Digital revolution: Will cryptocurrencies take over the world? – Are stablecoins really “stable”?

Original content: Digital revolution: Will cryptocurrencies take over the world? – Are stablecoins really "stable"?

Summary

Stablecoins, which are a category of digital currency, have many favorable characteristics. Payments can be settled essentially instantaneously, and "unbanked" individuals can easily use them. Their supplies are not limited, so potential problems with deflation do not arise with stable coins as they potentially could with limited forms of digital currencies.

Unlike other cryptocurrencies, such as Bitcoin and Ether that exhibit extreme levels of price volatility, the values of stable coins tend to be stable. Many stable coin issuers claim that their tokens are fully "backed" by reserves.

However, assets that can experience their own periods of illiquidity and price dislocation represent a significant proportion of the reserves of some stable coin issuers. If the confidence of investors in the value of their holdings is shaken, the stable coin issuers can experience "runs," much like commercial banks before the advent of deposit insurance and the creation of a robust supervisory and regulatory framework.

If the explosive growth that stable coins have enjoyed in recent years continues in coming years, then periods of financial market volatility could potentially become extreme.

Stablecoin issuers have largely operated in a regulatory vacuum until now. But regulators have become acutely aware of the potential risks that stable coins present, and they are scrambling to catch up. Some federal agencies have recommended that Congress pass legislation that would require stable coin issuers to become insured depository institutions, which would be subject to supervision and regulation by the appropriate regulatory bodies.

Furthermore, private stable coin issuers may soon face competition from central banks that are gearing up to issue their own digital currencies. We will discuss central bank digital currencies (CBDCs) in Part III of this series.

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