(Bloomberg) -- It may seem paradoxical, but in the entirety of the wild and woolly world of cryptocurrencies, what some of the top financial regulators are most worried about is the flavor of digital money designed to be the safest. Even the name, stablecoin, exudes, well, stability. But stablecoins in general and the giant among them, Tether, in particular have drawn increasing scrutiny amid worries that they could pose risks to cryptocurrency users and even to the global financial system. U.S. financial agencies have called for quick passage of legislation that would regulate stablecoin companies in much the same way as banks are regulated.
1. What are stablecoins?
Stablecoins are digital assets sometimes referred to as coins, sometimes as tokens, that are designed to keep their value. That is, to experience only the kind of volatility seen in traditional currencies, which have price swings that are generally far smaller than those of Bitcoin. Tether, for instance, sells its coins for $1 and promises to redeem them for $1 if customers want their money back.
2. How do they do that?
In one of two ways. Collateralized stablecoins are pegged to another asset, like the U.S. dollar, and their issuers say they back up the value of their coin by holding on to that asset or something similarly safe. Other stablecoins are pegged to the price of crypto assets such as Ether or, in certain DeFi (decentralized finance) apps, collections of coins put up as collateral. Some employ algorithms to manage supply and demand of the coin so what's in circulation matches what's held in reserve.
3. How many stablecoins are there?
There are dozens of stablecoins in use, with a combined market value that topped $130 billion in October, and more are coming. Most of those with large followings are tied to the U.S. dollar. But the largest is Tether, which is issued by Tether Holdings Ltd. There are now more than 69 billion Tethers in circulation, at least 48 billion of them issued this year.
4. Why are the coins popular?
Stablecoins can be a bridge between two worlds that weren't designed with mixing in mind -- cryptocurrencies and traditional finance. That makes them useful as a way to lock in gains from crypto trading or as a safe harbor if investors think a downturn is coming. They also make it easier to move funds onto crypto exchanges. Many exchanges don't have the relationships with banks needed to offer regular currency deposits or withdrawals, but can and do accept stablecoins such as Tether. Finally, stablecoins can streamline, speed up and make cheaper purchases and money transfers by using a different technology, called blockchain, instead of the traditional payments infrastructure.
5. What do financial regulators say?
In a highly anticipated report, the Treasury Department, Federal Reserve and other regulators urged lawmakers to let them police stablecoin issuers in the same way that they oversee banks, with robust capital requirements and constant supervision. But as a Plan B, the President's Working Group on Financial Markets made clear it would activate a rarely used power to examine whether the coins pose a systemic threat to financial stability -- a review that could trigger a raft of new rules.
6. What's the worry?
Regulators say the growing size of stablecoins has created a situation where huge amounts of U.S. dollar-equivalent coins are being exchanged without touching the U.S. banking system, potentially blinding regulators to illicit finance. “They are like money funds, they're like bank deposits and they're growing incredibly fast but without appropriate regulation,” Federal Reserve Chairman Jerome Powell said in testimony before Congress. Regulators are also worried about a panic causing something like a bank run. Money-market funds needed swift action by the Fed during both the 2008 financial crisis and the 2020 Covid-19 market crash to keep the uninsured investment pools from possible collapse.
7. What's being proposed?
While the recommendations envision stablecoins as a regulated banking product, the Working Group's report emphasizes that the Securities and Exchange Commission, Commodity Futures Trading Commission and other agencies can police transactions in the meantime that involve trading, lending and borrowing. The regulators also lay out reasons to oppose a situation in which stablecoins are backed by a major technology firm or other corporate giant. The report calls for a wall between tokens and non-financial businesses, emulating the longstanding division between banking and commerce. Such an idea could strangle efforts by Meta -- the company formerly known as Facebook Inc. -- and its partners to launch a stablecoin under the name Diem or to provide customers with crypto wallet services. Facebook recently began trials of a new crypto wallet service using a stablecoin from Paxos.
8. What are the issues with Tether?
Yes, there have long been doubts about Tether, the giant in the field with $69 billion in assets. A persistent group of critics has argued that, despite the company's assurances, the companies behind Tether don't have enough assets to maintain the 1-to-1 exchange rate, which would mean that the coin has been marketed in a way that is essentially a fraud. Tether has attempted to dispel those doubts by releasing attestations from an accounting firm stating that it does have the money, but those have raised other questions. The U.S. Department of Justice has also opened a criminal investigation into whether Tether executives committed bank fraud.
9. What is Tether backed by?
A Bloomberg Businessweek investigation, published Oct. 7, found that Tether's reserves include billions of dollars of short-term loans to large Chinese companies -- something money-market funds avoid. It also reported that Tether had made loans worth billions of dollars to other crypto companies, with Bitcoin as collateral. Tether said the vast majority of its commercial paper has high grades from credit-rating firms, and that its secured loans are low-risk, because borrowers have to put up Bitcoin that's worth more than what they borrow. The coins are fully backed, it added.
The Reference Shelf
- A Treasury Department summary of the report from the President's Working Group on stablecoins.
- Facebook's white paper outlined a plan for its own stablecoin.
- The Businessweek investigation: Anyone Seen Tether's Billions?
- A report on the regulatory situation from Bloomberg News
- A report on the State of Stablecoins by Blockchain.com.
- QuickTake primers on cryptocurrencies, stablecoins and Tether.
- The Bloomberg terminal's cryptocurrency monitor.
©2021 Bloomberg L.P.
Essential Business Intelligence, Sharp Market Insights, Practical Personal Finance Advice, Daily Fuel, Gold and Silver Prices and Latest Stories — On NDTV Profit.
