and access decentralized finance (DeFi).
  • Key component in the growth of the crypto asset and DeFi markets.
• Emerging market/developing economy role:
  • Dollar-denominated stablecoins could be used as a store of value and a hedge against inflation and currency depreciation.
  • Can enable "cryptoization" where users protect financial interests amid macroeconomic pressures and weak financial institutions.
  • Unregulated stablecoins can circumvent capital controls and complicate central bank macroeconomic management.
• Payment potential:
  • Argument exists that stablecoins could become privately issued money of the future, given that much circulating money is privately issued commercial bank money and blockchains may increase speed and reduce costs for certain services, particularly cross-border remittances.

Risks and failures

• Stability issues:
  • Most stablecoins fluctuate around their desired value rather than sticking rigidly to it.
  • Some can deviate significantly; algorithmic stablecoins are particularly risky.
  • Algorithmic stablecoins adjust issuance via an algorithm and may be backed by unbacked crypto assets.
  • Susceptible to de-pegging in the event of a large shock that becomes self-perpetuating.
  • Example: TerraUSD suffered a peg failure in mid-2022 after bank-like runs by users; its collapse (then the third-largest stablecoin) triggered significant ripple effects across the crypto market.
• Contagion risk:
  • Future contagion could extend beyond crypto markets because many stablecoins hold reserves in traditional financial instruments and exposure to crypto assets among traditional financial market participants has increased.
• Technology scalability and cost:
  • Distributed ledger technology has not been tested at scale from a payment perspective.
  • May yield modest efficiency gains for cross-border remittances and wholesale payments but may not offer sizable advantages over domestic payment systems in advanced economies.
  • Blockchain-based stablecoin transactions can be more expensive than alternatives (e.g., mobile or electronic money) unless transacted off-chain, which reduces transparency and decentralization.
• Financial inclusion reality check:
  • Most stablecoin users are educated, relatively young, and already have bank accounts.
  • Example non-crypto alternative performance: mobile/electronic money raised financial inclusion in Kenya from 14 percent to 83 percent between 2006 and 2019.
• Consumer protection gaps:
  • In many jurisdictions stablecoins and the wider crypto universe are not regulated for conduct and prudential purposes.
  • While some anti-money-laundering rules might apply, users lack protection and recourse if issuers are fraudulent, reserves are misrepresented, stablecoins are stolen, or users cannot access or redeem stablecoins at par.

Regulatory considerations and policy options

• Tailored regulation:
  • Authorities have considered regulating stablecoins according to business models, economic risks, and economic functions.
  • Examples of differentiated approaches:
  • Where stablecoins are not issued by banks and used for payments on a small scale: subject issuers to adjusted payment regulations.
  • Where stablecoins have less liquid reserve assets and are used for investment purposes: subject issuers to requirements similar to those applied to securities.
• Bank-like regulation proposal:
  • Many authorities have proposed applying bank-like regulations to stablecoins, particularly if they become widely used for payments.
  • If applied, stablecoins could effectively become the banks that crypto assets were meant to replace.
• Regulatory goals:
  • Protect users from losses and fraud.
  • Prevent circumvention of capital controls and complications for macroeconomic management.
  • Mitigate systemic risk and potential contagion to traditional financial markets.

Conclusions and recommendations

• Trade-offs:
  • Stablecoins diverge from crypto's original decentralized ideals by introducing centralized intermediaries and reliance on fiat reserves.
  • They offer potential benefits: choice, reduced concentration of power among "too big to fail" institutions, and expanded access to financial services.
• Conditions for constructive role:
  • With appropriate regulation and consumer protections, stablecoins could play a valuable role in payments and financial services.
  • They are not a standalone solution and are far from the revolutionary vision of crypto’s creators.

Parma Bains and Ranjit Singh, F&D Magazine, September 2022.

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