Are Stablecoins Safe? Many Observers Are Growing Concerned
With the rising popularity of stablecoins like USDT and USDC, many observers are growing concerned about their risk.
- Stablecoins have emerged from virtually nothing since 2020.
- But their increasing use has regulators and investors concerned.
- Tokens like USDT, TUSD, and USDC remain largely unregulated.
Stablecoins have grown rapidly over the course of the 2020s, with the market expected to reach $2.8 trillion in the next five years, up from $124 billion currently, according to private wealth manager Bernstein. However, stablecoins are mostly unregulated, despite their widespread use and their providing most of the liquidity for decentralized finance (DeFi) protocols.
This rapid growth coupled with a lack of regulation is causing observers to voice mounting concerns. With tokens like USDC and USDT becoming an ever more important part of the financial system, we look at some of the risks emerging on the horizon.
Lack of Audit or Reserves
Stablecoins are supposed to be backed by sufficient reserves to maintain their peg to the original asset—usually the US dollar. But some issuers have failed to prove they hold adequate reserves, raising fears that redemptions could be frozen. This happened with Tether (the issuer of USDT) in 2017 when it could not provide timely audits of its reserves.
Six years later, and we are still no closer to a full audit to prove USDT is backed by sufficient assets. The company has, however, produced attestations which verifies the accuracy of financial information. Although they lack the scope and depth of a full audit.
Price Volatility
Stablecoins are designed to do one thing: to maintain a stable value. However, several incidents have shown that stablecoin values can fluctuate, leading to big losses for investors and scares for systems relying on its value. The most devastating example took place in May 2022, with the depegging of TerraUSD. A crisis caused the stablecoin to plummet from $1 to under $0.01, causing a catastrophic domino-effect across the industry.
In October 2023, the stablecoin USDR lost its 1:1 peg to the US dollar after a run on redemptions. USDR is backed by real estate assets tokenized on the blockchain. However, most of these assets were illiquid, making it difficult to immediately sell them to meet redemption demands.
Most stablecoins, most of the time, have very little trouble sticking to their peg. But all it takes is a moderately prolonged depegging to cause a knock-on effect.Which leads us to…
Systemic Risks
If a major stablecoin collapsed, it could create contagion across crypto markets leading to heavy losses for investors. Just as TerraUSD did in 2022. Stablecoins like Tether’s USDT and Circle’s USDC have grown to hold tens of billions of dollars each. With such money behind them, regulators worry about the systemic risks if any fail.
In a 2020 report, the Bank for International Settlements wrote that “if stablecoins were to gain significant usage, runs on stablecoins could provoke fire sales of the assets used to back their value.” This, they concluded, could have “negative spillovers on the rest of the financial system.”
Crime and Money Laundering
The pseudonymous nature of crypto transactions makes stablecoins attractive for money laundering and terror financing. Criminals can convert their funds to (usually) a dollar-pegged stablecoin, and then move it through a non-KYC compliant decentralized exchange (DEX), making it harder to track. They also allow criminals to move their assets around in digital form with off-ramping to fiat.
There’s one problem, however. Not all stablecoin issuers are equally amiable with law enforcement. “USDT is really heavily used in the scamming world,” Robert Whitaker, Head of Law Enforcement Affairs at Blockchain Intelligence Group tells CCN. “Circle [the issuers of USDC] is a lot more ready to deal with law enforcement than Tether [the issuers of USDT].”
Threat to Monetary Sovereignty
The widespread adoption of stablecoins could undermine a nation’s monetary sovereignty and ability to implement independent monetary policy.
A 2023 IMF article outlined how certain emerging market economies are being significantly impacted as they witness increasing retail ownership and currency substitution. Essentially, citizens using dollar-backed stablecoins as an alternative to their own currency.
“Such substitution has the potential to cause capital outflows, a loss of monetary sovereignty, and threats to financial stability, creating new challenges for policy makers,” it read. The IMF implored legislators and regulators to get a grip and improve trust in their own currencies, banks and financial systems to avoid a flight to dollar-pegged stablecoins.
