Stablecoins Are Not Sound Money, Bank for International Settlements Warns

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Stablecoins are not sound money, as recent market turmoil and the collapse in prices of major cryptocurrencies show, warns the Bank for International Settlements (BIS).

In a chapter of its 2022 annual economic report, advanced on Tuesday, the BIS says that these cryptocurrencies pose new financial risks because they do not meet the demands of security, responsibility, efficiency, inclusion and openness for a usable digital monetary system.

Therefore “a digital version of money issued by the central bank could provide many of the same features offered by cryptocurrencies and stablecoins,” according to the BIS, which is based in the Swiss city of Basel.

This could avoid the structural limitations and risks of crypto assets, including congestion, high fees, and pseudo-anonymity, features that can facilitate abuse and illicit activity.

The economic adviser and head of studies at the BIS, Hyun Song Shin, said that “central banks seek to push the frontiers of what is possible, adopting new capabilities while ensuring that financial services are stable and interoperable nationally and internationally” .

THE COLLAPSE OF UST

The BIS discusses in the report the recent collapse in May of the terraUSD (UST) stablecoin, which is pegged to the dollar.

UST is the stable currency of the Terra ecosystem, created by the Korean Do Kwon and his company Terraform Labs. On the Anchor platform they even offered up to 20% annual deposit interest for saving UST.

Its use grew rapidly in 2021 and 2022 and before its collapse in May it was the third-largest stablecoin with a market capitalization at times reaching $18.7 billion.

Stable cryptocurrencies are digital assets that try to maintain a price without great volatility such as bitcoin or ether by being linked to assets that are considered safe such as the dollar.

UST was pegged to the dollar backed by an algorithm that constantly creates or destroys the currency to adjust its value to keep it pegged to the dollar.

Furthermore, UST is backed by the Luna token, which is also used to stabilize its price.

If the value of UST went above a dollar, you could exchange a dollar of Luna for UST and earn the difference and if the value of UST fell below a dollar, you could exchange UST for Luna and get the profit on the exchange.

In this way, the value of UST was adjusted to parity with the dollar, increasing or reducing its offer on the Terra platform as appropriate.

This could only be done if Luna’s market capitalization exceeded that of UST.

Luna’s value came from the entry of speculative users into the Terra ecosystem.

“To the extent that users were confident in UST’s stable value and Luna’s sustained market capitalization, the system could be maintained,” according to the BIS.

But once investors lost confidence, the system crashed and in May the value of UST almost hit zero.

What happened is that UST lost parity with the dollar and fell to 99 cents, then continued to fall until it lost almost 99% of its value in a few days.

Users destroyed their UST on a massive scale at a Luna dollar in hopes of selling Luna as long as it had any value, but given the size and speed of the impact, trust was gone and not enough people wanted to buy new Luna coins, so its price also collapsed, explains the BPI.

The crash of UST and Luna spread to other major crypto stablecoins.

The cryptocurrency Tether fell to a value of $0.95 and suffered outflows of more than $10 billion in the weeks that followed because it did not provide details of its reserve portfolio, so investors worried whether Tether had enough quality assets to sell. could be liquidated to support the parity with the dollar.

It seems that the regulated stablecoin USDC, which has better documented reserves, received the funds coming out of Tether.

Last year the BIS also addressed central bank digital currencies in its annual economic report.

90% of the world’s central banks are currently working on the design of wholesale or retail digital currencies, one of which is the People’s Bank of China, which has 261 million users.

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