Terra’s sharp decline has re-energized crypto skeptics. On May 10, amid the collapse of Terra, Treasury Secretary Janet Yellen argued before the Senate Banking Committee that stablecoins “run risks that could pose a threat to financial stability, risks associated with the payment system and its integrity.” Clearly, not every coin that calls itself a “stablecoin” is stable, but Ms Yellen is mistaken to think that stablecoins pose a systemic risk to financial stability.
A true stablecoin is a dollar-like token collateralized by an asset worth at least $1. The best-known stablecoins, Tether’s USDT and Circle’s USDC, account for $72.5 billion and $54 billion in supply, respectively. Opportunistic regulators and politicians, notably the Securities and Exchange Commission’s Gary Gensler and Sen. Elizabeth Warren, call stablecoins “wildcat banks” and argue that they are susceptible to runs.
But Tether and Circle are different from banks. Unlike bank deposits, USDT and USDC are redeemable only in amounts in excess of $100,000 and only to Tether and a select group of Circle’s financial partners. Instead, the majority of holders of these tokens can sell them on various exchanges or swap them for goods and services. More importantly, Tether and Circle can delay or suspend redemptions at any time – a time-tested solution in history. This keeps their balance sheets intact and makes it impossible to “shorten” either by attacking the dollar peg.
The only real risk for Tether and Circle is the loss of their bond holdings. On May 12, Tether’s chief technology officer, Paolo Ardoino, clarified that “over the past six months,” the company “has reduced the size of commercial paper by 50%”. [sic], Whatever was deducted from the commercial paper was rolled over to the US Treasury. This means that the Treasury now holds 60% of Tether’s reserves and 15% of commercial paper. Circle claims that as of May 20, 76 per cent of its reserves were in treasury and 24% in cash. It would require massive corporate or government defaults for Tether or Circle to incur significant losses. In such a financial apocalypse, stablecoin pegs will be the least of our worries.
In contrast, “coupon coins” such as Terra rely on decentralized finance protocols that mint new coins when their price is above their peg and sell interest-bearing “coupons” when the price is below the peg. The logic is that investors would buy coins to receive the coupon, which would push the price back up to the peg. But once speculative demand for coins subsides, issuing more and higher-interest coupons accelerates the eventual collapse of their peg.
Terra was launched in 2019 and its creator Do Kwon launched the Anchor Protocol, which rewards users with 18% to 20% annual interest on deposits of Tera USD (UST), Tera’s stablecoin. These rewards were paid for from reserves capitalized by Terra’s parent company.
Finally, UST and Luna (a sister token redeemable to UST) only existed to provide access to Anchor’s interest rewards. The more UST issued and deposited on Anchor, the faster Anchor’s reserve funds were depleted and the more expensive it became for Terra’s hedge-fund investors to hedge UST pegs on various exchanges. Holders began cashing in on their rewards in late January, threatening the peg of UST. In early May, Terra’s parent company, along with outside investors, spent billions to stabilize UST’s peg, but could not successfully restore market confidence. Just a few days later, the peg broke as investors sold Luna and withdrew their UST from Anchor. Instead of a dollar, the UST is worth just over a penny today.
Crypto skeptics will point to Terra as another episode of “Tulip Mania”. They will be far more correct than they know. Seventeenth-century Amsterdam was engulfed in new wealth, fueling a bubble in tulip-bulb prices and futures. Yet, contrary to popular myth, the tulip frenzy was not an extraordinarily popular delusion, but a game for a small group of wealthy merchants, with minimal economic consequences for Amsterdam in the end. Likewise, despite the pain of retail investors, Terra was a game of musical chairs for a relatively small group of large investors. The top 10 wallets using Anchor accounted for 27% of all UST, and the top 1,000 held 82%.
Acting Controller of the Currency Michael Hsu recently said of the Terra collapse that “there has been no transition from cryptocurrency to traditional banking and finance.” The true lesson from Terra – as from Tulip Frenzy – is that roulette games for wealthy bookmakers carry no systemic risk. Ms Yellen should stop worrying about stablecoins. True stable coins are not wildcat banks. The US Treasury and the Federal Reserve have better things to do – such as control inflation that currently threatens the stability of the dollar.
Mr. Ferguson is a Senior Fellow at Stanford University’s Hoover Institution and founder of GreenMantle. Mr. Rincón-Cruz is a researcher at the Hoover Institution, and the founder of Buttonwood, a DeFi/Web3 open-source software project.
Wonder Land: The White House now says the US economy is ‘in transition’. He liked that part. Images: Universal Archive via Getty Images/AP Composite: Mark Kelly
opinion | Sick stablecoins may not affect financial markets
Terra’s sharp decline has re-energized crypto skeptics. On May 10, amid the collapse of Terra, Treasury Secretary Janet Yellen argued before the Senate Banking Committee that stablecoins “run risks that could pose a threat to financial stability, risks associated with the payment system and its integrity.” Clearly, not every coin that calls itself a “stablecoin” is stable, but Ms Yellen is mistaken to think that stablecoins pose a systemic risk to financial stability.
A true stablecoin is a dollar-like token collateralized by an asset worth at least $1. The best-known stablecoins, Tether’s USDT and Circle’s USDC, account for $72.5 billion and $54 billion in supply, respectively. Opportunistic regulators and politicians, notably the Securities and Exchange Commission’s Gary Gensler and Sen. Elizabeth Warren, call stablecoins “wildcat banks” and argue that they are susceptible to runs.
But Tether and Circle are different from banks. Unlike bank deposits, USDT and USDC are redeemable only in amounts in excess of $100,000 and only to Tether and a select group of Circle’s financial partners. Instead, the majority of holders of these tokens can sell them on various exchanges or swap them for goods and services. More importantly, Tether and Circle can delay or suspend redemptions at any time – a time-tested solution in history. This keeps their balance sheets intact and makes it impossible to “shorten” either by attacking the dollar peg.
The only real risk for Tether and Circle is the loss of their bond holdings. On May 12, Tether’s chief technology officer, Paolo Ardoino, clarified that “over the past six months,” the company “has reduced the size of commercial paper by 50%”. [sic], Whatever was deducted from the commercial paper was rolled over to the US Treasury. This means that the Treasury now holds 60% of Tether’s reserves and 15% of commercial paper. Circle claims that as of May 20, 76 per cent of its reserves were in treasury and 24% in cash. It would require massive corporate or government defaults for Tether or Circle to incur significant losses. In such a financial apocalypse, stablecoin pegs will be the least of our worries.
In contrast, “coupon coins” such as Terra rely on decentralized finance protocols that mint new coins when their price is above their peg and sell interest-bearing “coupons” when the price is below the peg. The logic is that investors would buy coins to receive the coupon, which would push the price back up to the peg. But once speculative demand for coins subsides, issuing more and higher-interest coupons accelerates the eventual collapse of their peg.
Terra was launched in 2019 and its creator Do Kwon launched the Anchor Protocol, which rewards users with 18% to 20% annual interest on deposits of Tera USD (UST), Tera’s stablecoin. These rewards were paid for from reserves capitalized by Terra’s parent company.
Finally, UST and Luna (a sister token redeemable to UST) only existed to provide access to Anchor’s interest rewards. The more UST issued and deposited on Anchor, the faster Anchor’s reserve funds were depleted and the more expensive it became for Terra’s hedge-fund investors to hedge UST pegs on various exchanges. Holders began cashing in on their rewards in late January, threatening the peg of UST. In early May, Terra’s parent company, along with outside investors, spent billions to stabilize UST’s peg, but could not successfully restore market confidence. Just a few days later, the peg broke as investors sold Luna and withdrew their UST from Anchor. Instead of a dollar, the UST is worth just over a penny today.
Crypto skeptics will point to Terra as another episode of “Tulip Mania”. They will be far more correct than they know. Seventeenth-century Amsterdam was engulfed in new wealth, fueling a bubble in tulip-bulb prices and futures. Yet, contrary to popular myth, the tulip frenzy was not an extraordinarily popular delusion, but a game for a small group of wealthy merchants, with minimal economic consequences for Amsterdam in the end. Likewise, despite the pain of retail investors, Terra was a game of musical chairs for a relatively small group of large investors. The top 10 wallets using Anchor accounted for 27% of all UST, and the top 1,000 held 82%.
Acting Controller of the Currency Michael Hsu recently said of the Terra collapse that “there has been no transition from cryptocurrency to traditional banking and finance.” The true lesson from Terra – as from Tulip Frenzy – is that roulette games for wealthy bookmakers carry no systemic risk. Ms Yellen should stop worrying about stablecoins. True stable coins are not wildcat banks. The US Treasury and the Federal Reserve have better things to do – such as control inflation that currently threatens the stability of the dollar.
Mr. Ferguson is a Senior Fellow at Stanford University’s Hoover Institution and founder of GreenMantle. Mr. Rincón-Cruz is a researcher at the Hoover Institution, and the founder of Buttonwood, a DeFi/Web3 open-source software project.
Wonder Land: The White House now says the US economy is ‘in transition’. He liked that part. Images: Universal Archive via Getty Images/AP Composite: Mark Kelly
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