Op-Ed: Stablecoins and Bank Failure — the Unmitigated Risk of Fiat-Backed Tokens
Lately, news broke that Noble Bank, one of the early banks related with safeguarding Tether’s backing, is likely insolvent and will be obtainable for sale for as little as $5 million dollars.
While advanced versions of the story elucidate that this insolvency is the consequence of the loss of key clients – comprising Tether – from their network, it highlights a serious issue that affects nearly all fiat-backed stablecoin projects, one that very few people in the cryptocurrency community are taking note of: Banks Fail.
This should be of specific disquiet to the cryptocurrency community because of the several of emerging fiat-backed tokens that have hurled, leveraging singular storage of fiat currency in these types of institutions.
Ever since 2008, there have been over 500 bank failures in the United States. Most of these were minor, regional banks that were poorly exploited and not subject to the same capital requirements as the tier one players, but there are some astonishing names on that list as well.
These banks fail for the main reason: Credit and Operational Risk.
Simply put these banks had unresolved liabilities that they could not meet, were not exploited well enough to meet their extremely significant obligations, and therefore collapsed when it came time to meet their obligations.
This was seen most clearly in the 2008 financial crisis, in which a number of banks took on exposure to risky assets, leveraged them to purchase liabilities, and then were forced into insolvency when the market conditions changed resulting in these purchases becoming unprofitable.
To remedy this issue, Basel III and Dodd-Frank legislation were implemented to ensure stricter capital reserve requirements in the US. The idea was that banks that want to take on riskier positions must have commensurately sized capital reserves to act as a buffer in case these investments failed and to prevent the insolvency of the banks, thus avoiding the “too big to fail scenario.”
In other words, there’s an inherent risk in cryptocurrency projects that leverage traditional banking infrastructure – the small banks that are willing to work with cryptocurrency projects are also the riskiest because they are not subject to the same capital reserve requirements.
Ever since the launch of Tether, the cryptocurrency world has been obsessed with the concept of fiat-backed stablecoins. While there are many decentralized projects that tout algorithmic stability, the appeal of a token with a centralized store of value is clear – if you issue a token that’s worth a dollar, and you have a dollar ‘backing’ it, conceptually the token will probably be worth a dollar.
And these fiat-backed projects have gone on to raise significant capital, and achieve a total market cap of over $2.9 billion claimed to be sitting in bank accounts backing tokens.