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The Case for Stablecoins Being the New Shadow Banks

Stablecoins must provide liquidity transformation through sunny and stormy markets.
Photographer: Bloomberg/Bloomberg

What keeps breaking the buck, is engaged in financial transformation, and keeps on growing?

The stablecoin market. 

The value of the top four stablecoins has surpassed $100 billion in the space of four years, and the coins — which trade on a blockchain but attempt to maintain a one-for-one peg with fiat currencies — now form an integral part of the crypto ecosystem, often acting as the collateral behind DeFi and enabling transfers between crypto exchanges. 

But as the market grows, it’s also coming under increased scrutiny in part because it’s still unclear how stablecoin issuers are maintaining their pegs. Most of the criticism has so far been directed at Tether, which claims that its tokens are 100% backed by reserves, though it has released few details of what those are exactly. If Tether’s account of its reserves is accurate, then it’s  now a massive player in the commercial paper market which has historically been dominated by large investors such as regulated money market funds (MMFs). 

This is the reason why JPMorgan Chase & Co. strategist Josh Younger describes stablecoins as being “the primary interaction point between the crypto-native and traditional financial systems through their reserve funds.” The suggestion is that if stablecoins were to experience disruption, it could reverberate into financial markets through the commercial paper channel, again depending on what issuers hold:

The definition of shadow banks is notoriously fuzzy, but it typically includes non-regulated entities engaged in maturity or liquidity transformation — that is securing short-term funds to invest in longer-term assets, or converting illiquid assets into more easily spendable money. On that basis, stablecoins could well be taking questionable reserve assets and converting them into stable digital cash.

This isn’t a problem as long as the stablecoin market avoids huge bouts of redemptions. So far that has been the case, even in the sharp crypto sell-off in May. That’s somewhat surprising given that — by Younger’s calculations — the top four coins have ‘broken the buck’ (i.e. dipped below their peg) with some regularity; having spent the past 30% to 40% of the past three months trading below par. 

But an unexpected disruption risks causing problems for exchanges and issuers which provide the coins. That in turn could feed into the traditional financial system through the key funding market which is commercial paper, and again raises questions of financial stability given that stablecoin issuers are unregulated. That’s one reason why officials at the Federal Reserve have been talking about stablecoins, with Bank of Boston President Eric Rosengren recently keying in on their resemblance to traditional “but maybe riskier” prime money market funds.

Back to Younger: