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The International Monetary Fund’s (IMF) director for monetary and capital markets has warned of more stablecoin failures. Director Tobias Adrian particularly highlighted the risks of so-called algorithmic stablecoins, saying: “There are others that could fail.”
Algorithms do not provide actual financial support. In the end, there must be $1 worth of reserves for each stablecoin lest the issuer face a bankrun-like situation. Many algorithmic stablecoins have failed as the public lost confidence and demanded a payout, including TerraUSD, IRON, BasisCash, SafeCoin, BitUSD, CK USD, DigitalDollar, and NuBits.
Algorithmic stablecoins rely on assets in various wallets, smart contracts, and liquidity pools to defend a $1 peg. TerraUSD (UST) exemplified the failure of algorithmic stablecoins when it collapsed in May despite promises by a once-$29 billion ecosystem to maintain a price of $1. UST holders quickly lost $14 billion in mark-to-market capitalization, plus untold billions from DeFi and other contracts tied to UST’s price as it sold off to $0.
IRON, another algorithmic stablecoin similar to UST and promoted by Mark Cuban, suffered a similar fate. Titan Finance claimed to back IRON with its own token plus Circle’s USDC, but his $1 bond eventually failed in June 2021 in another bank run type event and IRON collapsed to $0.
Algorithmic stablecoins have not outgrown traditional stablecoins
Traditional stablecoins are backed by assets held by a central custodian — rather than anything accessible to an algorithm — and are far larger. The backers of collateral-backed stablecoins like Paxos, Circle, or Tether usually promise that customers can redeem their stablecoins for $1 at the enterprise level.
Because of that promise, these are Stablecoins typically trade within a $1 cent range. Examples of asset-backed, non-algorithmic stablecoins are Tether (USDT), Binance USD (BUSD), Pax Dollar (USDP), and USD Coin (USDC).
These stablecoins carry the risk that their managers will lie or that they will suspend redemptions, making them similarly vulnerable to bankrun-type panics. For example, Tether’s critics have accused it of not holding adequate reserves or not preparing a financial audit. Tether severed its relationship with its first auditor, Friedman LLP, blaming Friedman’s “intolerably detailed procedures.”
Although algorithmic stablecoins are plagued with problems, Traditional stablecoins also pose significant risks to investors. IMF Director Adrian warned that fiat-backed stablecoins could fail as they may not be backed 1:1 with cash.
For example, between February 19, 2019 and March 4, 2019, Tether edited its claim that it supports USDT solely with cash. It deleted that pledge and replaced it with a new pledge to back USDT with a basket of assets, including commercial paper. Today, the latest version of this ever-changing promise is to back USDT with various assets such as gold, commodities, secured debt, bonds, and secured loans.
The IMF has continued to reiterate calls for crypto regulation.
Read more: ECB calls for stablecoin regulation to protect broader economy
The IMF considers stablecoin risks distinct but serious
Another recent IMF report echoed Tobias Adrian’s call for regulation. However, it stopped sounding an alarm when it noticed this The crypto industry currently poses no risk of contagion to broader economies.
According to his report, the impact of this year’s crypto bear market has mostly impacted digital assets, businesses, and hedge funds. The report mentioned a slowdown in advanced economies but gave heavy weighting to the impact of digital assets.
In summary, the multi-ten-billion-dollar collapse of the UST ecosystem was an unequivocal call for regulators to act. The IMF wants better stablecoin regulation that focuses on investor protection. His director recognized that Regulating the more than 40,000 coins listed on CoinMarketCap is a challenge. However, he advised that as a first step, entry points such as stablecoin issuers and exchange owners should be regulated.
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