The Secret Dangers of Stablecoins
The concept is simple, but not altogether novel. What do you do to ensure confidence in your currency, crypto or otherwise, especially if you have no track record and haven’t had sufficient time to build up governmental credibility or the strong legal, social and economic institutions to support the stability of your currency? Why, you peg it to something that already has of course.
1. The 1997 Asian Financial Crisis
The concept of pegging one nation’s currency (especially a nation from the developing world) to a more stable currency (read “U.S. dollar”) is not new. Countries have done it for centuries, to ensure that imports are not kept too expensive, while maintaining the strength of their exports, especially where said exports are dollar-denominated commodities. Southeast Asia is blessed with an abundance of natural resources. Tin, rubber, oil palm, natural gas, oil, copper, silver and rice, the region is a cornucopia of the stuff that the rest of the world wants. But in the latter half of the 20th century, Southeast Asia was just coming off the ravages of the Second World War and rebuilding its hitherto agrarian and commodity-dependent economy. Industrialization was nascent and to ensure that countries like Thailand, Malaysia, Indonesia and the Philippines were able to fund their ambitious infrastructure and modernization projects, dollars were needed. To ensure that these dollars weren’t too expensive, a managed exchange rate, one where the value of the local currency was pegged to the dollar was used to ensure price stability domestically and also so that exports brought in sufficient hard currency.
But by the midsummer of 1997, profligate borrowing of dollars in Thailand had reached a point where the Thai baht (the Thai local currency) had reached such a point where there were murmurs among foreign exchange speculators that the Thai government no longer had sufficient hard currency reserves to keep the artificial peg of the baht to the dollar. Speculators, like vultures circling a weakened member of the herd on the plains of the Serengeti swooped what looked like easy pray. Although George Soros (who first shot to notoriety for shorting the British pound) took most of the blame, there were other actors as well. Whether or not Soros and Co. were ultimately responsible for setting off the Asian Financial Crisis, governments from Thailand to the Philippines could no longer support the artificial peg of their currencies against the dollar. Eventually, their tiny foreign exchange reserves ran dry.
The fallout from the Asian Financial Crisis was felt broadly across almost all Southeast Asia’s financial markets. As foreign capital pulled out of what was then labelled another emerging world “basket case,” it took the region a full two decades to return to prominence.
A currency peg is a tricky thing to maintain at best. Which is why Singapore’s central bank, the Monetary Authority of Singapore keeps its cards close to its chest, weighting the Singapore dollar against a basket of global currencies, which only the very top brass of the central bank know of. There are many moving parts when you’re trying to stave off inflation while keeping exports cheap. But the lesson from the Asian Financial Crisis was this, ultimately, the region suffered a crisis of confidence, which sent currencies like the Thai baht, the Malaysian ringgit and the Philippines’ peso into a tailspin.
Could the same thing happen for stablecoins?
2. Are stablecoins an accident waiting to happen?
Since cryptocurrency values have a tendency to fluctuate wildly against the U.S. dollar, a stablecoin, pegged by an asset such as gold or the U.S. dollar should provide price stability and allow for greater and widespread adoption of cryptocurrencies in general. The concept of stablecoins is sexy in its elegance, but belies a more worrying assumption. Unlike the currencies that were backed by governments in the Asian Financial Crisis, the pegs of stablecoins are maintained by companies. We’ve already seen how even Tether (USDT), the first widely accepted stablecoin was subject to scrutiny when allegations rose of how Tether simply issued more USDTs to manipulate the value of Bitcoin and was not backed by genuine U.S. dollars in deposit. Tether itself fired its auditors (not a good sign) and finally settled on a law firm to back its claim that every USDT was backed by a good’ole greenback. Contrary to popular belief, lawyers are not the equivalent of auditors.
An auditor conducts investigations into a firm’s accounts, valuing its assets, determining if its balance sheets are a true reflection of a company’s financial affairs and state. But a law firm is in the business of opinions (educated, evidenced or otherwise). What should have been a straightforward exercise — are the dollars in Tether’s bank or not? — turned into one big fiasco. And while Tether continues to rank among the top ten cryptocurrencies in the world by market cap, clouds remain over whether or not the dollars are truly there.
In the corporate world, it’s not uncommon to go shopping for auditors until one finds an “amenable” auditor to represent a financial state of affairs that suits your needs. Large, listed companies typically use one of the big four accounting firms because that provides an air of credibility. Tether went straight for a law firm.
Unlike currencies pegged to the U.S. dollar, there’s nothing to stop a stablecoin from issuing more of their coins, even if the assets which back them are insufficient. In many ways, it’s the ultimate cover for a ponzi scheme. Because unlike a cryptocurrency which exists on a public blockchain and is open to inspection by anyone, the assets backing stablecoins are opaque and anathema to the very ethos of transparency that was the genesis of the blockchain. For adopters of stablecoins, you’re not betting on the asset behind the stablecoin, you’re betting that a COMPANY will not defraud holders of the stablecoin by minting so much of the stuff without the assets to back it. And unlike in a sovereign nation where the central bank acts as the buyer of last resort, there is no buyer of last resort when it comes to stablecoins.
If a run occurs on any stablecoin, there’s no guarantee that the firm issuing the stablecoin will take the necessary steps to shore up the value of said stablecoin. Nor that the stablecoin issuer will make available the assets backing the stablecoin for inspection. To make matters worse, even if the stablecoin issuer were able to produce all of these proofs that the stablecoin is backed by the assets it claims to be backed by, there’s no guarantee that the stablecoin has sufficient use to ensure a ready market for the stablecoin. Even more so than countries pegging their currencies to the dollar, where IMF bailouts are still a possibility, there are even more assumptions and moving parts when it comes to stablecoins.
Finally, a stablecoin such as one backed by gold or the greenback assumes that the value of the asset which it is based on has a stable value as well — a huge assumption. Gold moves opposite to the dollar which moves opposite to interest rates. Think of it as trying to juggle an iron, a bowling ball and a tennis racket while playing a guitar with your feet. When it comes to commodity trading at least there is one base currency — the dollar, but with stablecoins, there is the value of the stablecoin relative to the asset it claims to be backed by and the movement of the underlying asset’s value versus the dollar it is based on.
Does that mean that stablecoins are a no-go? Not exactly. But I wouldn’t be betting the farm on them for now. The idea of swapping a cryptocurrency which is open for inspection on the blockchain for an opaque altcoin based on the opaque promises of a commercial entity seem to me to be a step backwards on Satoshi Nakamoto’s original vision.
Bitcoin and the blockchain were supposed to take us further into a world where trust wasn’t needed. Math, code and cryptography would finally remove the need for “trusted” intermediaries. Stablecoins instead introduce more intermediaries which we need to trust.