At the Austrian Economic Research Conference (AERC 2023) event in Auburn, Alabama, behind a wooden podium once used by Ludwig von Mises, I presented my paper: The Instability of Stablecoins.
Whether it’s called a pyramid, ponzi, shell game, or a grand delusion containing fraudulent elements, there’s something peculiar going on in the stablecoin industry; almost too familiar, and it requires explanation...
As of time of writing, CoinMarketCap shows the top three stablecoins by market cap being: Tether (USDT), USD Coin (USDC), and Binance USD (BUSD), valued at $79 billion, $33 billion, and $8 billion respectively.
These stablecoins work as follows:
You have $100 USD. You deposit this money with the Circle company (operator of USD Coin). In exchange, they create 100 USDC coins and give them to you. You are now free to use the coins at your discretion by holding them in a digital wallet, depositing on a crypto exchange, sending to friends, or making purchases online at participating retailers.
“Stability you can trust,” is a heading on USDC’s website, as explained:
Known as a fully-reserved stablecoin, every digital dollar of USDC on the internet is 100% backed by cash and short-dated U.S. treasuries, so that it’s always redeemable 1:1 for U.S. dollars. USDC reserves are held in the custody and management of leading U.S. financial institutions, including BlackRock and BNY Mellon.
They didn’t include Silicon Valley Bank as a leading institution, but more on that in a moment.
Tether and Binance tout similar claims. According to Tether’s main page:
All Tether tokens (USD₮) are pegged at 1-to-1 with a matching fiat currency and are backed 100% by Tether’s reserves.
According to Binance’s main page:
All reserves are held 100% in cash and cash equivalents; hence customer funds are always available for 1:1 redemption.
Sounds promising! The depositors simply exchange US dollars for newly minted stablecoins, supposedly always redeemable, on demand at a rate of 1:1 with US dollars. Hence the term stablecoins.
The natural due diligence to follow is to examine each company’s reserves to see what exactly comprises their asset base. Here’s Tether Holdings Limited Independent Auditor’s Report on the Consolidated Reserves Report, as of December 31, 2022.
When banks practice this kind of maturity mismatch—potentially immediate-term liabilities (deposits) backed by long-term assets (loans and Treasury securities), it is called “fractional reserve banking.”
The propensity for there to be a “run” on a stablecoin or discounting the price below 1:1 on the US Dollar should be considered an ever-present threat.
During the week of AERC, the banking crisis dominated news headlines. After a tumultuous weekend, on Monday, March 13 CNBC wrote:
Last week Circle said that $3.3 billion of its cash reserve is with SVB. After the bank’s collapse, USDC lost its $1 peg, falling as low as 86 cents on Saturday, according to CoinDesk data.
Despite the Fed not being in the business of bailing out stablecoin operators, USDC coin was saved because the Fed unveiled a multi-billion dollar bailout for collapsing banks. The intervention secured USDC’s cash reserve and the coin went back to par with the US Dollar.
Yet the pyramid is still being built!
As illustrated through BlockFi, a crypto exchange that filed Chapter 11 as of November 28, 2022, who once paid interest on stablecoin deposits just like a checking or savings account, customers could deposit their USDC at BlockFi and earn a rate of interest.
Unfortunately, these weren’t term deposits, as the fine print details:
You may make a request for complete or partial withdrawal of principal from your Crypto Interest Account at any time.
Once again there exists the same maturity mismatch between liabilities (customer’s stablecoins) due on demand against what could only be longer dated assets (e.g., US treasuries) providing interest income to BlockFi… until the scheme imploded.
In a world full of hope and desperation, in which demand deposits have become a risky endeavor, this offers very little confidence; first we must hope the crypto exchange can honor the deposit, then that the stablecoin company can honor the deposit… and in 2023 we must now hope the bank can honor the deposit!
Stablecoins offer valuable insights into how a truly free banking system could look; understanding that in a truly free banking system, there would be no bailouts. While lots can be said about stablecoins, the real systemic threat doesn’t lie within these private companies voluntarily offering services to customers. Rather, the real instability will come from an involuntary, legal tender, forced upon society – stablecoin – known as a Central Bank Digital Currency (CBDC)... Coming soon whether we like it or not.
