Tether Compliance Analyst: How can global encrypted stablecoins promote financial stability?

The author of this article, Matthew Alexander, is a compliance analyst at Tether. The article first appeared on Cointelegraph

Compile | PANews

Stablecoins can provide a cost-effective means for crypto market participants and also rebalance capital in global financial markets.

Over the past year, three major financial watchdogs—the Bank for International Settlements, the U.S. Federal Reserve, and the Financial Stability Board—have expressed concern about the threat posed by encrypted stablecoins to global financial stability. Stablecoins have the potential to improve payment efficiency, but in the context of "financial stability", they believe that stablecoins may bring many risks to the traditional financial industry.

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What exactly does financial stability mean?

In fact, one of the easiest ways to conceive of financial stability is this: be stable. The global financial crisis of 2007-2008 can be seen as the epitome of modern financial instability, and it was in response to the recurrence of such crises that the leaders of the Group of Twenty established the Financial Stability Board in 2009, which is organized by the Bank for International Settlements Hosted and funded to oversee the global financial system and coordinate the work of financial institutions and other global institutions. The FSB has three main stated objectives, namely:

1. Efforts to promote the stability of the global financial system;

2. Address vulnerabilities affecting the financial system;

3. Prevent the recurrence of events similar to the 2007-2008 global financial crisis.

But why did the financial crisis that shocked the world in 2008 happen? Do we have the ability to prevent such incidents from happening again? In fact, after the 2008 global financial crisis, academics gave three explanations for the cause of the crisis:

1. The financial services industry is too greedy;

2. Moral failure;

3. Excessive risk taking.

Based on the above discussion, financial regulators need to make a coordinated response to this global financial crisis, that is, to identify and control financial systemic risks. Although many countries have given definitions of "financial systemic risk", the definition of "financial systemic risk" quoted by Toronto jurist Michael Trebilcock in 2011 by the Supreme Court of Canada seems to be more widely accepted. The generally accepted definition is:

"The risk of a 'domino effect', whereby the risk of default by one market participant will affect the ability of other market participants to meet their legal obligations, triggering a cascade of negative economic consequences across the financial system."

There is also a definition of "financial systemic risk" given by American legal scholars that is also widely cited, which is:

"The risk potential of large fluctuations in asset prices, corporate liquidity, bankruptcies and efficiency losses due to economic shocks."

All these definitions and descriptions of "financial systemic risk" basically capture the adverse effects of financial systemic risk, but at the same time, these definitions have a common defect, that is, they do not address the "risk" mentioned in the definition at all. ” or “economic shock” reasons. In fact, the sharp decline in asset prices themselves is the main cause of the real shock to the systemic economy, often in the form of margin calls. The "domino effect" mentioned above is caused by the liquidation of leveraged positions or the inability to liquidate them in an orderly manner.

In the final analysis, systemic risk should be the risk of triggering "sudden and sharp declines in the prices of widely held assets". It is understood that during the global financial crisis of 2007-2008, the assets that were widely held were subprime mortgage-backed securities, AAA-rated products, and residential real estate.

Next, let's analyze what exactly caused the prices of "widely held assets" to fall sharply during the global financial crisis?

What caused the price of "widely held assets" to fall sharply during the global financial crisis? The answer lies in price discovery. Price discovery is a process in which buyers and sellers interact to generate market prices. The so-called "discovery" is It means that the supply and demand relationship can be determined to satisfy a given asset within a given time.

In the futures market, price discovery is a process in which the supply and demand parties bargain openly, and through fierce competition, the commodity price level is continuously updated and spread to the world, so that the commodity price becomes the world price. Simply put, price discovery is the process of discovering competitive prices and global prices.

Price discovery is one of the important economic functions of futures markets. Different from the price formation of decentralized transactions in the spot market, the futures market can form a relatively mature and excellent price mechanism, which is similar to a perfectly competitive market. The futures price is the price of buying and selling futures contracts formed by conducting futures transactions in the futures market, and futures transactions are carried out in specialized futures exchanges. According to the regulations of futures trading, all contracts must be bought and sold through public outcry in the trading floor of the futures exchange, and private transactions are not allowed. This makes all futures contracts sold through competition. The market becomes an open and free competitive market. The resulting futures price can more accurately reflect the real supply and demand situation and its changing trend. Competitive price information in various futures markets continues to spread to the world and influence each other, thus forming a global competitive price.

The global financial crisis of 2007-2008 was more like the inevitable result of a collapse in long-term price discovery in the residential mortgage credit market, although there were some people who profited from this crisis, such as hedge fund manager John Paulson. John Paulson explained to the U.S. Congress that he and his partners were very concerned about weak credit underwriting standards. According to their analysis, the subprime debt was worthless, but it could get a AAA rating, because the financial market widely relied on AAA ratings. , which means that the price discovery mechanism in the market is completely suppressed by blind AAA ratings. As demand for high-yield subprime mortgages grows out of touch with the creditworthiness of residential borrowers, the market will inevitably begin to "rediscover" the prices of these assets—a painful process, of course, that we See the "global financial crisis".

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What Stablecoins Really Mean

In an analysis published by three regulators, the Bank for International Settlements, the U.S. Federal Reserve, and the Financial Stability Board, stablecoins are described as a cryptocurrency that attempts to address the high volatility of other cryptoassets such as Bitcoin (BTC) — but , this expression may be somewhat misleading.

In fact, the main role of stablecoins is to solve the inefficiencies of traditional fiat currencies and the banking industry by infusing the basic economic properties of fiat currencies into high-speed moving encrypted assets. The origin of stablecoins has nothing to do with the volatility of Bitcoin. The competitor of global encrypted stablecoins is not Bitcoin, but to promote and facilitate more people to access this novel, digital and scarce asset. Stablecoins would not exist if traditional money and banking were not so slow, costly and exclusive.

Global crypto stablecoins may be becoming a widely held asset, but so far have not been systemically threatened. Stablecoins are held because they are useful in transactions, not as investments, so from this perspective, there is nothing in common between stablecoins and the complicated subprime mortgage bonds of the GFC place. Stablecoins are tied to the value of the fiat currency (or gold) people are using to buy them, and are linked to the issuer, so they don't deliberately appreciate or depreciate. Literally, stablecoins represent more claims on assets, including bank payments-do you think that stablecoins are actually very "simple"? Indeed, this is the main reason why global stablecoin price discovery is so reliable.

The primary market mostly consists of verified customers who can receive tokens at a fixed exchange rate or exchange tokens directly with the issuer. In the secondary market, the price is strictly controlled by supply and demand, but because the primary market participants will engage in arbitrage activities in the secondary market, the token price will hover around the fixed exchange rate. If prices deviate significantly in either direction, those proven entities can make a quick profit by taking advantage of the price differential between the primary and secondary markets. In the wider financial ecosystem, there are few financial products that more perfectly realize the "neoclassical price ideal" of market equilibrium.

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How can global crypto stablecoins contribute to financial stability?

Although the Bank of International Settlements, the Federal Reserve Board of the United States, and the Financial Stability Board recognized the potential of stablecoins to improve payment efficiency, they also emphasized that for financial stability and other related reasons, global encrypted stablecoins should be accepted with caution. However, the analysis of the three regulators, the Bank for International Settlements, the US Federal Reserve Board, and the Financial Stability Board, is mostly one-sided because they do not consider the potential of stablecoin products to enhance financial stability.

For some local policymakers, there is a need to explore the potential of stablecoins to enhance financial stability. Global crypto stablecoins can provide sophisticated market participants with a cost-effective financial means to quickly move and rebalance capital across global markets. With the reduction of transaction friction, the market price discovery mechanism will become healthier, and more participants will actively enter the market. This is the best way to prevent financial systemic risks.

For traditional supervisory agencies, the concept of financial stability they understand usually includes the profitability and solvency of existing financial institutions, so regulators will worry that the widespread adoption of global encrypted stablecoins will "further reduce bank profitability, which in turn will lead to Banks take more risk.”—This thinking is understandable, but policymakers must recognize that existing traditional financial institutions are not fully representative of the wider financial system, and that stable bank profits do not equate to global financial stability.

For millions of people around the world, cryptoassets are an effective addition to the global financial system. Regardless of the concerns of these watchdogs, the potential for global crypto stablecoins and other cryptoassets to enhance financial stability and liquidity at the individual and household level has considerable societal implications and should not be overlooked by policymakers.

The views, ideas and concepts expressed in this article are solely those of the author, Tether Compliance Analyst Matthew Alexander, and do not reflect or represent the views and opinions of PANews.