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BERKELEY, California (Project Syndicate) – While cryptocurrency craze may have peaked, new units continue to be announced, apparently from the day. Among the new arrivals stand out the so-called "stable coins". Bearing names such as Tether, Basis and Sagacoin, their value is strictly linked to the dollar
BUXX, -0.32%
the euro
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or a basket of national currencies.
It is easy to see the attractiveness of these units. Vital money provides a reliable means of payment, unit of account and reserve of value. But conventional cryptocurrencies, like Bitcoin, exchange at wildly fluctuating prices, which means that their purchasing power – their dominance over goods and services – is highly unstable. So they are unattractive as a unit of account.
The problems with the last wave of cryptocurrencies will be familiar to anyone who has even met a single study of speculative attacks on the exchange rates anchored, or to anyone who has had a coffee with a central banker in emerging markets. But this does not mean that the defects of these schemes will be familiar to investors.
No healthy grocer would have rated the products on its shelves in Bitcoin
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. No worker would want a long-term employment contract that would pay them a fixed number of such units.
Moreover, since their ability to command goods and services in the future is similarly fluctuating, cryptocurrencies like Bitcoin are not attractive as a store of value. (Cryptocurrencies are also put to the test as a means of payment, but let's leave this alone for now.)
Stable currencies claim to solve these problems. Because their value is stable in terms of dollars or equivalent, they are attractive as units of account and deposits of value. They are not just vehicles for financial speculation.
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But this does not mean they are vital. To understand why, it is useful to distinguish three types of stable coins.
The first type is fully guaranteed: the operator holds reserves equal to or greater than the value of coins in circulation. Tether, which is pegged from one to one to the dollar, claims to hold deposits in dollars equal to the value of its circulation. But the veracity of this statement has been challenged.
This still points to another problem with this model: spending. To issue a Tether dollar value for you or me, the platform must attract a dollar of investment capital from you or me and put it into a dollar bank account. One of us will therefore have exchanged a perfectly liquid dollar, backed by the full trust and credit of the US government, for a cryptocurrency with dubious support that is inconvenient to use.
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This exchange can be interesting for money launders and tax evaders, but not for others. In other words, it is not obvious that the model will be in scale, or that governments will leave it.
The second type of stable currency is partially guaranteed. In this case, the platform holds even dollars, for example 50%, to the value of coins in circulation.
The problem with this variant will be familiar to any monetary policy maker whose central bank has tried to fix an exchange rate while maintaining reserves that are only a minimal part of his liabilities.
If some coin owners doubt the life of the peg, they will sell their properties. The platform will have to buy them using its dollar reserves to prevent the price from falling. But since the stock of dollar reserves is limited, other investors rush to get out before the closet is discovered. The result will be the equivalent of a bank run, which will lead to the collapse of the peg.
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The third type of stable currency, which is not collateralized, has this problem in spades. Here the platform emits not only crypto-coins but also crypto-bonds. If the price of the coins starts to fall, the platform repurchases them, in exchange for additional bonds.
Bonds should attract investors because they trade at a discount – so that, in principle, their price may increase – and because the issuer promises to pay interest to bondholders in the form of additional currencies. That interest must be financed with the income from the issuance of future coins.
Here too, the model defect will be obvious even for a beginner banker. The ability of the issuer to serve the bonds depends on the growth of the platform, which is not guaranteed. If the result becomes less certain, the price of bonds will decrease. More bonds will have to be issued to prevent a given fall in the value of the currency, making it even more difficult to fulfill the obligations of interest.
In plausible circumstances, there may be no price, however low, that will attract buyers additional obligations. Once again, the result will be the collapse of the peg.
All this will be familiar to anyone who has even met a single study of speculative attacks on exchange rates anchored, or anyone who has had a coffee with an emerging central banker market.
But this does not mean that it is familiar to wet-behind-the-ears software engineers who advertise stable coins. And that does not mean that the flaws of their currently fashionable schemes will be familiar to investors.
This article was published with permission from Project Syndicate – The Stable-Coin Myth.
