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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
The writer is a law professor at the American University Washington College of Law
Holders of stablecoins have rarely panicked when their value has fallen below the $1 level they are meant to be pegged to. But that does not mean that will not happen in the future.
Policymakers and market participants need to think about what a run on these crypto assets might look like and its consequences in light of the realities of stablecoin markets.
Many discussions of stablecoins are based on unfounded assumptions that stablecoins are a means of consumer payment. Likened by former Securities and Exchange Commission chair Gary Gensler to the “poker chips at the casino”, stablecoins are in reality generally used as collateral for crypto loans, or as a place to park funds between crypto trades.
They are backed by a reserve of real-world assets that is intended to ensure they maintain a set value — typically $1 per coin. However, they lose their $1 peg all the time, dropping below the set level. In one six-month period in 2023 alone, Moody’s documented some 609 “depegs” among large stablecoins.
Those included the USDC stablecoin, which faced a run of selling pressure after it emerged that $3.3bn of its reserves were deposited in cash at the failing Silicon Valley Bank. Its price dropped as low as 90 cents. The US government swooped in to guarantee all of Silicon Valley Bank’s deposits — but what if it hadn’t?
If a large stablecoin issuer faced a run and was forced to start selling off its reserve assets at fire-sale prices, that could push down the market price of those assets, as well as imperilling the issuer’s own solvency. Is that what we have to look forward to?
Congress passed the Genius Act almost a year ago, and US banking regulators have proposed rules to implement that legislation. These will require US-registered stablecoins like USDC to be backed by cash, Treasuries and other relatively safe assets. Ever-Panglossian, the crypto industry’s champions in Congress assure us that the quality of stablecoin reserves will prevent runs and fire sales.
But the largest stablecoin, Tether USDT, is not issued in the US and so is not bound by these reserve requirements. And there’s no guarantee that liquidating even good reserves in a hurry will be costless. After all, money market mutual funds — which invest in similarly safe assets — experienced runs and required bailouts after some funds lost their $1 per share value in 2008, and came under stress in 2020.
Ultimately, the impact of stablecoins will depend on the degree of adoption. On their own, laws legitimising them probably won’t be enough to juice consumer take-up. This explains why the crypto and banking industries in the US are fighting so bitterly over “yield.” Stablecoin issuers aren’t permitted to pay interest under the Genius Act, but crypto exchanges and other parties can reward stablecoin users in ways that may encourage consumers to ditch their bank account in favour of stablecoins.
Without the confidence that government-backed deposit insurance inspires, consumers have incentives to redeem their stablecoins from their issuers at the first sign of trouble. It is under-appreciated, though, that most consumers may lack the contractual right to do anything other than try to find another buyer on an exchange. Consumers are thus left to the vagaries of the secondary markets if their stablecoins haemorrhage value.
Analysis of stablecoin runs should therefore focus on large institutional stablecoin users, who do have contractual rights to redeem their coins direct from their issuers. The market “capitalisation” of stablecoins has risen and fallen along with demand for other crypto assets and has stagnated somewhat since November’s crypto crash. But there is a push to “tokenise” traditional financial assets by recording their ownership on a blockchain ledger. The crypto industry hopes that institutions will use Genius Act-legitimised stablecoins to settle transactions involving these tokenised assets.
If stablecoins are viewed less as poker chips, and more as a part of traditional finance, institutions will be far more sensitive to them losing their dollar peg. We could start to see more runs, particularly if there is turmoil in crypto or tokenised asset markets and blockchain-based transactions settled in stablecoins start to be unwound en masse.
Given stablecoins’ concentrated holdings of Treasuries and the status of sovereign bonds as the global financial system’s “haven” assets, run-driven fire sales could trigger problems in many other financial markets. To avoid these eventualities, bailouts will probably be on the table, and the US Congress will have only itself to blame.
