When America’s oldest money-market fund “broke the buck” in 2008, it was a key moment of the financial crisis. The Reserve Primary Fund had to break its promise to return $1 for every share to its investors in the wake of Lehman Brothers’ landmark bankruptcy. Retail investors soon found out that banklike stability pledged by such funds did not mean banklike protection. Stricter regulations as to what money-market funds could invest in ensued. Something just as existential may be happening in the $1.3tn crypto market.
Tether, the cryptosphere’s biggest stablecoin, last week briefly broke its one-to-one link with the US dollar. Unlike Bitcoin or other more esoteric crypto assets, stablecoins are meant to avoid volatility, as their name suggests. They claim to be underpinned by real-world assets and so act as a vital cog to the crypto market, providing traders with a safe place to park their cash between making bets on more volatile digital coins. That stability is now in question, and the entire crypto market is uneasy.
Tether dropped to 95.11 cents on Thursday before recovering. It says it continued to redeem its tokens at $1 each to those who asked (it had more than $4bn worth of requests by Friday). Meanwhile, a smaller stablecoin rival called TerraUSD — which did not even claim the safety net of actual reserves and instead relied on a peg run by algorithms — collapsed in value.
If armchair investors lose their shirts and a few crypto bros see their egos deflated, the reaction may be a shrug of the shoulders. It is not as if there were no warnings. But that underestimates the risks to the real economy from the $180bn stablecoin market.
If Tether does indeed have $80bn of assets to back its 80bn coins in circulation, this would place it among the world’s biggest hedge funds, with almost half its holdings in US Treasuries and another quarter in corporate debt. If a fire sale of these assets ensues as Tether tries to retain its dollar peg, or faces a wave of redemptions, the sheer size of such moves could make already jittery financial markets even more volatile.
It does not help that there have been persistent questions over whether Tether’s assets really do fully back its coins, and related fines from two US watchdogs. Reports suggest that some of the corporate debt is issued by Chinese companies. Even in the face of last week’s farrago, the company has resolutely refused to detail how its seemingly vast reserves are managed, claiming that this amounts to its “secret sauce”. Banks have found, to their cost, that distrust only prompts a rush for the exit. The faith of crypto’s true believers may yet be sorely tested.
This means politicians must stop dithering and heed the warnings about stablecoins from central banks like the Federal Reserve, Bank of England and European Central Bank. Banks keep only a fraction of their assets as liquid reserves to back up the value of deposits. In return, they are tightly regulated. Stablecoins can prompt banklike runs yet enjoy the scant regulation of the cryptosphere. Real-world rules are needed.
Part of the problem is trying to define what crypto assets are, and therefore what agency should have oversight; stablecoins muddy definitions further. Another issue is countries’ wildly divergent attitudes to crypto: where some see risk, others see reward. Unless they move in concert, action is futile, as the UK watchdog found when it rejected Binance, a big crypto exchange that has since been welcomed by France. But turf wars are a distraction when it comes to a $180bn market with global reach. The risk of inaction is that financial stability is threatened by stablecoins’ next, bigger wobble.