The biggest threat to crypto comes from stablecoins

Federal Reserve board member Lael Brainard

(Image credit: © Shutterstock)

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Bitcoin and other cryptocurrencies have endured a rollercoaster ride in recent weeks, partly because authorities across the world appear to be paying them more attention.

We explain stablecoins in more detail below, but in short, the ideas is to create a cryptocurrency with a “stable” value, which means it can actually be used in practical day-to-day transactions as money – very much like government-issued or “fiat” currencies, such as the pound or dollar. While scepticism about crypto’s aspirations abounds, it’s very clear that central banks are taking these potential competitors seriously.

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In a recent speech, Lael Brainard, one of the Federal Reserve’s more influential governors, noted that “if widely adopted, stablecoins could serve as the basis of an alternative payments system oriented around new private forms of money”.

Brainard warns of a lack of regulatory oversight and “the risk of run-like behaviour” – whereby the value of a private currency collapses because people lose confidence in it (something which has, of course, happened to plenty of fiat currencies over time).

Brainard has a point. The best-known and largest stablecoin is Tether. Tether is “pegged” to the US dollar – in theory you should always be able to swap one Tether for one US dollar. However, to make such a promise you need to be able to back it up, and as Jemima Kelly points out on FT Alphaville, Tether’s story has changed on this over time.

“Tether used to claim all its tokens were backed one-to-one by US dollars held in cash reserves.” However, last month Tether revealed that in fact, just under 76% of its reserves are in “cash or cash equivalents” and overall, just under 3% in total is in actual dollars. This is unaudited, so you also only have Tether’s word to go on.

Yet while the idea of an economy in which private currency issuers compete with one another (rather than the state monopolising the currency), is alien to us today, there have been periods of successful “free banking” in the past.

Regulators will talk disparagingly of “wildcat” banks in the US in the 1800s, but academics generally agree that Scotland’s free banking system worked well between 1716 and 1845.

It’s right to be sceptical of many of the utopian promises and rickety structures coming out of cryptoland. But you should be equally clear-eyed about the position of governments: they have no intention of giving up their monopoly currency issuer status.

Dabble in crypto by all means – but don’t invest money you can’t afford to lose and watch the regulators closely. Ironically, the more popular crypto becomes, the greater the risks.

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