Stablecoins follow the value of another type of asset
Published: 3 November 2021
A sub-group to crypto currencies is known as stablecoins. Their value is tied to the value of other assets, such as one or more national currencies or other financial assets. The issuers of stablecoins claim that they hold a reserve of, for instance, a volume of US dollars, gold or government securities that can back up their value. The two largest stablecoins are Tether and USD Coin, which are both connected to the US dollar. In August 2021, the total value of stablecoins issued had grown to around USD 110 billion, from USD 60 billion in March 2021. However, these are still limited volumes in relation to the entire market for crypto currencies. So far, stablecoins have largely been used as a bridge between national currencies and investments in other crypto currencies, rather than as a means of payment. The crypto currency Diem, which a group of companies headed up by Facebook is planning to launch, is intended to be a stablecoin and differs from the current stablecoins in that its purpose is to create a global means of payment.
Despite stablecoins being constructed to be more stable, they can entail risks to financial stability, and the financial system as a whole, if they were used on a broad scale. Stablecoins have similarities to so-called money market funds, as the reserve for some stablecoins is largely invested in short-term assets, such as commercial paper (like a money market fund, but without complying with the same regulations and requirements that these funds observe). In times of financial crisis, it is common for market actors to move their holdings to safer assets and for the value of certain other assets to decline. If the assets in the reserves for stablecoins fall in value, this can lead to the issuers of stablecoins having liquidity problems. If this in turn leads to the demand for stablecoins declining, the issuers may need to sell assets quickly, which can lead to the price of the underlying assets falling even further and reinforcing a crisis that is already under way. If stablecoins based on another currency than the national one gain a footing in one country, for instance if a stablecoin backed by US dollars were used to a large extent in Sweden, this could also limit the country’s potential to conduct national monetary policy and implement measures in the event of a financial crisis.