Stablecoins are quite popular among members of the crypto community.
They are great ways to escape bad market conditions, hedge against inflation, and are way less volatile forms of crypto that remain at the same price, 99% of the time.
The remaining 1%, however, is the problem.
Stablecoins are usually "pegged" to other assets like currency, precious metals or commodities, allowing them to remain at a fixed price at all times. However, sometimes, stablecoins "depeg".
When this happens, billions of dollars end up going down the drain, as we have seen with stablecoin like Terra USD and USDC earlier this year.
A recent study by the Bank for International Settlements (BIS), however, claims that stablecoin are far from stable and that Central Bank Digital Currencies (CBDCs) may be the answer.
The study by the BIS compared stablecoins to the onshore and offshore USD markets, like the Eurodollar and the forex markets.
According to the results of this study, the BIS claims that in the Eurodollar and the FX markets, when the private bank credit reaches its limit, the central bank always intervenes to preserve the parity of the USD.
A good example is what happened during the global financial crisis of 2008, when the US Federal Reserve offered a $600 billion swap line to other central banks, to support the offshore USD market.
The BIS went further to highlight how stablecoin keep themselves pegged:
1. Reserves
2. over-collateralization, and
3. algorithmic trading.
According to the BIS, all of these mechanisms are deeply flawed. The Bank of International Settlements states that these methods may not be enough to meet demand during times of market stress and mass withdrawals.
The BIS also says that stablecoins confuse their liquidity (the ability to meet short-term demand) with their solvency (the ability to meet long-term demand.
The study cites the temporary collapse of USDC earlier this year, when SVB collapsed in March 2023.
The BIS also threw a few jabs at algorithmic trading, as a way to keep stablecoin pegged.
The study claims that these protocols depend on market expectations and the algorithm's credibility. A simple glitch or regulatory challenge may be all it takes to depeg these stablecoins.
The study suggested that instead of backing stablecoins up with reserves or algorithms, a better model would be the Regulated Liability Network (RLN).
The big problem with this model is that decentralization jumps out the window.
However, all stablecoin transactions settled on a single ledger. This ledger will be operated by a single network of licensed banks, which are supervised by the central bank.
In other words, the BIS suggests that a CBDC is superior to decentralized stablecoins.
The study concluded by saying that stablecoin are "primitive" forms of money that fail to keep up with fiat money markets.
The study also recommends that stablecoins should be regulated and integrated with the existing financial system, rather than trying to replace or disrupt it.
In all, this is the second report from the BIS this month, about why stablecoins may be inferior to CBDCs.
Disclaimer: Voice of Crypto aims to deliver accurate and up-to-date information, but it will not be responsible for any missing facts or inaccurate information. Cryptocurrencies are highly volatile financial assets, so research and make your own financial decisions.