The existential threat facing stablecoins
Stablecoins — digital currencies linked in a fixed 1-to-1 exchange rate to real currencies like the dollar or the euro — face an existential threat from the world's central banks.
Why it matters: If the future of currency is digital, then stablecoins offer version 1.0 of what a digital dollar might look like. But they are also under-regulated, systemically risky, and uniquely vulnerable to the rise of official central bank-backed digital currencies, or CBDCs.
Where it stands: Stablecoins have been growing fast. The two largest, Tether and USDC, are now worth more than $100 billion combined, up from less than $25 billion at the beginning of the year.
- The quality of the collateral backing Tether, and even the existence of that collateral, is worryingly vague. Fears remain that if Tether is revealed to be a Ponzi, its collapse could bring down bitcoin and the whole world of cryptocurrency.
- The dream of stablecoins is that they will be used for payments — and that's already beginning to happen, in a very small way.
- Regulators have taken note: The Bank of England, for instance, in a new discussion paper, has made it clear that stablecoin payments need to be regulated just as assiduously as anything passing through the banking system.
The big picture: A CBDC is the ultimate stablecoin. Rather than forcing users to trust that some private company is backing its coins with real currency, CBDCs are directly backed by the full faith and credit of the sovereign.
- Stablecoin defenders, like Circle, which issues USDC, say that CBDCs could destabilize the banking system by causing deposits to migrate from banks to retail accounts held directly at the central bank.
- Yes, but: CBDCs can easily be set up as two-tier systems where banks issue their own wallets and individuals can't hold direct accounts with the central bank.
Between the lines: Early CBDCs have been introduced either in countries where the government desires visibility into every commercial transaction (China), or in countries where traditional banking and payments are extremely difficult for topographical reasons (the Bahamas).
- The Fed is moving slowly on creating its own digital currency — this is an area where there's no real first-mover advantage, and where countries can learn a lot from those who go before them.
The bottom line: Stablecoin issuers aren't going to face direct competition from the U.S. government any time soon. But, in 2008, money-market funds almost brought down the financial system. No regulator wants to take the risk that stablecoins might similarly become too big to fail.