When America’s oldest money market fund “broke the goat” in 2008, it was a key moment in the financial crisis. The Reserve Primary Fund had to break its promise to return $1 for each share to its investors in the wake of Lehman Brothers’ historic bankruptcy. Retail investors soon learned that bank-like stability promised by such funds did not mean bank-like protection. Stricter rules followed about what money market funds could invest in. Something just as existential can happen in the $1.3 trillion crypto market.
Tether, the cryptosphere’s largest stablecoin, briefly broke 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 an essential cog for the crypto market, providing traders with a safe place to park their money between bets on more volatile digital coins. That stability is now under discussion and the entire crypto market is restless.
Tether fell to 95.11 cents on Thursday before recovering. It says it continued to exchange its tokens at $1 each to those who asked (it had more than $4 billion in requests as of Friday). Meanwhile, a smaller stablecoin rival called TerraUSD — which didn’t even claim the safety net of actual reserves and instead relied on an algorithm-run link — collapsed in value.
When armchair investors lose their shirts and see a few crypto brothers drain their egos, the reaction could be a shrug. It’s not like there weren’t any warnings. But that underestimates the risks to the real economy of the $180 billion stablecoin market.
If Tether did indeed have $80 billion in assets to back its 80 billion coins in circulation, it would place it among the world’s largest hedge funds, with nearly half its holdings in US Treasury bonds and another quarter in corporate debt. If a sudden sale of these assets occurs as Tether tries to maintain its dollar peg, or faces a wave of redemptions, the sheer magnitude of such moves could make already twitchy financial markets even more volatile.
It doesn’t help that there have been lingering questions about whether Tether’s assets really fully cover its coins, and the associated fines from two US watchdogs. Reports suggest that some of the corporate debt has been issued by Chinese companies. Even in light of last week’s farrago, the company has firmly refused to go into detail about the management of its seemingly vast reserves, claiming it amounts to its “secret sauce”. Banks have found, at their cost, that distrust only fuels the haste for the exit. The faith of the true believers of crypto is yet to be put to the test.
This means that politicians need to stop hesitating and heed the warnings about stablecoins from central banks like the Federal Reserve, Bank of England and the European Central Bank. Banks hold only a fraction of their assets as liquid reserves to support the value of deposits. In return, they are strictly regulated. Stablecoins can cause bank-like runs, but enjoy the sparse regulation of the cryptosphere. Real 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 is the widely differing attitudes of countries towards crypto: where some see risk, others see reward. Unless they work together, action is futile, as the British watchdog found when it turned down Binance, a major crypto exchange that has since been welcomed by France. But turf wars are a distraction when it comes to a $180 billion market with global reach. The risk of doing nothing is that financial stability is threatened by the next, bigger wobble of stablecoins.