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The Importance of Being Stable

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USDC

Thu, May 12, 2022

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It also deeply reinforces and lends urgency to the policy work underway in major jurisdictions around the world to level the operating, risk management and prudential grounds on which stablecoins - and those instruments masquerading as stable, but are otherwise backed by a blend of volatile assets, personal promissory statements and unilateral intervention methods, whether in code or governance - are regulated.

Complex Systems Fail in Complex Ways In this case, many of the fears highlighted by the President’s Working Group on Financial Markets (PWG), which issued a report on stablecoins urging Congressional action, have manifested themselves.

Reinforcing the message that complex systems fail in complex ways, what an algorithmic stablecoin like UST promised to achieve defies not only how markets work, but also ended up having more in common with a “digital derivative” or a security than a price stable, dollar-referenced asset designed as a medium of exchange.

Although there have been other examples of stable-in-name-only tokens de-pegging or breaking the buck, the self-immolation of an algorithmic stablecoin of these proportions warrants real rectitude in crypto markets and gives credence to regulatory and consumer protection concerns.

They may also may be present in larger asset-referenced stablecoins (what the Europeans are labeling as Systemic Asset Referenced Tokens, or SARTs in the Markets in Crypto-Assets Framework), where collateral and the composition of reserves is too opaque to inspire confidence or too correlated with illiquid assets with questionable credit quality to endure periods of stress.

Whereas the impact of an algorithmic stablecoin flaming out might be narrowly circumscribed to crypto capital markets, the impact of larger SARTs suffering a loss of confidence or redemption pressure, could pose systemic risk in the wider economy.

Algorithmic stablecoins with complex collateralization structures and technological stabilization mechanisms may be important financial technology experiments, but their placement (for the lack of a better namesake) next to instruments designed to fundamentally upgrade trusted banking and payments infrastructure was clearly a regulatory oversight

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