According to a new Bank for International Settlements (BIS) report, stablecoins lack the “mechanisms” to maintain stability.
Written by the Monetary and Economic Department of the BIS, the report considered stablecoins from a money market perspective.
By comparing on-chain transactions, the world’s central bank deliberately created an “alternate universe” where stablecoins and their underlying infrastructure exist parallel to the current financial system.
At least, that’s what the researchers would have readers believe.
According to the authors, stablecoins function as settlement mechanisms and not as a means of exchange at par with the underlying fiat currency.
The paper uses the history of offshore transactions, including the $600 liquidity swap mechanism created by the Fed in 2007 during the financial crisis, to make its case.
There are Three Kinds of Stablecoins
Per the paper’s argument, three kinds of stablecoins exist:
-Those backed by short-term treasury notes (USDT, USDC)
-Longer-term backed stablecoins with a higher margin (DAI)
-Programmatically collateralized stablecoins (Terra Luna, FRAX)
Researchers considered the fundamental arguments that underpin the different kinds of stablecoins to be fundamentally flawed, using the redemption factor as the cause for their collective failure as an asset class.
The assault against stablecoins continued, with the BIS making its case that the liquidity pump during the COVID-19 pandemic gave rise to a bubble where stablecoins rule, linking the divergence between on-chain and off-chain interest rates as the reason for the boom.
The report considered other examples using the Silicon Valley Bank failure.
Circle, the USDC issuer, had the same lender of “last resort” as SVB.
Per the definition of the different kinds of liquidity, the report identified the mechanisms stablecoins deploy in their operations as “monetary liquidity,” iterating that stablecoins depend on “market liquidity” during redemption events, iterating that parity basis cannot be maintained.
Liabilities Increase During Asset Sales
The paper’s central argument is that all the current stablecoins will have net liabilities should massive redemptions occur during runs.
Runs generate massive outflows.
Per the report, even the stablecoin short-term sale mechanisms will fail because of higher interest rate margins and a lack of market controls, which offshore liquidity infrastructure possesses via fiat instruments.
According to the report, other interruptions, like multiple chains and bridges, also contribute to the liquidity burden.
The BIS makes a no-holds-barred case for regulated infrastructure (CBDCs) in various iterations and deployments.
One such example in the report is the “Regulated Liability Network,” which serves as the infrastructure for tokenized deposits, privacy concerns notwithstanding.
The paper’s premise on trust and credibility underpins the BIS’s issue with stablecoins.
These parity ecosystems take power away from the government and give it to the people, hence the paranoia.
Some stablecoins have failed.
That is a fact.
Others will still further down the line in the future. However, it doesn’t mean that stablecoins are a failed asset class. The reverse is the case.
Innovation has been the driver behind the cryptospace and shall remain so.
Something regulatory bodies are scared of and seek to control by any means.