Stablecoin scepticism

"There's nothing that can be done on blockchain that can't be done better than the way that the current financial institutions are working” - Eric Trump, April 2025

Crypto enthusiasts rarely shy away from extoling the virtues of blockchain and decentralised currencies. They are supposedly seamless, efficient, transparent, democratised, egalitarian, and entirely disconnected from the financial plumbing that so often goes awry.

In the 17 years since Bitcoin first emerged, it has morphed from a once fringe asset into a quasi-religious movement. Its ascent has seen its value almost doubling every year over the past decade (with a few setbacks along the way). Today, the entire crypto universe is valued at $3.4tn, with Bitcoin representing nearly two-thirds.

However, Bitcoin still has no economic use and sits firmly at the speculative end of the investment universe – it is four times as volatile as frontier equity markets. It has no cash flow (making it impossible to value), and is neither a currency (too clunky), nor a compelling store of value (too volatile).

Could stablecoins be more economically viable? They are reportedly the next big development in the decentralized finance (DeFi) epoch. They offer the promise of a digital, decentralised payment system, but without Bitcoin-like volatility. And they are set to get further impetus from two important bills making their way through Congress: specifically, the GENIUS (Guiding and Establishing National Innovation for U.S. Stablecoins) and STABLE (Stablecoin Transparency and Accountability for a Better Ledger Economy) Acts.

Broadly, the bills set out a new regulatory framework – in what is still a largely unregulated space - to promote transparency and ultimately encourage greater usage of stablecoins in payments. But regulatory ‘legitimacy’ does not mean completely safe.

President Trump is intent on making US the 'crypto capital of the planet'. But cutting through the bewildering vernacular, the risks still seem to outweigh the modest benefits.

A different sort of cryptocurrency

Stablecoins have been in existence for over a decade, with Tether (USDt) pioneering the first asset-backed coin in 2014. Like Bitcoin, they still rely on a distributed ledger infrastructure in which transactions are digital and immutable. But unlike their gregarious free-floating cousin, they are meant to be boringly stable – pegged to the relevant asset. Tether is a fiat-backed currency and, in theory, redeemable 1:1 for US dollars. There is a certain irony in a cryptocurrency being seen as safer because it is backed by an existing fiat currency…

Confusingly not all stablecoins have their own blockchain. Tether is available on a number of different blockchain protocols, which suggests scalability – i.e. the number of transactions per second – may not be a limiting constraint. Dollar-backed stablecoins account for most assets, though other variants are growing.

USDt is the largest stablecoin in terms of trading volume and market value - at ~$120bn, it is more than twice the size of all the other stablecoins combined. Other notable coins today include USD Coin (USDc) and the newly minted USD1 stablecoin launched by Trump’s World Liberty Financial (this is distinct from the $TRUMP memecoin issued back in January).

Stablecoins gained significant traction through the pandemic, when the virtual new-paradigm mentality was in vogue. That momentum has yet to fade: Tether’s total volumes reportedly exceeded Visa last year. However, this rapid growth likely has more to do with Bitcoin’s fortunes than underlying demand for digital payments. The majority of stablecoin demand today stems from its role as a source of liquidity in crypto trading.

Fundamentally, stablecoins are intended to bridge the gap between traditional and digital finance. Smart contracts may potentially allow for full supply chain provenance, copyright management and even ‘tokenizing’ real life assets (such as stocks or real estate). They also offer an alternative payment option to individuals who have been locked out of the US dollar financial system.

In some instances, the attractions are illicit, such as attempts to circumvent sanctions. One of the key features of the new US regulation is to introduce new anti-money laundering rules and improved transaction monitoring. But stablecoins can also be used for a positive social purpose: financial inclusion. There are an estimated 1.4bn ‘unbanked’ adults globally – whether because of market failure or distrust. Not to mention the many individuals that don’t have the benefit of a stable domestic fiat currency.

Stablecoins are no panacea

However, for those not engaged in crypto speculation or those unable to hold US dollars directly, the benefits are less clearcut.

While stablecoins can offer the promise of instantaneous cross-border payments at low cost, their role in making everyday payments has been relatively slow. Banks and payment networks in the big developed markets – fearful of disintermediation – will likely remain a headwind to widespread adoption.

Blockchain-enabled applications are still short supply – though as ever, many potential opportunities remain on the horizon. Computational demands – and their energy needs – are rising. One estimate puts the annual energy consumption of the DeFi universe at close to 68TWh, which is more than Switzerland’s annual energy needs.

But for deposit-holders, the biggest headwind is the lack of yield. Few stablecoins pay any interest, allowing the operators of the coin to benefit from interest received on the fiat collateral. It’s little wonder that Tether Ltd., which has fewer than 100 employees, reported earnings of $13bn in 2024. Some yield-bearing coins are slowly coming the market, but these are the exception not the rule.

Meanwhile, USDt is not a bank deposit and is therefore not FDIC-insured (which protects conventional savings accounts against bank failure up to a limit) nor does it have wider meaningful consumer protection in place. The same could also be said of money market funds, but these vehicles do pass on income, and they are tightly regulated, with assets audited and ringfenced. However, ‘Tether’s Reserves’ – a mix of cash and ‘other securities’, including commercial paper and Bitcoin – may be about to change. The new US regulation imposes much stricter reserve requirements.

Another stablecoin, DAL, relies on smart contracts and algorithms rather than direct dollar backing to maintain its peg to the US dollar. One such algorithmic ‘stablecoin’ - the infamous TerraUSD – serves as a cautionary tale. In 2022, a loss of confidence and a lack of adequate reserves led to what would have been a classic bank run had it been a bank to begin with. The spectacular collapse left some depositors (and investors) significantly out of pocket.

Don’t take the orange pill

Crypto-hype is unlikely to abate with Trump in the Oval Office, but our (stablecoin) scepticism is little changed. While stablecoin creators are financially motivated to issue as much as possible, the benefits for would-be-depositors are questionable. The absence of any yield makes inflation an even bigger threat than is the case for conventional currency; wider counterparty and collateral concerns warrant caution.

As ever, many subtle, but important questions remain. What about the role of Central Bank Digital Currencies? Talk of a Fedcoin, for example, might be one visible competitor to private stablecoins (particularly for depositors merely looking to transact domestically). In the absence of bank-like regulation, what about wider financial stability? If money were to become wholly private sector in nature, and banks are no longer required to intermediate transactions, how does credit get created? Does a shrinking conventional deposit base push up the cost of financing? Will reduced reserves constrain the potency of central bank policy?

Tighter regulations are welcome and will alleviate some of these risks. But talk of the beginnings of a new financial system, and of greater global economic freedom – as some proponents advocate – seem a little far-fetched.

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