buiter39_Guillaume PayenSOPA ImagesLightRocket via Getty Images_tethercryptocurrency Guillaume Payen/SOPA Images/LightRocket via Getty Images

Stablecoins, Riskycoins, and Dodgycoins

Recent price implosions have shown that not all so-called stablecoins are so stable after all. As policymakers draft regulations to bring some order to the crypto industry, they should focus on the economic functions that various digital tokens perform, rather than on formal legalistic labels.

NEW YORK – With no intrinsic value, no backing by anything, and a freely floating price, Bitcoin is too volatile to be appealing as a medium of exchange or a store of value. These flaws have given rise to other cryptocurrencies that are convertible on demand at a set price to something that is supposed to be more stable. But the British Financial Conduct Authority has rejected calling them “stablecoins,” on the grounds that their purported stability is merely aspirational. Policymakers in the European Union and the United States also will need to consider these issues as they draft new laws regulating cryptocurrencies.

Among the different types of cryptocurrencies using the “stablecoin” moniker, some are backed by assets and some seek to maintain their value algorithmically. But the only type deserving of the name is tokenized e-money on the blockchain, fully backed by off-chain liquid financial assets with stable values.

One example is Tether, the third-largest cryptocurrency by market capitalization. According to its website, “All Tether tokens are pegged at 1-to-1 with a matching fiat currency (e.g., 1 USD₮ = 1 USD) and are backed 100% by Tether’s reserves.” Currently, about 86% of Tether’s reported reserves are in cash or short-term liquid assets. Tether tokens can be used as a medium of exchange or as collateral in decentralized finance (DeFi). But there have been controversies over whether holders have a legal right to convert their tokens one-to-one with the dollar, and whether Tether is adequately backed and would be able to withstand a mass withdrawal.