The rise of cryptocurrencies has revolutionized the financial landscape, offering a decentralized alternative to traditional banking systems. Among the various cryptocurrencies, government-backed stablecoins have emerged as a popular choice due to their inherent stability and pegging to a stable asset like a fiat currency.
A stablecoin refers to a specific type of cryptocurrency that is intentionally tied to the value of a fiat currency. Its primary purpose is to provide a consistent and steady value within the highly fluctuating realm of cryptocurrencies. When a stablecoin is pegged to the US dollar, its primary objective is to maintain a fixed price of $1.
Stablecoins come in various forms, with notable types including algorithmic stablecoins, cryptocurrency-backed stablecoins, and fiat-backed stablecoins. In the case of a fiat-backed stablecoin, it signifies that the stablecoin is supported by a government-issued currency, such as the US dollar. This backing ensures that the stablecoin holds its value and remains stable in the volatile cryptocurrency market.
There are many stablecoins in the market today, but Tether (USDT) and Circle’s USDC have dominated the stablecoin market for years. However, their dominance is now facing a potential challenge from government-backed stablecoins.
What is Tether (USDT)?
Tether (USDT) is one of the most well-known and widely used stablecoins in the cryptocurrency market. Tether (USDT) was introduced in 2014 and is issued by Tether Limited. It operates on various blockchain platforms, including Ethereum, Tron, and others, as a token.
The primary purpose of USDT is to maintain a stable value by being pegged to the value of the US dollar. For every USDT in circulation, it is claimed that there is an equivalent amount of US dollars held in reserve by Tether Limited. This is referred to as a fiat-backed stablecoin, as it aims to maintain a 1:1 ratio between USDT and US dollars.
USDT serves as a popular tool for traders and investors within the cryptocurrency ecosystem. It provides a means of storing value and facilitating transactions without the need for traditional banking systems. Moreover, its stability relative to the US dollar can help mitigate the volatility commonly associated with other cryptocurrencies.
However, it’s worth noting that Tether company and its stablecoin, USDT, have faced scrutiny and controversies regarding the transparency and actual reserve holdings claimed by Tether Limited. These concerns have led to ongoing discussions about the stability and legitimacy of USDT in the cryptocurrency community and regulatory bodies.
What is Circle (USDC)?
USDC stands for USD Coin, which is a widely used stablecoin in the cryptocurrency market. It was launched in 2018 as a collaboration between Circle and Coinbase, two prominent companies in the cryptocurrency industry.
Similar to other stablecoins, USDC is designed to maintain a stable value by being pegged to the US dollar. For every USDC token in circulation, it is backed by an equivalent amount of US dollars held in reserve by regulated financial institutions. This makes USDC a fiat-backed stablecoin, aiming to maintain a 1:1 ratio between USDC and US dollars.
USDC operates on the Ethereum blockchain as an ERC-20 token, which means it leverages the Ethereum network’s infrastructure and benefits from its widespread adoption. This allows for fast and secure transactions, as well as compatibility with various decentralized applications (DApps) and exchanges.
The transparency and regulatory compliance of USDC have been emphasized by its creators. Circle provides regular attestations from independent auditors to verify the reserves backing USDC, adding an additional layer of trust for users and investors.
USDC has gained popularity within the cryptocurrency ecosystem due to its stability and the credibility of its issuers. It serves as a reliable medium of exchange, store of value, and facilitates seamless transactions across various platforms and exchanges.
What is a government-backed stablecoin?
Government-backed stablecoins, also known as central bank digital currencies (CBDCs), are digital currencies issued and regulated by central banks. They are digital representations of fiat currencies aimed at providing the benefits of cryptocurrencies while maintaining the stability and reliability associated with government-issued currencies.
The primary objective of a government-backed stablecoin is to combine the advantages of cryptocurrencies, such as speed and efficiency of digital transactions, with the stability and trust associated with traditional fiat currencies. These digital representations of fiat currencies are designed to maintain a stable value and act as a reliable medium of exchange within the digital economy.
Government-backed stablecoins are typically created using blockchain or other distributed ledger technologies, allowing for secure and transparent transactions. They can be used for various purposes, including everyday transactions, remittances, and even as a tool for implementing monetary policy.
The issuance and regulation of government-backed stablecoins are under the purview of the respective central banks or government entities. As a result, they are subject to the existing legal and regulatory frameworks of the country, ensuring compliance and oversight.
Examples of government-backed stablecoins include the proposed digital currencies like the Digital Yuan (e-CNY) by the People’s Bank of China, the Digital Euro by the European Central Bank, and the ongoing research and development of CBDCs by other central banks worldwide.
Government-backed stablecoins have the potential to reshape the financial landscape by providing a trusted and efficient digital form of money directly issued by a nation’s central authority. Their introduction could impact various sectors, from financial systems and cross-border transactions to monetary policies and financial inclusion.
Government-backed stablecoins vs Tether and Circle
As CBDC initiatives gain momentum worldwide, they pose a significant threat to Tether and Circle’s dominance in several ways.
Trust and stability
The backing of a government institution provides an inherent level of trust and stability to government-backed stablecoins.
Unlike Tether and USDC, whose reserves are subject to skepticism and occasional controversies, government-backed stablecoins offer a higher level of transparency and accountability. Users are more likely to trust a digital currency issued and regulated by their respective governments, reducing the reliance on privately issued stablecoins.
The primary concern revolves around the possibility of a significant stablecoin issuer, such as Tether, encountering a situation akin to a “run on the bank” or a situation similar to what caused the collapse of Terra Luna’s TerraUSD (UST).
Stablecoins face the vulnerability of experiencing runs, characterized by sudden surges in redemption requests triggered by factors such as price declines, rumors of instability, or concerns regarding the quality of underlying assets. These situations can lead to a rapid sell-off of the assets supporting the stablecoin, potentially resulting in further outflows as investors worry about the issuer’s ability to fulfill future redemption requests entirely. This vulnerability is similar to that observed in other investment products, especially certain money market funds (MMFs) that strive to maintain a stable net asset value. However, for some stablecoins, this vulnerability may be magnified due to the lack of comprehensive regulations within the crypto ecosystem.
To mitigate these risks, the design of a stablecoin arrangement plays a crucial role. Issuers can employ strategies such as overcollateralization, where high-quality liquid assets back the stablecoin in excess, ensuring the potential for full redemption even during stressful periods. Transparent governance structures, including regular independent audits, can instill confidence in investors by verifying the issuer’s claims regarding the value and liquidity of reserve assets. Additionally, stablecoin issuers can establish legal frameworks that provide investors with clarity and certainty regarding their redemption rights, even in cases of issuer insolvency. Such measures aim to enhance stability and bolster investor trust in the stablecoin ecosystem.
Officials in the United States, including Yellen, have drawn comparisons between stablecoins and money market funds. This analogy harkens back to the events of 2008 when the Reserve Primary Fund, an original money market fund, experienced a loss in its net asset value. The fund had invested in commercial paper, specifically short-term corporate debt from Lehman Brothers. The collapse of Lehman Brothers led to a mass exodus of investors.
Initially, Tether had claimed that its reserves were exclusively composed of dollars. However, following a settlement with the New York attorney general in 2019, the company reversed its stance. Disclosures unveiled that Tether possessed minimal cash reserves but held significant amounts of unidentified commercial paper.
In response to these revelations, Tether has expressed its intention to reduce its exposure to commercial paper while increasing its holdings of US Treasury bills. This strategic shift aims to bolster the stability and transparency of Tether’s reserve holdings.
And although the risks associated with stablecoins such as Tether are relatively more controllable compared to algorithmic stablecoins like UST, the fundamental factor that determines their stability lies in the creditworthiness of the issuing firms.
Integration into existing financial systems
The widespread adoption and acceptance of CBDCs can undermine the demand for Tether and USDC. Governments have the power to integrate their digital currencies into existing financial systems, encouraging businesses, banks, and individuals to transact with CBDCs directly.
This integration would reduce the need for intermediaries like Tether and Circle, thereby diminishing their market share.
Governments can leverage their regulatory power to limit the growth of private stablecoins while simultaneously promoting their own CBDCs. Regulatory measures, such as stricter compliance requirements or limitations on the issuance and usage of privately issued stablecoins, can create a favorable environment for CBDC adoption.
This could potentially reduce the attractiveness of Tether and Circle’s stablecoins, causing a shift in dominance towards government-backed alternatives.
For privately issued stablecoins like USDT and USDC, there is no central regulatory authority in charge while for the government-backed stablecoins, every country’s central banks are supposed to be in charge of regulating them.
The emergence of government-backed stablecoins poses a formidable challenge to the dominance of Tether and Circle’s stablecoins. The trust, stability, and regulatory advantages offered by CBDCs can undermine the market share of private stablecoins and potentially reshape the stablecoin landscape.
As governments worldwide continue to explore and develop their digital currencies, the battle for dominance in the stablecoin market is poised to intensify, creating new opportunities and challenges for both private and government-backed players.