What if stability doesn’t imply there is no risk?

The crypto industry is one that relies on its inherent volatility for attracting investments. With real applicable use cases of the technology still far and wide between, investors, both institutional and retail, are seeking means of capitalizing on the price hikes of popular cryptocurrencies. Speculation is still one of the key attractive features of the given market, and with good reason, considering that Bitcoin alone has appreciated by over 25,000% over the last two years.

Stablecoins were introduced into the crypto market for the very purpose of eliminating some portion of volatility and providing investors, and average users, the ability to make payments at predictable and even stable exchange rates. Such amalgamation of traditional fiat currencies with exchange rates set by central banks has had an impact on the crypto market at large, spawning a vast number of stablecoins pegged to anything from national currencies and gold to petroleum and even talent.

Though attractive as an alternative to volatile assets, stablecoins still bear a large number of risks both for their users and the crypto market as a whole, while posing a significant threat to financial systems worldwide. 

Of Noble Purpose

The idea behind stability is that holders of some form of currency seek predictability of prices. Crypto market participants are no different, as they often sell various items and assets for stablecoins, because they help them protect themselves from volatility. But if they had the opportunity to exchange their digital assets for fiat money in seconds without the need to deposit and withdraw anything from their account of a cryptocurrency platform, it would be more convenient and less risky to do so.

For instance, integrating IBAN accounts into a crypto platform so that users could freely operate with both fiat and digital currencies via a single app would make daily financial transactions way more convenient. 

Though initially designed to hedge against volatility, stablecoins have since acquired a set of risks that set them aside as second-grade assets on the cryptocurrency market. Speaking of risks, stablecoins pose a significant threat for the overall financial system due to their unregulated nature and the fact that they are issued by whoever wants to.

Regulating The Irregular

Money, in any of its forms, has to be regulated to be acceptable within a legal framework. Stablecoins are currently not regulated in any way that would make them acceptable within the global financial system as legal tender. There are also no standards for regulation, despite the many attempts by various regulatory authorities to devise a unified approach. This is especially relevant in light of the fact that the US is the biggest potential market for stablecoins and no unified legal framework for them has been adopted by the authorities therein, which are, de facto, global in their reach.

The precedents marking the need for regulation of stablecoins can be traced in numerous statements by such prominent individuals as billionaire Mark Cuban, who announced on June 17th that stablecoins must be regulated and defined as such on a global level for financial clarity and accountability. In truth, the investor had every right to make the statement, considering that there is no clear definition about what a stablecoin is, and Wikipedia articles do not count here.

Given that many stablecoins are backed (or not) by other cryptocurrencies, collateral or even commodities, makes them volatile as well, especially in light of the turbulent market dynamics sweeping across the global economy. This shaky state of affairs is not only casting doubt on the stability of stablecoins in their nature, but is also highlighting their deficiencies as reliable assets for predictable transactioning, unlike fiat, which has the necessary mechanisms to remain pegged to a certain value. The fact that stablecoins have no ‘central bank’ makes them vulnerable and their namesake – loose.

A Veil Of Doubt

The question of transparency about stablecoin reserves is just as much up in the air as the very fact of their existence altogether. The slew of scandals surrounding Tether is proof of the discrepancies in the virtues of blockchain the moment it is tethered to the real world and the assets needed to make it run.

Such lack of certainty is making investors wary of the risks associated with stablecoins and the potential of them losing value in case of unforeseen or regulatory conditions. If a stablecoin is issued in a region embroiled in geopolitical turmoil, chances are quite high that its collateral can be made worthless, in case a sanction regime is imposed, or relations worsen with states that have sway over financial gateways.

Even worse is the case and higher the risks if the stablecoin is backed by other cryptocurrencies, since the latter cannot even be properly traced or accounted for, much less regulated like collateral or commodities in reserves. Some examples are Stellar, though, like Maker, which operates at a 150% collateral ration, ensuring investors of its stability.

A Question Of Repute

Regulatory and accountability risks aside, the very method of operation of stablecoins imposes reputational risk for the crypto industry. The numerous allegations of fraud against crypto projects are one thing, but allegations and legal charges of deceit and manipulation of accountability reports on collateral in the case of stablecoin projects is a completely different matter. The fact that stablecoin projects were entangled in legal cases cast doubt on the reputation of the asset class, and the industry as a whole, detracting investors from the ‘stable’ bay into the safer waters of fiat.

Conclusion

Stablecoins are still an asset class that is undefined and needs much work to be both regulated and fine tuned to achieve a level of adoption and trust that would turn them into a risk-hedging instrument. At present, the algorithms and collateralization approaches employed by various stablecoin projects are imperfect, as are the employed mechanisms of oversight. Chances are high that over time stablecoins may reach maturity and be traded on par with fiat money.