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How global stablecoins can promote financial stability worldwide

June 27, 2020

Last year, three major financial regulators raised concerns about the threat to financial stability that stablecoins are said to represent. While recognizing the potential to improve payment efficiency, Reports from the Bank for International Settlements, the US Federal Reserve and more recently the Financial Stability Board highlight numerous risks under the motto “Financial Stability”. The concern with global stable coins is that the CEF defines them as something “potential reach and acceptance in multiple jurisdictions and able to reach substantial volume”. The CEF report included a glossary with definitions of key terms, although none was intended for “financial stability”.

The importance of “financial stability”

The easiest way to imagine financial stability is the lack of instability. The Global Financial Crisis 2007-2008 (GFC) it was the epitome of modern financial instability. In response to this crisis, the G20 leaders established the Financial Stability Council in 2009, which was organized and funded by the BIS, the BIS The CEF monitors the global financial system and coordinates the work of national tax authorities and other global organizations. Its main objective is to “eliminate weaknesses that affect financial systems in the interest of global financial stability”. Preventing another event similar to the GFC is probably the main goal of this organism.

But what caused the global financial crisis in 2008? How can another be avoided? The stream of post-crisis academic statements generally had a common theme: greed, moral failure, and excessive risk taking within the industry. Financial services. Once popularized and widely accepted, this story triggered a coordinated global political response to the GFC: Identification and control of “systemic financial risk”.

How global stablecoins can promote financial stability worldwideHow global stablecoins can promote financial stability worldwide

This risk has been defined in many ways. In 2011, Canada’s Supreme Court cited a definition by the Toronto legal scholar. Michael Trebilcock::

“Risks that create a ‘domino effect’ in which the default risk of one of the market participants impairs the ability of others to meet their legal obligations, which triggers a chain of negative economic consequences that penetrate an entire system financially.”

A much-quoted American legal scientist, You have defined the risk as follows:

“The potential for significant volatility in asset prices, corporate liquidity, bankruptcies and loss of efficiency due to economic shocks.”

These descriptions clearly illustrate the adverse effects of systemic financial risk, but have one common mistake: The reason for such “risks” or “economic shocks” is never fully addressed., this treatment generally does not include / understand what the abrupt downward movements in asset prices are, in themselves the true economic shocks of systemic relevance, these shocks manifest in the form of margin calls, the “domino effect” mentioned above caused by the development of lever positions or the inability to do so properly. Ultimately, systemic risk is the risk of a sharp decline in widespread asset prices. During the GFC, these assets were mortgage-backed subprime securities, other high-end products (AAA), and residential real estate.

What caused the sharp drop in the price of these assets during the GFC?

The answer lies in pricing. This is the process by which the interactions between buyers and sellers generate a market price. This implies “discovering” where the supply and demand of a particular asset are at a given time. The GFC can best be explained as the inevitable result of a longer breakdown of pricing on residential property mortgage markets. When asked how his company managed to benefit from the collapse, the hedge fund manager said: John PaulsonDeclares to the United States Congress Because he and his employees were very concerned about weak credit insurance standards, according to their analysis, the risky securities were worth nothing, but received AAA ratings.

Even though mortgage creators were in the best position to perform a credit analysis, they had strong financial incentives to turn a blind eye, unlike subprime investors who were credit analysis despite the strongest financial incentives to perform, were unable to do so to do. The mechanics of pricing in this market were completely hampered by blind and widespread confidence in AAA ratings, while demand for high-yield securities grew out of contact with residential borrowers, which was painful “rediscovery” of the prices of these assets .

The antidote to systemic financial risk is to enable and maintain healthy pricing mechanisms in largely persistent asset markets. This goal is favored by the presence of demanding market participants: those who do not rely on rating agencies to allocate capital. These companies play a big role in the pricing mechanism, but their work is not easy. They need a profitable means to quickly change and balance their capital on the world markets. This is where stable coins would come into play.

The real meaning of stable coins

Reports from the three regulators described stablecoins as a mechanism to deal with the high volatility of other crypto assets such as Bitcoin (BTC). However, this characterization is misleading. Stablecoins have been developed to address inefficiencies in traditional money and banking by providing highly mobile crypto assets with the key economic properties of fiat money. Its origins have little to do with Bitcoin’s volatility. Instead of competing with Bitcoin, global stablecoins are making it easier to access this novel, digital and scarce commodity. If traditional money and banking were not so slow, expensive and exclusive, there would be no stable coins today.

Global stablecoins can aim to become a widespread commodity, but their properties are not systematically threatening as they are more suitable for transactions than for investments. These products have practically nothing to do with complex high-quality stocks. Risk associated with the GFC. They do not significantly estimate or reduce the value of the fiat currency (or gold) in which they were purchased and to which the issuer is linked. They are literally a right to assets, including money in a bank. Because of this absolute simplicity, pricing for global stablecoins is extremely robust.

Primary markets consist of verified customers who can issue or exchange tokens at a fixed rate. In secondary markets, prices are strictly determined by supply and demand, but remain primary market participants due to arbitrage activities close to the fixed price. If prices differ significantly in both directions, these audited companies can make a quick profit by taking advantage of the difference between the primary and secondary markets. There are only a few products within the broad financial ecosystem in which the neoclassical ideal of market balance is perfectly realized.

The business is very simple. Unlike many financial intermediaries, Stablecoin global issuers don’t trust placing risky bets to make a profit. Rather, they earn commissions by simply managing their respective tokens while maintaining and benefiting from the reserve assets of primary market participants. Stable coins are all about protecting these preserved assets.

How global stable coins promote financial stability

We should be careful to take advantage of the key efficiency gains that global stablecoins have historically offered for financial stability reasons. The BIS, the Federal Reserve and the CEF report that numerous risks are listed under this banner, but their analysis is mostly one-sided: the potential of these products to improve financial stability is not taken into account, lResponsible national politicians should take this potential into account. Global stablecoins offer demanding market participants profitable means to quickly change and balance their capital in the global markets. This reduced friction encourages more active market share and healthier pricing mechanisms that are the best defense against systemic financial risks.

The notion of financial stability of these regulators means that the profitability and solvency of traditional financial institutions are concerned, that the widespread introduction of global stable coins “could further reduce bank profitability, which could lead to banks.” take more risks. “ However, responsible national politicians must recognize that established financial institutions are not synonymous with the broader financial system.

The stability of bank profits cannot be synonymous with global financial stability. For millions of people worldwide, crypto assets are a welcome addition to the global financial system. Regardless of the concerns of these regulators, the potential of stable coins and other crypto assets to improve financial stability and mobility at the individual and household levels is of the utmost social importance. Responsible national politicians should not overlook this.

The views and opinions expressed here are solely those of the author and do not necessarily reflect Cointelegraph’s views.

Matthew Alexanderis a compliance analyst at Tether, a token backed by real assets like the US dollar, euro and gold. By anchoring or “tying” to a real currency, Tether offers protection against the volatility of cryptocurrencies.