Stablecoins Want to Be the Future of Money. There’s a ‘Deficit of Trust’

Issuers of stablecoins want to redefine money by establishing digital tokens with a fixed price of $1. Tether and USDCoin lead the market, which is presently valued at $155 billion, up 445% year over year.

Yet coin issuers face pressure to reveal more about what is really backing their tokens. While their reserve holdings reports have improved in recent years, they remain less comprehensive and consistent than those for money-market funds or other traditional assets used as cash substitutes.

Authorities are concerned about transparency since they see stablecoins as a systemic economic danger. According to a recent Biden administration study, coin makers should be regulated similarly to insured banks. Additionally, coin issuers have recently been asked to testify before Congress on their reserve and capital management methods.

Certain credit-rating specialists are becoming more concerned about traditional money-market funds. "What we're seeing here is a lack of trust in coin issuers," Alastair Sewell, senior director of fund and asset management ratings at Fitch, said.

He pointed out that stablecoins are insufficiently substantial to disrupt conventional short-term financial markets. Their increase, however, raises concerns that they will affect money-market funds that hold in commercial paper, a $1.2 trillion sector in the United States.

"In the case of a run on stablecoins, which would force them to liquidate reserves, there would likely be overlap with money-market funds, and you would see the effects," Sewell noted in an interview.

Tether and Circle Internet Financial, the company that launched USDCoin, certify their reserves regularly. Report is released every three months for Tether and every month for Circle; however, neither is released immediately. In the case of Tether, the preceding one occurred 64 days after the quarter ended. Circle has not yet made its November report public.

USDCoin reserves, according to a Circle representative, are entirely cash and short-term US Treasury debt. The firm's most recent financial statement, on the other hand, indicates that it may acquire further cash proxies in the future.

"Tether has always had complete support," a business representative said, noting that the vast bulk of the firm's commercial paper is rated A-2 or above by rating agencies. Furthermore, the representative said that almost all fresh money entering Tether since June 30 was stored in cash, bank deposits, or Treasury notes.

Based in the British Virgin Islands, Tether Limited Holdings has said that its digital currencies are "100% guaranteed" by its reserves and that it keeps a daily record of the company's bank balances and reserve value. According to a Cayman Islands-based accounting firm's third-quarter report, Tether declared $69.16 billion in assets and $69 billion in liabilities, almost entirely consisting of the tokens it generated.

According to the audit, Tether had 44% of its reserves in commercial paper and certificates of deposit, 28% in Treasury bills, and 12% in cash, bank deposits, and money-market funds. The other 16% consisted of secured loans to unrelated parties, "business bonds, money, and precious metals," as well as other assets, such as digital tokens.

The quality of Tether's reserves seems to be increasing. The company halted investing in "repo" contracts for short-term assets in the third quarter, substituting them with money market funds. It increased its Treasury securities holdings from 24% to 28% and cut its commercial paper and deposit holdings to 44% from 49%.

Sewell is concerned that Tether and other cryptocurrency issuers do not give comprehensive asset-level disclosures, in contrast to money-market funds, some of which provide daily asset-level data. "It is far more opaque than a money market fund," he said. "What I'd want to see is a line-by-line dissection of the text. That would reassure investors and me."

Tether has been penalized by authorities for failing to keep sufficient reserves. In February, the company and a subsidiary, Bitfinex, agreed to pay an $18.5 million punishment to the New York attorney general. In October, Tether was ultimately fined $41 million by the Commodities Futures Trading Commission for its reserve and reporting practices from 2016 to 2018.

Circle, the organization that backs USDCoin, said in its October monthly report that its $33 billion in cash and cash equivalents accounted for 100% of its reserves, according to auditing firm Grant Thornton, which compiled the report.

Additionally, it seems Circle has completely shifted to cash and currency equivalents. In May, it held just 61% of reserves in cash and equivalents, with the remaining split among various debt instruments and cash proxies. Circle has been providing monthly attestations on its reserves since 2018.

Circle has compelling reasons to build up its reserves; it aims to go public through a merger with Concord Acquisition Corp., a special-purpose acquisition company (CND).

The firm may be very profitable. USDC tokens are predicted to reach $194 billion in circulation by the end of 2023, up from $42 billion at present. In 2023, $886 million is forecast, up from $115 million this year and $407 million in 2022. Additionally, Circle expects to generate an operating profit of $76 million in 2023, equating to a 10% adjusted margin.

According to the October filing, Circle is also diversifying its assets beyond cash and T-bills. "All USDC reserves would be held in cash, currency equivalents, short-term US government treasuries, and available-for-sale debt instruments," the petition adds.

"The dollar-denominated reserves that support USDC are wisely held in the care, custody, and supervision of the regulated banking system of the United States," Circle CEO Jeremy Allaire wrote to Congress on Dec. 8, ahead of a hearing on stablecoins before the House Financial Services Committee.

However, coin issuers may need to dispel some of the mystery around them for regulators and experts to embrace them as a risk-free digital currency on a par with money market funds or the old dollar.