How Stable Are Stablecoins?
INSIGHTi
How Stable Are Stablecoins?
July 28, 2021
Stablecoins are a type of digital asset generally designed to maintain a stable value by linking its value to
another asset or a basket of assets. The term stablecoin does not affirm that a particular coin actually
achieves a stable value. Some consider terms such as “private asset-linked tokens” as better descriptors of
the nature of the instruments. Collateral backing stablecoins could include fiat currencies, traditional
financial assets, or other digital assets. The top three stablecoins by value (Tether, USD Coin, and Binance
USD) reached around $100 billion in market capitalization as of July 2021. Stablecoin-related policy
concerns include issues related to market integrity, investor protection, financial stability, monetary
policy, payments, and illicit activity prevention. This Insight focuses on stablecoins’ design structure,
selected investor protection issues, and financial stability concerns.
Stablecoins’ Investment-Fund-Like Structure
Stablecoins often have reserve asset portfolios that hold collateral assets backing the coins’ value. Many
industry observers view this structure to be similar to pooled investment vehicles, such as exchange-
traded funds (ETFs) or money market mutual funds (MMFs), which are overseen by the Securities and
Exchange Commission (SEC).
Some stablecoins’ perceived investment fund structure has captured congressional attention in recent
years. For example, the Facebook-backed stablecoin Libra, which was later renamed Diem, has attracted
congressional inquiries since its announcement in 2019. At related congressional hearings, Facebook
received multiple questions regarding whether Libra was an ETF and how it should be
regulated. Facebook argued that Libra was a payment tool instead of an investment vehicle because “you
cannot use an ETF for payments” and it did not meet the Howey Test criteria used to determine if a
financial instrument is a security.
If a stablecoin were to be deemed an ETF or MMF (either through interpretation of the existing legal
frameworks and SEC authorities or the creation of new frameworks and authorities), it would be required
to comply with the SEC’s regulatory regime governing securities, investment advisers, and investment
companies. In this case, SEC approval would be required to launch stablecoin projects.
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Investor Protection: Disclosure and Transparency
The largest stablecoin, Tether, was created in 2014 with a prospectus that states, “each tether issued into
circulation will be backed in a one-to-one ratio with the equivalent amount of corresponding fiat
currency.” Subsequently, the New York attorney general’s office investigations revealed that it was
not fully backed in this way at all times, raising investor-protection concerns. The office charged Tether
and its affiliated trading platform Bitfinex $18.5 million to settle a case in 2021, claiming that the
stablecoin overstated its reserves and covered up losses. Tether and Bitfinex denied any wrongdoing but
paid the fine and agreed to provide quarterly disclosures of reserve assets. With Tether’s first disclosure of
its reserves breakdown (Figure 1) for March 2021, investors learned for the first time that a large portion
of Tether’s reserves was in unspecified commercial paper, a type of short-term debt instrument that could
expose the holder to losses in the event of issuer default or substantive collateral downgrade, although
such events are rare given the short-term nature of the instrument.
Tether’s market valuation achieved around $60 billion as of July 2021, and some observers worry that any
potentially deceptive activities may create widespread harm to investors. Tether’s disclosure of reserve
asset breakdowns, which allowed investors to identify Tether’s potentially deceptive claim that it would
be backed by fiat currency one-to-one, drew discussions about whether such disclosure should be more
broadly mandated for other stablecoins. Opponents of such a mandate worry that additional disclosures
may increase compliance costs and hinder innovation.
Figure 1. Tether’s Reserve Asset Breakdown on March 31, 2021
Source: Tether; see also a summary table by Federal Reserve Bank of Boston.
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Financial Stability: Will Stablecoins Face “Run” Risk?
Industry observers and regulators have voiced concerns about stablecoins’ potential to trigger capital
markets contagion—that is, that losses or instability of stablecoins could generate distress in other
markets. For example, credit rating agency Fitch Ratings issued a release saying that Tether’s commercial
paper holdings may be larger than those of most prime MMFs—instruments that played a role in financial
instability during the 2007-2009 financial crisis and the Coronavirus-induced market selloffs in 2020, and
are currently at the center of a regulatory reform debate—and that a sudden mass redemption could affect
financial stability of short-term credit markets. In addition, Federal Reserve Bank of Boston President
Eric Rosengren reportedly said stablecoins are like MMFs, asserting that their size and opacity mean they
could pose financial stability concerns and that stablecoins’ market capitalization has reached more than
20% of the size of prime MMF assets (Figure 2).
Figure 2. Stablecoins’ Market Capitalization Relative to Prime Money Market Mutual Fund
Assets Under Management (%)
October 6, 2014-June 23, 2021
Source: Federal Reserve Bank of Boston based on data from Coin Metrics and iMoneyNet.
Some observers argue that stablecoins in general are subject to runs, if coin holders have suspicions about
their backing. Even without the influence of adverse market conditions, certain stablecoins have already
displayed run-like behavior (e.g., a large number of investors withdrawing their investments
simultaneously, which could potentially trigger negative feedback loops and contagion effects). For
example, the Iron Titanium token faced a run-like scenario in June 2021 and saw its price crash to near
zero from around $60 within one day.
Calls for Regulatory Changes
Federal Reserve Chair Jerome Powell said at a Senate Banking hearing that stablecoins are not yet
adequately regulated, stating, “They’re like money funds, they’re like bank deposits and they’re growing
incredibly fast but without appropriate regulation.”
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At a President’s Working Group on Financial Markets (PWG) meeting in July 2021, Treasury Secretary
Janet Yellen “underscored the need to act quickly to ensure there is an appropriate U.S. regulatory
framework in place.” The PWG plans to issue stablecoin-related recommendations soon.
Bills in the 116th Congress would have subjected stablecoins to increased regulation. For example, H.R.
5197 (116th) and H.R. 8827 (116th) would have subjected certain stablecoins to securities and banking
regulation, respectively.
Author Information
Eva Su
Analyst in Financial Economics
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