‘Primitive’ Stablecoin Lacks Mechanisms that Maintain Fiat Stability: BIS ‘Primitive’ Stablecoin Lacks Mechanisms that Maintain Fiat Stability: BIS
Stablecoins are facing scrutiny for their lack of mechanisms that ensure money market stability in fiat, according to a study released by the Bank for International Settlements (BIS).
Study on Stablecoin Mechanisms
The study conducted by BIS used a “money view” of stablecoin, drawing an analogy with onshore and offshore USD settlement to identify weaknesses in stablecoin mechanisms. It highlighted the reliance on the central bank to protect the par in global dollar settlement, especially during economic stress or banking crises.
Weaknesses of Stablecoin Settlement Mechanisms
The study revealed that stablecoins rely on up to three superficial mechanisms, including reserves, overcollateralization, and/or an algorithmic trading protocol, to maintain parity with the fiat USD. However, these mechanisms are insufficient in ensuring long-term solvency, as they primarily focus on short-term liquidity. This lack of mechanisms to maintain stability during economic stress is a significant concern.
Impact of Banking Crisis
The study cited examples from the banking crisis of this year, where central banks’ lender of last resort support for traditional banks inadvertently affected stablecoins, exposing the shortcomings of stablecoin mechanisms in comparison to traditional banking systems.
Regulated Liability Network as a Model Solution
The study proposed the Regulated Liability Network as a model solution, advocating for a fully-fledged banking system that includes the central bank to provide stability and credibility lacking in current private crypto stablecoins.
BIS’s Attention to Stablecoins
The BIS has been closely monitoring stablecoins, particularly their failure to maintain their pegged value. The increasing legislative attention in the European Union, United Kingdom, and United States further underscores the growing significance of stablecoins in the financial landscape.
Editor Notes: A Word on Stablecoins
Stablecoins are a vital component of the crypto ecosystem but require robust mechanisms to ensure their stability and reliability, especially in the face of economic turbulence. The importance of regulatory oversight and central bank involvement in stabilizing cryptocurrency-backed assets cannot be overstated.
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