Stablecoin purveyor Tether is again in the news as regulators scrutinize the sector and make uncomfortable comparisons to money market funds. The Wall Street Journal wrote on Saturday, "Risks of Crypto Stablecoins Attract Attention of Yellen, Fed and SEC." The piece explains, "Stablecoins, digital currencies pegged to national currencies like the U.S. dollar, are increasingly seen as a potential risk not just to crypto markets, but to the capital markets as well. Treasury Secretary Janet Yellen is scheduled Monday to hold a meeting of the President's Working Group on Financial Markets to discuss stablecoins." (See the Treasury's "Readout of the Meeting of the President’s Working Group on Financial Markets to Discuss Stablecoins," see our July 13 Link of the Day, "Fitch Looks at Tether Risks," and our June 2 LOTD, "Bloomberg Opinion Hits Tether CP.")
The Journal tells us, "Stablecoins are a key source of liquidity for cryptocurrency exchanges, their largest users, which need to process trades 24 hours a day. In the derivatives and decentralized finance markets, stablecoins are used by traders and speculators as collateral, and many contracts pay out in stablecoins. Stablecoins have exploded over the past year as cryptocurrency trading has taken off. The value of the three largest stablecoins -- tether, USD Coin and Binance USD -- is about $100 billion, up from about $11 billion a year ago."
They quote Boston Federal Reserve President Eric Rosengren June speech, "There are many reasons to think that stablecoins -- at least, many of the stablecoins -- are not actually particularly stable." The article says, "In December, the president's working group released a statement on the regulatory issues concerning stablecoins. `Among other things, it suggested that best practices would include a 1:1 reserve ratio and said issuers should hold 'high-quality, U.S.-dollar denominated assets' and hold them at U.S.-regulated entities."
The WSJ adds, "Neither Circle nor Tether provides a detailed breakdown of where their reserves are invested and the risks users of the tokens are taking. This lack of information has alarmed central bankers and lawmakers in the U.S. and overseas.... What the companies have disclosed is that they have invested the reserves in corporate debt, commercial paper and other markets that are generally considered liquid, and in cash equivalents. Tether, according to a report it released earlier this year, held about half of its reserves in commercial paper -- short-term loans used by companies to cover expenses. The credit ratings of the commercial paper and whether it came from the U.S. or overseas couldn't be determined."
Finally, they write, "Regulators don't have to look far for examples of what can go wrong in the world of finance. Money-market funds came under pressure last year during the pandemic-driven selloff and required support from the Fed. Dozens of money-market funds needed to be propped up during the 2008-09 financial crisis to prevent them from 'breaking the buck,' or falling under their standard of a $1-a-share net asset value."
CNBC's "Mad Money" and Jim Cramer also questioned the reserves of stablecoins and Tether yesterday. The show featured a segment discussing a new paper, "Taming Wildcat Stablecoins," written by Yale School of Management's Gary Gorton and Federal Reserve Board of Governors' Jeffery Zhang. The paper's Abstract says, "Cryptocurrencies are all the rage, but there is nothing new about privately produced money. The goal of private money is to be accepted at par with no questions asked. This did not occur during the Free Banking Era in the United States -- a period that most resembles the current world of stablecoins. State-chartered banks in the Free Banking Era experienced panics, and their private monies made it very hard to transact because of fluctuating prices. That system was curtailed by the National Bank Act of 1863, which created a uniform national currency backed by U.S. Treasury bonds. Subsequent legislation taxed the state-chartered banks' paper currencies out of existence in favor of a single sovereign currency."
It continues, "The newest type of private money is now upon us -- in the form of stablecoins like 'Tether' and Facebook's 'Diem' (formerly 'Libra'). Based on lessons learned from history, we argue that privately produced monies are not an effective medium of exchange because they are not always accepted at par and are subject to runs. We present proposals to address the systemic risks created by stablecoins, including regulating stablecoin issuers as banks and issuing a central bank digital currency."
The paper explains, "Stablecoin issuers appear to understand that they have the same problem that all banks inherently have. What exactly is the backing for their money? If the stablecoins are not perceived as safe because coin holders have suspicions about the backing, then they may be inclined to run on the issuers. With respect to demand deposits, this problem was solved with federal deposit insurance. Stablecoin issuers try to convince holders of their coins that the coins are backed by reliable assets."
It comments, "Other stablecoin issuers are less clear about their holdings. Tether, for instance, describes its backing assets this way: 'Every Tether token is always 100% backed by our reserves, which include traditional currency and cash equivalents and, from time to time, may include other assets and receivables from loans made by Tether to third parties, which may include affiliated entities (collectively, 'reserves'). Every Tether token is also 1-to-1 pegged to the dollar, so 1 USDT Token is always valued by Tether at 1 USD.' New York Attorney General Letitia James sued Bitfinex and Tether, both owned by Hong Kong-based iFinex, asserting that 'Tether's claims that its virtual currency was fully backed by U.S. dollars at all times was a lie.'"
The study tells us, "These entities agreed to pay $18.5 million. In the settlement, Tether agreed to the following: 'Publication of Tether's Reserves: On at least a quarterly basis for a period of two (2) years following the effective date of this Settlement Agreement, Tether will publish the categories of assets backing tether (e.g., cash, loans, securities, etc.), specifying the percentages of each such category, and specifying whether any such category constituting a loan or receivable or similar is to an affiliated entity, in a form substantially similar to that previously presented to the OAG.' Tether then released one page with two pie charts showing backing of 3.87 percent cash and 2.94 percent Treasury bills."
It also discusses past problems with money market mutual funds, explaining, "Suffice it to say, policymakers who were considering whether to regulate money market funds as banks in the 1970s did not foresee the need for future government bailouts. In this Part, we provide a historical overview of money market funds and the consequences of labeling them as securities when it was obvious that their economic content was equivalent to a demand deposit. If there were any confusion about this point, the runs on money market funds in 2008 and in March 2020 provide further evidence."
The piece adds, "Runs on money market funds can destabilize the entire short-term credit market. When a money market fund is inundated with redemption requests in a panic, the fund may have insufficient cash to meet the redemptions. The fund may seek to raise cash by declining to roll over its maturing holdings of commercial paper or other short-term claims, or by selling its assets in illiquid markets at fire sale prices. These actions by money market funds reduce the supply of short-term credit in the economy, raise the price of short-term credit, and drive down the market values of short-term debt instruments in the financial system -- thus creating additional pressures on money market funds, other investors in the short-term funding markets, and borrowers in these markets. This is precisely what occurred in September 2008."
