The Weird, the Bad, and the Ugly behind Un-stablecoins
By Mark Hays
The crypto industry’s Republican allies have introduced retrograde legislation to normalize the crypto assets known as stablecoins. This comforting moniker for a particular class of crypto assets is largely a public relations ploy that obscures their inherent risks. They really should be called un-stablecoins. However, they are a critical component of the crypto industry’s digital casino. And the crypto industry expects a huge return on its $130 million electoral spending spree. As such, passing this legislation would anoint stablecoins with federal imprimatur, exposing more crypto investors and the entire economy to more risk and instability.
Stablecoins are crypto assets whose price and value are (in theory) stabilized to address the infamous volatility of crypto. The value of most crypto is largely in the eye of the beholder, with wild price fluctuations driven by rumor and hype. This is great for speculators and scammers who benefit from booms and busts but make most crypto assets a terrible substitute for actual money, because, unlike the dollar, the token price might collapse or skyrocket overnight. Money is used in transactions because we have a common understanding of its value. If a loaf of bread at the store was priced in an unfamiliar or inconsistent way (say, three gumdrops one day, two gold coins the next), it would be impossible to determine the market value of the loaf of bread.
Stablecoins purport to address this massive crypto shortcoming by pegging their price to something else (most often the U.S. dollar) and by having them backed (or collateralized) by some reserve that allows a customer to rapidly convert stablecoins into money. Pegging the stablecoin price to a less volatile instrument (dollars or government bonds primarily) helps stabilize the price. The firms that issue stablecoins collateralize these holdings with enough assets (cash, government securities, precious metals, or sometimes a pool of other crypto assets) so that customers can cash out their stablecoins for money.
Right now, stablecoins are almost entirely used to invest in speculative and highly volatile crypto assets. They are used on crypto exchanges because it is often easier, faster, and cheaper to buy crypto with stablecoins than with cash (because of conversion fees and transaction lags). And, in countries with highly volatile currencies and fragmented payment architecture, some people use stablecoins for purchases and cross-border transactions. But in the U.S., the dollar is stable and convenient, and payment networks are ubiquitous and robust, meaning most people here don’t need to use stablecoins to buy groceries or pay utility bills.
So, for practical purposes, the main use case for stablecoins in the United States is enabling gambling on crypto. Without stablecoins, speculative investment in crypto would be much more difficult for investors large and small. Stablecoins resemble two similar financial vehicles people use to make investments: Money market mutual funds and bank deposits. Money market mutual funds (regulated by the SEC and state securities regulators) are investment accounts backed by stable assets that people use as reserves to purchase stocks or bonds and as an account to deposit their returns when they sell these assets, sometimes earning modest interest on their holdings in the meantime. Stablecoins are a reserve for crypto investors to purchase and deposit their crypto investments. In this sense, stablecoins are like casino poker chips. You buy chips in order to play roulette, then cash out your winnings (or forfeit your losses), where the chips have a fixed dollar-for-dollar value and there is a fee to purchase.
But stablecoin issuers also resemble banks taking deposits. Banks hold depositors’ money, promising to keep it safe and have it available on demand. In the meantime, banks use these deposits to support lending and other services that generate fees and profits. The role that well-regulated banks play in money creation is a core element of our payments system that ideally undergirds the provision of credit, people, and businesses need to finance their lives and livelihoods (though definitely not all people or communities, and many discriminatory flaws and injustices in the banking system persist).
All told, stablecoins present a host of risks, and the industry-backed stablecoins legislative proposals that are being considered now before Congress fail to adequately address those risks. Here are just a few.
Concentration Risks: Big Tech firms like Meta and X as well as large retailers such as Walmart have expressed interest in issuing or sponsoring stablecoins for use on their platforms or in stores. The Bank Holding Company Act restricts these arrangements that combine banking and commerce because they pose huge risks to consumers and the economy. These risks include data privacy, consumer exploitation and manipulation, and economic concentration risks. For example, X could surveil people’s individual transactions with its Musk Money and offer preferences or penalties to customers based on their use of its new coin. Commercial stablecoin issuers could unduly control pricing or demand for products and effectively hold vast pools of customer deposits. And, if a company with a branded stablecoin went into a tailspin, it would not only affect the company but also its stablecoin could spread contagion that would cause a market crash.
Run and Contagion Risks: Bank depositors are generally confident they can access their funds on demand because of the backstop of federal deposit insurance and bank supervision, which greatly reduces risk of bank runs by customers cashing out en masse spurring bank failures. Stablecoins issuers don’t have deposit insurance but rely on asset reserve funds that collateralize these coins – generally cash, government securities or sometimes portfolios of crypto. Stablecoin issuers really should have enough funds to fully redeem their users on demand, but stablecoin holders only have the issuers attestations (instead of audits) that they have the right quantity and quality of reserves – a promise on paper, not real proof.
Many stablecoin issuers have had problems managing their reserves or meeting this redemption demand. Stablecoin Tether has been fined multiple times for misleading people about its inadequate reserves. The stablecoin Circle lost its peg to the dollar because $3.3 billion of its Tether reserves were in uninsured accounts at Silicon Valley Bank, causing the value of its alleged stablecoin to plummet. In fact, a 2023 Bank of International Settlements study of 60 stablecoins, including prominent ones like Circle and Tether, found that they all had lost their price peg at least once, calling into question whether these are stablecoins or un-stablecoins. And when investors have doubts about reserves, their efforts to quickly redeem their holdings can create runs that can collapse the price of the stablecoin and cause market contagion since stablecoins provide essential liquidity for crypto markets. The stablecoin Terra was algorithmically-backed by a sister crypto token Luna, and when this exotic and fragile arrangement began to unravel, investors fled for the exits, leading to its collapse which triggered the broader crypto crash in 2023.
Consumer Risks: The goal of making stablecoins widely used and accepted for consumer payments as a substitute for the dollar is a crypto industry El Dorado that could bring crypto into the financial mainstream and generate a gusher of profits. But using stablecoins for payments could leave consumers vulnerable to consumer fraud and mishap, more so than credit cards or bank debits. Consumers can make erroneous transactions, have their wallets hacked to make unauthorized payments, or can be tricked into doing so. Current consumer law helps consumers dispute fraudulent charges; reverse ones made in error or limit their liability in such cases. But the crypto industry deceptively claims that, since blockchain transactions are largely irreversible, stablecoin issuers and crypto firms can’t be held to the same standards, suggesting crypto consumers will have less protection than other consumers.
Meanwhile, just like other crypto assets, stablecoins have become a popular tool for illicit finance. Stablecoin issuers don’t always know who is buying or using their coins and for what purposes from user-controlled self-hosted wallets, and the industry’s inconsistent or willful noncompliance with anti-money laundering rules means it’s easy for bad actors to use stablecoins to facilitate consumer fraud, launder narcotics smuggling or human trafficking, or finance nuclear weapons proliferation, among a long list of other harms.
Custody Risks: For stablecoins to work, their reserves must be legally protected in the event of bankruptcy and the stablecoins themselves must be protected from fraud or theft. But stablecoin issuers have had problems on both fronts. Crypto platforms, coin issuers, and wallet providers are all vulnerable to cyber hacks and theft. Meanwhile, many crypto platforms and issuers have commingled their reserve asset funds with customer funds. When these platforms have failed, a lack of explicit bankruptcy protections (or deposit insurance) meant that stablecoin holders who thought their assets were safe have become unsecured creditors, waiting in line for months or years to reclaim some portion of their assets. Terra holders were promised $4 billion to cover $40 billion in losses, but only as unsecured creditors pending the company’s liquidation.
Stablecoins are subject to a host of other risks, including credit risk, operational risks, cybersecurity risks, settlement risks, and more. These new technologies don’t magically change the economics of finance or the risks and conflicts of interest. If anything, new technology creates novel risks on top of the old ones. The crypto industry’s stablecoin legislative proposals fail to meaningfully address these risks and end up giving the industry bank-like privileges without the same obligations and oversight. Doing so would only amplify stablecoin risks for users as well as potentially transmit the next crypto crash to the broader financial system and real economy to devastating effect.
Yet, the same cryptocrats and DOGE bros that are assaulting the foundation of democratic governance are demanding this stablecoin bill as the price of their fealty to the Trump administration. Locking in stablecoin policy is a prerequisite for future crypto industry giveaways. Supporting these stablecoin bills as introduced rewards these tech broligarchs and paves the way for even more extractive and perilous crypto measures that will pose even greater risks to consumers, community, and the economy as a whole.
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