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(NEW YORK) – In the exploding realm of cryptocurrencies, a new line of financial products has emerged that has attracted the attention of both investors and regulators – so-called “stablecoins” backed by cash or other currency reserves.
Stablecoins try to offer the best of both worlds: the stability of a traditional, government-backed currency, and the privacy and convenience that crypto transactions offer. They are often marketed to investors who may not have a stomach for the volatility associated with Bitcoin, Ethereum, and other popular cryptos – which are known to see large increases in value every day.
The existing stablecoins market is worth approximately $ 113 billion, said Gary Gensler, chairman of the US Securities and Exchange Commission, earlier this month during a speech at the Aspen Security Forum. He added that in July, almost three-quarters of trading on all crypto trading platforms was between a stablecoin and another token.
Even social media giant Facebook is trying to get in on the action, trying to launch its own stablecoin-like project after its initial attempts at cryptocurrency Libra failed.
As stablecoins have grown in popularity recently, they have also drawn a new scrutiny from government agencies and regulators. According to a reading released earlier this week, Federal Reserve officials reflected on the threats posed by “new financial deals like stablecoins” and raised concerns about the lack of transparency and regulation.
Treasury Secretary Janet Yellen also last month urged regulators to “act quickly” in creating new regulatory frameworks for stablecoins, warning of their “potential risks to end users, the financial system and national security.”
Here’s what experts say investors should know about the novel class of cryptos that have dominated headlines for the past few weeks.
What are stablecoins?
Stablecoins are essentially cryptocurrencies that are backed by a reserve value – usually a traditional currency such as the US dollar. The valuations of stablecoins should therefore be less volatile than other digital currencies, as they are directly linked to a fixed, non-virtual currency.
“Think of stablecoin as a cryptocurrency with no or limited volatility. That’s the best way to think about it, “Haran Segram, professor of finance at New York University’s Stern School of Business, told ABC News, adding that they are sometimes viewed as a” bridge between fiat currencies and cryptocurrencies. ” . Fiat currencies are traditional currencies like the dollar that are supported by the government.
“Stablecoins 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. “That makes it difficult to use as a currency.” Bitcoin’s value surged 100% in 2021 alone – starting the year at less than $ 30,000, it peaked over $ 63,000 in April, before hitting back to $ 30,000 in July. Dollar mark declined. On Friday, Bitcoin was trading at just over $ 46,000.
“If I tell you that a latte costs $ 2.50, you know what that means – but when I quote a price for a latte in Bitcoin, it is really hard to keep track because it is on you Day equals $ 2.50, the next day it’s equivalent to $ 25, ”he added.
The pegging of cryptocurrencies to a fixed exchange rate relative to the US dollar, as stablecoins attempt, makes them “more useful as a currency,” according to Routledge.
“It’s a stablecoin because they call it a stablecoin”
While this may sound like an overall positive trend to everyday investors interested in crypto, experts and authorities are warning of lurking risks associated with the largely untested stablecoin market.
Segram noted that one of the most popular stablecoins on the market is Tether, which claims to be backed one-to-one against the US dollar.
“The problem with this is that they did some research and then they actually found that one unit of this stablecoin was backed by $ 0.74,” Segram said. “So things like this, what people say it’s a stablecoin, maybe not really a stablecoin.”
“Investors and your audience should be aware of this,” he told ABC News. “Because people don’t know exactly what’s going on behind the scenes, and I really want to encourage your readers to be aware of that.”
New York Attorney General Letitia James’s office opened an investigation into Tether which found there were times when Tether had no access to banking and “did not hold a dollar per tether to secure the circulating Tether, contrary to his representations. ”As part of an agreement with James’ office, Tether is excluded from doing business with New Yorkers, but admitted no wrongdoing and promised more transparency. However, the Hong Kong-based company still claims on its website that Tether tokens are “100% covered by Tether’s reserves” at a conversion rate of one Tether token equal to one US dollar.
“Under the terms of the settlement, we do not admit any wrongdoing,” Tether said in a statement on his website in response to the investigation. “The settlement amount we have pledged to pay to the Attorney General should be viewed as a measure of our desire to leave this matter behind and focus on our business.” The company added that it is about the ” Customer Loyalty, ”said Tethern’s market cap has increased from $ 2 billion to over $ 34 billion over the past two years during the ongoing investigation.
“Tether is complicated because it’s an international business,” added Routledge, asking about who regulates it. “Cryptocurrencies, one of their charms or weaknesses, is that they do not come under anyone’s direct jurisdiction.”
For most stablecoins, it’s “a stablecoin because they call it stablecoin,” added Routledge.
Despite the pledge of cash reserves, there is a risk that some stablecoins will operate on the assumption that the likelihood of simultaneous liquidation is low if confidence remains high.
“If everyone thinks Tether is going to be a stablecoin, it will work as a stablecoin and the few people who have to exchange it in the ‘Tether Store’ to be slang would do that,” he said. “The problem with this policy is that you can get what currency economists would call a speculative attack, which is that we believe Tether doesn’t have enough money, and I think everyone thinks they’ll all point and demand These currencies – it’s a bit of a run on the bank. “
“That makes it really hard to stabilize because your credibility as a stablecoin makes it stable, and that’s inherently volatile,” he said.
Why the Fed and Yellen are so concerned about stablecoins
Yellen’s calls for swift action to create a regulatory framework for stablecoins have been taken up by other lawmakers.
Stablecoins were also recently debated by Fed officials who “highlighted the fragility and general lack of transparency surrounding stablecoins” at their recent meeting of the Federal Open Market Committee. “The importance of close monitoring and the need to develop an appropriate regulatory framework to address all financial stability risks associated with such products.”
Segram said that while stablecoins can self-regulate to some extent by being transparent to the public, I think Yellen is calling for more top-down regulation than it is voluntary.
That could mean keeping the reserve currency in an independent location or regularly reviewing claims, he added.
Segram added that meanwhile, the Fed may have other concerns about stablecoin growth.
“If stablecoins become popular, the central bank will lose its control,” said Segram, noting that there had been discussions about a stablecoin-like “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 manage demand, supply and all other means,” Segram said.
Routledge added that the Fed may also be concerned about a “bank panic” situation with lots of assets flowing through a given stablecoin.
“If for any reason this stablecoin is in shock – it may be a systemic event for the financial system,” he added. “That’s what the Fed has on its radar.”
Meanwhile, during his remarks in Aspen earlier this month, SEC chairman Gensler signaled that the regulations could be cracked down.
Gensler said the use of stablecoins on crypto trading platforms “can help those trying to circumvent a variety of public goals related to our traditional banking and financial system: anti-money laundering, tax compliance, sanctions and the like”.
“This also affects our national security,” he added. Gensler said he looks forward to working with regulators and lawmakers on these matters.
Despite the risks, Segram sees cryptocurrencies as the future, which could be in part why regulators are ringing the alarm bells and why there is so much discussion about a potential central bank digital currency. Large US companies like Amazon and Walmart recently announced they would be hiring cryptocurrency experts, and a growing number of companies are accepting cryptos as a means of payment.
China’s central bank has already launched its digital yuan, he added, saying that the US will most likely step in at some point if it does not want to lose its status as the “reserve currency of the world”.
“If a stablecoin is issued by a private agency, it is not 100% fail-safe,” he said. “In a democracy like ours or other democracies, in which there is a certain political stability and currency stability, a digital central bank currency could be the right way to go.”
“I think of stablecoin as a kind of link between fiat currencies and cryptocurrencies, that takes that to another level,” he said.
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