Stablecoins are an important component to the crypto-currency ecosystem. However few people are aware of the potential risks that owning stablecoins carry. The recent comments by SEC senior advisor Valerie Szczepanik suggesting stablecoins may be securities highlights the potential risks of current stablecoins. This article explores some of these risks and suggests a new alternative for those who want to avoid them.
If you hold a stablecoin that enables you to redeem the coin for US dollar, Euros or any other currency, holding the coin exposes you to counter-party risk. Counter-party risk means the risk that the coin issuer, their bank, trust company or other entity employed in the redemption process fails.
For example, Tether banks with Deltec Bank & Trust Limited based in the Bahamas. If you own Tether what do you know about this bank? If the bank fails, or is corrupt then your ability to redeem Tether for US dollars may be limited or non-existent if these events take place.
USDcoin uses several banks, Silvergate Bank, US Bancorp Asset Management (USBAM). The website says:
“Silvergate will serve as settlement bank, where all transaction-related activity will be managed, whereas USBAM will hold USDC reserve balances.”
If you use USDcoin to trade or hold as a cash equivalent you need to be aware that your ability to redeem your coins depends upon the integrity of these organisations. Investing is always a balance between risk and return. In mitigating counter-party risk it is important to read the small print and do your due-diligence.
That said, however good your due-diligence is the very fact that stablecoins offer you a redemption process where you can exchange your coins for fiat (or gold) exposes you to the systemic risk of the financial system collapsing. This risk may seem slight, however the more you understand about systemic risk the less easy it is to shrug off.
In essence the financial system is now just one system like a single super-computer. This has been brought about because the overwhelming majority of financial instruments such as options, futures, and swaps are derivatives. Being a derivative means that the value of the instrument depends upon the value of another, underlying asset.
Institutions trade these derivatives between themselves. This has created the situation where, for example the value of Deutsche Bank depends on the value of Bank of America because they have traded these instruments with each other.
So what’s the problem you say? The problem is that if Deutsche Bank fails, it is going to take Bank of America down with it because Bank of America becomes insolvent without the underlying asset of the derivatives it has traded with Deutsche Bank. Bank of America then fails and this triggers other failures throughout the system.
This is exactly what happened on 15th September 2008 when Lehman Brothers failed. Governments around the world had to step in to guarantee bank deposits and pump trillions of dollars into the system to keep it afloat.
Because stablecoins have banks and other institutions as part of their redemption process they are part of this systemic risk. Circle, the owner of USDcoin may be the most reliable, squeaky clean company on the face of the Earth. It makes no difference. If the system goes down your ability to redeem tokens may fall to zero.
Systemic risk may sound like scare-mongering but the reality is that a holder of stablecoins carries a level of risk that would never be contemplated by companies like Google or Amazon. Google would never run its services on a single super-computer, not matter how amazing. The risk of catastrophic failure would be just too great. Instead it uses over two and a half million servers. It knows a portion of these will fail but none of these failures is going to bring down the company. If Google would not tolerate this level of risk why should you?
Law makers create rules for us to live by. Unlike a truly decentralised system like Bitcoin where there is no ownership, stablecoins are all issued by someone with a head office somewhere. Governments have the power to seize bank account assets if they suspect suspicious behaviour. They also have the ability to re-write the rules if required. The haircut Cyprus bank account holders took in 2012–13 banking crisis is an example of what governments can do.
Because the value of stablecoins relies on the value of other assets such as US dollars or Euros, these assets are always open to the risk that either the coin issuer or their partners fall foul of the law or that the laws change preventing you from being able to redeem your coins. The comments by SEC senior advisor Valerie Szczepanik are an example of this: existing stablecoins may be classed as securities severely limiting their lawful use.
Because stablecoins are part of the crypto ecosystem there is a perception that they are somehow at arm’s length from regulators in the same way as Bitcoin. This is not the case. Asset freezing or seizures remain risks stablecoin users have to contend with.
There is also the thorny issue of whether existing stablecoins are securities under SEC laws. Benjamin Sauter and Jake Chervinsky of Kobre & Kim LLP believe the issue is far from clear and both the SEC and the Commodity Futures Trading Commission (CFTC) may have grounds to class them as securities if they choose.
Enter Saver Token
There is nothing like a good look at risk to sober the mind. The exercise is not designed to dissuade the use of stablecoins but make sure we know the terrain. Most of these risks are only discussed in the fine print of stablecoin websites if at all and therefore should see the light of day.
Branton Kenton-Dau had no intention of countering these risks when he developed Saver Token https://savertoken.life/ . The purpose of the token was to enable people to inflation-proof their investments by a token tracking the value of the US Consumer Price Index (CPI-U). That would mean a token would buy the same amount of goods in 5, 10 or 30 years’ time as it does today. However as he got closer to the 25th April launch he began to realise that the way Saver Token had been built helps stablecoin users overcome many of the risks just discussed.
How is this done? Saver Tokens hold no underlying assets. With no underlying assets there are no banks, no trusts, and no redemption mechanisms. With no counter-parties there can be no counter-party risk. With no counter-parties there is no exposure to the risk of the financial system collapsing. With the tokens traded on the Waves DEX there is less chance that regulators can seize what you own.
Saver Tokens have no underlying assets because the project expects token holders to create the value of the token themselves. One of the great open secrets of our time is that only people can create financial value. Not governments or banks. Money, like language is a human artefact. All the derivatives that constitute today’s financial system must eventually have their value based on something that people give value to in themselves. The list is pretty small: land, property, currencies, commodities and some crypto currencies such as Bitcoin.
Saver Tokens makes explicit use of this value-creating-ability of people. The website has a Savers Pledge that ensures everyone is aware that Savers function like Bitcoin, the US dollar or any other currency where the value is based upon the need and expectation of users. As the only reason to buy Saver Tokens is to trade them at the Target Price of the CPI-U index all token holders have a vested interest in doing this.
The great advantage of people re-discovering their value-creating ability is that like Bitcoin, Saver Tokens are a self-contained independent silo of value. With the tokens secured on the Waves blockchain, if the rest of the financial system experiences meltdown the tokens would still be accessible.
To put this another way, counter-party, systemic, and to some extent regulatory risk are functions of a system where the fact that people create value has been obscured. By being up-front about this Saver Token avoids the majority of these risks. This does not mean Saver Token is without risks of its own. All investment products carry risk. To say otherwise would be naïve. But by closely following the design of Bitcoin (without the volatility) Saver Token holds promise as a de-risked stablecoin alternative. The FAQ section of the website goes into more detail.
If stablecoin holders switch to using Saver Token they receive an unexpected bonus. Stablecoins are not that stable. If linked to a fiat currency they are depreciating assets. For example the US dollar loses on average 33% of its value every 10 years. By tracking the US CPI-U Saver Tokens are designed not to depreciate. This makes them a return to genuine stable money as well as avoiding many of the risks plaguing stablecoins today.