Stablecoins such as Tether have been in the news lately as regulators discuss potential regulations for these crypto asset and some search for what is actually backing these stablecoins.
Before going any further, let's clarify what exactly stablecoins are.
What is a Stablecoin?
Stablecoins are a type of cryptocurrencies that are intended to maintain a steady price. Most of them are backed by some sort of reserves such that converting a stablecoin to dollars should be pretty easy, and there should be enough dollars to redeem each coin. The effectiveness of a stablecoin’s ability to hold a steady price is largely dependent on those reserve assets, and investors' faith in them. Some coins can become unhooked from the currency they are supposed to remain "pegged" to. but other coins like Tether have been largely successful.
A stablecoin has two primary functions; Stable valuations on part with a fiat currencies such as the dollar or euro, and instant processing with a high level of security and privacy offered by blockchain technology. These two principles allow traders to convert other currencies, such as bitcoin or dollars, quickly into a stable crypto currency that investors can be confident will hold roughly the same value tomorrow.
An investor who wants to convert Bitcoin into dollars because they are bearish on bitcoin’s future price movement or simply wants to hold a more steady investment, can convert bitcoins into a stablecoin for a fast and secure transaction on the blockchain. This is possible since stablecoins, such as Tether, USD Coin, and Binance USD, are designed to always equal $1. Tether, for example has traded between $0.99 and $1.01 for all of 2021 for one day where it jumped all the way to $1.02.
Stablecoins allow traders to move between cryptocurrencies or even across international borders easier than with fiat currencies. By being both on a blockchain, and backed by some real asset, they provide the stability of regular currency, while also providing some of the advantages of cryptocurrencies.
What’s the Current Situation?
The main problem with stablecoins at the moment is that there are few or no no regulations. Having an asset that allows for an easy and quick transfer of money across the world is great but can be taken advantage of by criminals ranging from terrorist organizations to people trying to avoid taxes.
The government isn’t concerned with someone using Tether to quickly switch between Bitcoin and Ethereum. But someone compensated for illegal activity in bitcoin that then uses a stablecoin to convert those bitcoins into a more widely accepted fiat currency isn’t the kind of thing regulators like. These kinds situations become increasingly problematic when cryptocurrencies are being moved across borders in an attempt to avoid even more regulations.
Just recently, a presidential commission recommended that stablecoin issuance be restricted to banks to give regulators more jurisdiction over them. Top regulators think the coins strength as a digital payment method but need more oversight as they are linked to national currencies and are used as a place to temporarily hold assets.
What’s Backing These Stablecoins?
For Tether's price to remain $1.00 there should be one U.S. dollar of assets for each Tether. Tether Holdings Ltd. acts essentially as a bank in that it takes dollars from investors and credits them with Tether so that people can use the coins on crypto exchanges to bet on bitcoin, ether, or any other crypto. Thus, Tether Holdings is supposed to have enough assets to maintain a 1-to-1 exchange rate of Tether to dollars.
There are currently roughly 70 billion Tethers in circulation meaning that Tether Holdings Ltd. should have $70 billion in assets. However, many critics doubt that Tether actually holds that many assets. Further if enough people tried to redeem Tethers all at once, it could set of something of a bank run, forcing Tether to liquidate a lot of assets all at once, which could potentially have a negative effect on the broader credit markets.
The reality is that many of stablecoins insist that they are backed properly by reserve assets but without regulations and transparency, there’s little in the way to confirm that.
