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Why Yellen, Powell Cast a Wary Eye on Stablecoins

A pedestrian walks past signage for Ethereum, top, and Bitcoin outside the Hong Kong Digital Asset Exchange Ltd. digital currency trading store in Hong Kong, China, on Thursday, June 24, 2021. Hong Kong Digital Asset Exchange is a cryptocurrency platform and is the first to combine online and physical exchange in Hong Kong. Photographer: Paul Yeung/Bloomberg
A pedestrian walks past signage for Ethereum, top, and Bitcoin outside the Hong Kong Digital Asset Exchange Ltd. digital currency trading store in Hong Kong, China, on Thursday, June 24, 2021. Hong Kong Digital Asset Exchange is a cryptocurrency platform and is the first to combine online and physical exchange in Hong Kong. Photographer: Paul Yeung/Bloomberg (Bloomberg)
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It may seem paradoxical, but in the entirety of the wild and woolly world of cryptocurrencies, what some of the top financial regulators are most worried about is the flavor of digital money designed to be the safest. Even the name, stablecoin, exudes, well, stability. But stablecoins in general and the giant among them, Tether, have drawn increasing scrutiny amid worries that they could pose risks to cryptocurrency users and even to the global financial system. With Tether, there’s also the question of whether the $69 billion in safe assets that the company issuing the currency says is backing it are really safe.

1. What are stablecoins?

Stablecoins are digital assets sometimes referred to as coins, sometimes as tokens, that are designed to keep their value. That is, to experience only the kind of volatility seen in traditional currencies, which have price swings that are generally far smaller than those of Bitcoin. Tether, for instance, sells its coins for $1 and promises to redeem them for $1 if customers want their money back.

2. How do they do that?

In one of two ways. Collateralized stablecoins are pegged to another asset, like the U.S. dollar, and their issuers say they back up the value of their coin by holding on to that asset or something similarly safe. Other stablecoins are pegged to the price of crypto assets such as Ether or, in certain DeFi (decentralized finance) apps, collections of coins put up as collateral. Some employ algorithms to manage supply and demand of the coin so what’s in circulation matches what’s held in reserve.

3. How many stablecoins are there?

There are dozens of stablecoins in use, with a combined market value that topped $100 billion in May, and more are coming. Most of those with large followings are tied to the U.S. dollar. But the largest is Tether, which is issued by Tether Holdings Ltd. There are now 69 billion Tethers in circulation, 48 billion of them issued this year.

4. Why are the coins popular?

Stablecoins can be a bridge between two worlds that weren’t designed with mixing in mind -- cryptocurrencies and traditional finance. That makes them useful as a way to lock in gains from crypto trading or as a safe harbor if investors think a downturn is coming. They also make it easier to move funds onto crypto exchanges. Many exchanges don’t have the relationships with banks needed to offer regular currency deposits or withdrawals, but can and do accept stablecoins such as Tether. Finally, stablecoins can streamline, speed up and make cheaper purchases and money transfers by using a different technology, called blockchain, instead of the traditional payments infrastructure.

5. What’s going on with Tether?

Doubts about Tether’s backing have dogged it for years. A persistent group of critics has argued that, despite the company’s assurances, Tether Holdings doesn’t have enough assets to maintain the 1-to-1 exchange rate, meaning its coin is essentially a fraud. Tether has attempted to dispel those doubts by releasing attestations from an accounting firm stating that it does have the money, but those have raised other questions. 

6. What is Tether backed by? 

A Bloomberg Businessweek investigation, published Oct. 7, found that Tether’s reserves include billions of dollars of short-term loans to large Chinese companies -- something money-market funds avoid. It also reported that Tether had made loans worth billions of dollars to other crypto companies, with Bitcoin as collateral. Tether said the vast majority of its commercial paper has high grades from credit-rating firms, and that its secured loans are low-risk, because borrowers have to put up Bitcoin that’s worth more than what they borrow. The coins are fully backed, it added.

7. What do financial regulators say?

Two of the most powerful of them, U.S. Treasury Secretary Janet Yellen and Federal Reserve Chair Jerome Powell, have called for regulation of stablecoins. Yellen is pushing financial regulators to “act quickly” in drafting stablecoin rules. It remains unclear whether a push to treat them like bank deposits will win out over a campaign by the Securities and Exchange Commission to approach most cryptocurrencies as if they’re securities. Some say Congress must clarify the situation. The U.S. Department of Justice has also opened a criminal investigation into whether Tether executives committed bank fraud.

8. What’s the worry?

Regulators say the growing size of stablecoins has created a situation where huge amounts of U.S. dollar-equivalent coins are being exchanged without touching the U.S. banking system, potentially blinding regulators to illicit finance. “They are like money funds, they’re like bank deposits and they’re growing incredibly fast but without appropriate regulation,” Powell said in testimony before Congress. They’re also worried about a panic causing something like a bank run. Money-market funds needed swift action by the Fed during both the 2008 financial crisis and the 2020 Covid-19 market crash to keep the uninsured investment pools from possible collapse.

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