Can cryptocurrency turn the tide?

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Some cryptocurrencies known as stablecoins today are the economic equivalent of money market funds, and in some cases their practices should cause us to fear that they will break the ball, creating significant damage to the market. broader crypto market.

One of those stablecoins is Tether. With a market cap close to $ 60 billion, it’s almost as big as the reserve fund was in 2008. Each Tether token equals $ 1. But, as with the Primary Reserve Fund, the true value of these tokens depends on the market value of Tether’s reserves – the portfolio of investments made with the fiat currency it receives.

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Tether recently revealed that as of March 31, only 8% of its assets were in cash, treasury bills and reverse repo notes. Almost 50% were commercial paper, but no details were provided on its quality. “Fiduciary deposits” represented 18%. Even more troubling: 10% of total assets were in “corporate bonds, funds and precious metals”, almost 13% were in “secured loans (none to affiliated entities)” and the rest in “other”, which includes digital tokens.

Tether separately provided a report from accounting firm Moore Cayman indicating that Tether’s assets exceed “the amount required to redeem” the tokens in circulation. But that report did not provide any description of the assets. It appeared to be based solely on management’s accounting, noting that Tether’s policy is to use “historical cost” and that “the realizable value of these assets[…]could be significantly different ”.

These facts should warn holders of Tether – and other stablecoins – that they might struggle to get $ 1 back for each token. Tether does not claim that its tokens are backed by fiat currency. He is simply saying that his tokens “are 100% backed by Tether’s reserves,” which are defined so broadly that any asset could be eligible. Tether also says that it “reserves the right to delay any refund or withdrawal if such delay is necessitated by the illiquidity or unavailability or loss of any Reserve” and that it “reserves the right to redeem Tether tokens through in-kind redemptions of securities and other assets held in the Reserves. “

A money market fund would never be allowed to follow such policies. The Securities and Exchange Commission allows money market funds to use a net asset value of $ 1 under stable pricing conventions – valuing assets at amortized cost rather than market price, and using pricing “rounded to a dime.” “- on the sole condition of limiting their risk. investments should have minimal credit risk and short maturities, such as short-term government securities and high-quality commercial paper, and they should limit the amount invested in a single issuer. The board of directors of the fund must also believe that a net asset value of $ 1 reflects the market value of its assets.

But stable coins like Tether don’t face such constraints. There is no US legal framework to regulate them. There is no requirement on how reserves are to be invested, nor any requirement for audits or reports.

If any of Tether’s investments became worthless or lost value, he would suffer the equivalent fate of breaking the bullet. And if for some reason a wave of Tether holders suddenly tried to convert their tokens to cash, we don’t know if Tether could liquidate enough investments quickly to meet demand.

The consequences of such an inability to cope with a sudden wave of withdrawals could be significant in the larger crypto ecosystem. Tether is the most traded cryptocurrency; its recent volume has been more than double that of Bitcoin. Coindesk recently described Tether as “a key plumbing fixture for the roughly $ 2 trillion global crypto market,” as traders “use it to quickly transfer dollar value between exchanges in order to grab arbitrage opportunities when a bank transfer is unavailable or too slow “.

A research report from JPMorgan earlier this year stated that 50% to 60% of all Bitcoin transactions are for Tether, and trading is dominated by proprietary trading companies using high frequency algorithmic strategies. If these algorithms were turned off – as has happened in Treasuries and other asset classes when volatility increases – there could be a significant drop in liquidity. “A sudden loss of confidence in [Tether] would probably generate a serious liquidity shock in the Bitcoin markets, ”he noted.

It’s easy to imagine other collateral consequences, especially since the recent rise in crypto prices has likely been fueled in large part by debt. When liquidity suddenly drops and prices fall, those in leveraged positions are in a hurry.

About 65% of Tether tokens are held through the Chinese exchange Huobi, according to crypto analysis firm Long Hash. Chinese investors may convert the renminbi into Tether in order to trade other cryptocurrencies while avoiding legal or regulatory constraints. Ownership is also highly concentrated, according to Coinmarketcap. Although there are nearly 3.5 million addresses that hold Tether tokens, the top 10 addresses hold 24% and the top 100 hold 41% of all tokens. This could increase the risk of leakage.

Just two years ago, stablecoin risks were brought to public attention by Facebook Inc.’s proposal for Libra. He wanted to create a “single world currency” or a stable currency that would be pegged to a basket of fiat currencies. It has sparked widespread opposition from central bankers and politicians, with many fearing it will undermine sovereign currencies. Facebook then had to promise during congressional hearings that it would not launch the idea unless regulators approved.

In the months that followed, the Financial Stability Board proposed some principles for regulating stablecoins, which Donald Trump’s administration broadly endorsed in a press release last December. These included restrictions on reserves, limits on risks and transparency requirements. Libra, now called Diem, has been redesigned to address many of these concerns. But regulators have not approved it and, more importantly, the United States has not implemented the principles of counseling in general.

Last fall, the Office of the Comptroller of the Currency issued guidelines that national banks could hold stablecoin reserves if they verified daily that reserves were at least equal to tokens in circulation. But stable coin issuers do not have to follow OCC guidelines. Tether, for example, keeps its reserves in a small bank in the Bahamas.

We need to strengthen the regulation of cryptoassets in general and stablecoins in particular. A bill has been introduced in Congress that would require stablecoins to be issued by a bank and impose certain standards, but no one can guess if that goes ahead.

So maybe Gary Gensler, the new SEC chairman, should consider regulating stablecoins the same way as money market funds: issuance of a stablecoin should be conditional on adherence to limiting practices. risks designed to ensure that the tokens are worth that price. These should limit reserve investments to those with minimal credit risk and short maturity. There should also be liquidity requirements.

The SEC is about to review the adequacy of its regulation on money market funds because the reforms it imposed following the 2008 financial crisis were not sufficient. When financial markets became very stressed in March 2020, a rush on money market funds was only prevented by the extraordinary interventions of the Federal Reserve. Hopefully regulators take a closer look at stablecoins before they experience the crypto version of the disclaimer.

This story was posted from a feed with no text editing.

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