Even as they have proliferated in recent times, stablecoins – cryptoassets that have a stable value with respect to a basket of goods or fiat currencies – present their set of issues. Analysts from investment bank JP Morgan highlighted some of them in a note to clients.
The first problem with stablecoins is that they may not be able to maintain their value during periods of stress. Specifically, the lack of a financial infrastructure for emergencies, such as short-term loans to tide over a payments issue, may be a hindrance to their growth.
“The risk of payment system gridlock, particularly during period of stress, could have serious macroeconomic consequences,” the analysts wrote. In other words, stablecoins with high demand and low liquidity at their disposal may face scaling issues because the current regulatory structure does not accommodate them.
The analysts also noted that negative yields, which are fast becoming common throughout much of the developed world, may afflict stablecoins backed by fiat currency and treasury reserves. Several government bonds have already veered into negative territory and this may prove problematic for the overall value and profits from stablecoins for investors.
Facebook’s Libra cryptocurrency, which will be backed by a reserve basket of currencies, may be exposed to such risks. “Any system that relies on reserve-asset income to fund operational and other ongoing costs becomes unstable in a negative yield world,” the analysts wrote. “With more than half of the high-quality short-term sovereign debt already negative, the vast majority of the remainder made up of U.S. government securities, and trends pointing towards global monetary easing, a fully negative yielding Libra reserve has become a plausible (some would argue likely) risk,” the analysts stated.
The Stablecoin Risk
Stablecoins have become popular because they provide a respite from the volatility of cryptocurrency markets. Some have said they might fulfill Bitcoin’s original promise of becoming a transaction mechanism for daily use.
They come in different forms. Some are backed by fiat currencies and government bonds, others by commodities like gold and silver, and still others by prominent cryptoassets, such as Ethereum and Bitcoin.
But that backing has, so far, been fraught with complications and controversies. Tether, the most popular stablecoin and the world’s sixth- most valuable cryptocurrency as of this writing, has been dogged by controversies that its reserves are not fully-backed with the US dollar. Despite shunting between banks and financial service institutions, the stablecoin’s backers have refused to submit to a public audit of their finances.
In the absence of a viable banking alternative, stablecoins within crypto have also set up complex inter-relationships that may not hold in case of problems. MakerDAO, a popular stablecoin platform, has a liquidity providing contract – a smart contract that trades with Ethereum’s blockchain, to enable users to exchange DAI, the platform token, for Ethereum’s Ether. The problem is that Ether has a volatile price history which, in turn, may decline the value of an investor’s holdings.