Debunking Myths Around the Stability of Stablecoins: Part 1

When an obscure organisation calling themselves the Tether Foundation launched their cryptocurrency Tether (USDT) in 2014, they did so to the irrevocable disruption of the future of the international payments industry, and the financial system as a whole. 

Unlike other cryptocurrencies which existed at the time such as Bitcoin and Ripple, which have a value based around their utility - storing value and peer-to-peer debt transfers, respectively - Tether’s value wasn’t to be derived from its function; the price of Tether was to be kept pegged, in perfect parity, with the US dollar. 

The Tether Foundation proclaimed that they were able to achieve this by keeping $1 USD in a treasury reserve for every USDT minted, as a means of guaranteeing that the value of their token was backed by a corresponding quantity of fiat currency, which could be redeemed on a 1:1 basis. 

The gravity of the implications of this cannot be overstated; by tokenising and decentralising the value of the US dollar, the Tether foundation had, for the first time in history, facilitated a stable, asset-backed payment system which was completely free from intermediaries. Users could make peer-to-peer transactions without any interference from centralised authorities, safe in the knowledge that what they were transferring had its value back by an equally-sized asset pool managed by an organisation who were completely removed from the transaction process itself. 

However, the emergence of the Paradise Papers in November 2017 cast doubt over the legitimacy and probity of the Tether Foundation. The Papers - a set of over 13 million confidential electronic documents leaked to German newspaper Süddeutsche Zeitung - revealed that crypto exchange Bitfinex were behind the inception of the Tether Foundation; a provenance which would be innocuous enough in itself, were it not for the obscure and surreptitious manner in which the exchange had chosen to conduct its business.

To put it plainly - if they had nothing to hide, why were they hiding the fact they were behind The Tether Foundation. 

Questions and suspicions were soon answered and addressed; in April 2019, during a court case initiated against Tether by the New York Attorney General’s office, it emerged that each unit of USDT was actually backed by $0.74 of US dollar equivalents - a breach of the 1:1 ratio set out in Tether’s whitepaper.

It’s little wonder, therefore, that Yale economist Gary Gorton recently equated Tether to the “Wildcat Banking” paradigm which was prevalent in the US in the mid-nineteenth century. Operating primarily as banks of issue rather than deposit banks, wildcat banks circulated currency that was formally redeemable in gold or silver coin, but practically based on other assets such as government bonds or real estate notes. 

From 1837 to 1863, many U.S. banks received charters from state regulators, without operating under any form of federal regulation. These wildcat banks issued their own currencies, and printed their own US bank notes, for which redemptions into federally-issued notes were largely impossible.

For nearly 30 years, these banks operated with what can only be described as success; their customers, under the illusion that the bank notes they were being issued had the backing of the federal government, were perfectly willing to use them for purchases and transactions. Eventually though - and, indeed, inevitably - these customers became aware that the currency they were using weren’t redeemable for anything, and were in essence valueless. Unsurprisingly, the government stepped in and enacted the National Bank Act of 1863, which led to the instant cessation of the wildcat banking system. 

The cause of their demise was the same red flag currently being fervently waved by Tether, and many other fiat-backed “stable”coins; namely, that there is a distinct lack of real-world assets which guarantee that their token price is exactly what their issuers claim it to be. The imperative requirement for maintaining a 1:1 value-ratio is a creditable means for assuring redeemability. 

Earlier this year, the Bank for International Settlements (BIS) published a paper about Central Bank Digital Currencies (CBDCs), in which they rebuked fiat-backed stablecoins for representing a claim on an intermediary, rather than functioning as the digital equivalent of cash. Unlike Bitcoin, Ripple, or currencies which derive value from utility, without a means for guaranteeing redeemability, stablecoins are just entries on a blockchain ledger; and while this ledger may prove ownership, it does not in itself prove value. 

Without hard-backed assets the value of a stablecoin is purely speculative, and as soon as users stop believing that each token is worth exactly $1 - or whatever price one base unit of their purportedly underlying asset is worth - then those tokens will become valueless, and their stability will be immutably disproved.