‘Primitive’ stablecoin lacks fiat stability mechanisms: BIS

Stablecoins lack critical mechanisms to ensure financial market stability and an operating model that gives central bank regulatory control is superior to private stablecoins, according to a study released by the Bank for International Settlements (BIS).

The authors used Statcoin's “financial perspective” and analogies with onshore and offshore US dollar settlement to examine the weaknesses of Statcoin's settlement strategies.

According to the study:

“In both the Eurodollar and FX markets, when private bank lending reaches the limit of elasticity [that is, loses the ability to maintain par]central bank credit is pumped in, with the ultimate goal of maintaining the global dollar parity of payments.

During the financial crisis of the late 2000s, when eurodollar holders sought to bring their money offshore, the Federal Reserve issued $600 billion in liquidity swaps with other central banks, using what its secretaries described as a “non-trivial institutional tool.”

Related: BOE Governor Dumps Crypto, Stablecoins in Support of ‘Improved Digital Currency'

Stablecoins bridge on-chain and off-chain currencies and maintain the equivalent of the fiat dollar in up to three “surfaces”: via reserve, over-backing, and/or algorithmic trading protocol.

Reserves are, essentially, “the equivalent value of short-term reliable dollar assets.” Stablecoins are based on their liquidity — the ability to meet short-term demand, reserves or algorithms — based on their ability to break even, the authors say.

Reserves are also tied to the fiat money market. This stable coin links stability to financial market conditions, but in times of economic stress, there are mechanisms that attempt to maintain bank flow both onshore and offshore. Stablecoin lacks such mechanisms. One example the authors give is this year's banking crisis.

Central bankers may have been surprised by March 2023 support for Silicon Valley Bank, the lender of last resort for the USDC, which holds large deposits at SVB as liquid reserves.

Also, stable coins must be equal between them. Bridges are another pain. The authors compare blockchain bridges to foreign exchange brokers, which rely heavily on credit and accept asymmetries in system flow. Stablecoins cannot do that. The high interest rates on the chain make their task even more difficult.

Okay, Boomer

— psswrd12345 (@psswrd12345) November 17, 2023

The study suggested that a regulated accountability network could provide a model solution to the problems faced by stablecoins. In that model, all claims are settled on a single ledger and within a regulatory perimeter. “The commitment to a fully-fledged banking system that includes a central bank and today's lack of private crypto stablecoins would be credible,” the authors said.

BIS has been paying more attention to stable coins. Earlier in November, he released a study that examined examples of stablecoins that failed to maintain their value. That is also a testament to the increasing role of the legislative stable coin in money in the European Union, the United Kingdom and the United States.

Journal: Unstable Coins: Debasement, Bankruptcy and Other Risks Looming.