A Q&A with Prof. Rich Lyons
Cryptocurrencies like Bitcoin, with their roller-coaster price movements, are not investments for the faint of heart. In recent years, however, a new form of cryptocurrency has emerged with the promise of less volatility. So-called stable coins, such as market leader Tether, are pegged one-to-one to the U.S. dollar or other asset, in theory making them safer. Prof. Rich Lyons, an expert in currency exchange rates, recently co-authored a paper examining what keeps stable coins stable.
What exactly are cryptocurrencies?
They are part of the digital asset economy, which lies outside the traditional banking system and is generally housed on a blockchain, a secure, decentralized electronic ledger used to record transactions. The digital asset economy includes cryptocurrencies like Bitcoin and so-called initial coin offerings. These assets serve multiple purposes. For example, I could issue 100 tokens and, by buying one, you could own one one-hundredth of a work of art. In addition, this digital asset economy gives people in countries that might not be able to hold assets because of capital controls or other restrictions access to more of the world’s assets.
What’s the purpose of stable coins?
The issuers and traders of cryptocurrencies aren’t like regulated financial institutions. They don’t have “know-your-customer” rules or anti-money-laundering regulations. At first, this digital asset economy lacked a store of value, that is, assets with relatively low volatility that people could hold knowing the value wouldn’t change drastically. Because Tether and other stable coins are pegged to traditional currencies, they have become stores of value in that alternative financial world.
Haven’t stable coins been controversial?
Yes. For example, there was a question of whether the issuers of Tether were manipulating the price of Bitcoin. That scenario is possible in part because in more than 50% of transactions, people use Tether to buy and sell bitcoins. It’s cheaper and more frictionless because both are outside the banking system. Going from dollars to bitcoins has higher transaction costs, because you are going from outside to inside the banking system.
Are stable coins as safe as claimed?
Tether is pegged to the dollar at one-to-one, and its price has generally traded within 1% of this. But about 18 months ago, there was some concern that Tether was not backed one-to-one with assets; i.e., if there was a mass redemption of Tether, the collateral would not be sufficient to cover the full amount. This concern led the price to fall as low as 95 cents to the dollar. There was an audit, which was not 100% transparent, but it did restore confidence in the marketplace.
What questions should we be asking about stable coins?
Stable coins come in a number of different flavors. Some purport to be 100% backed by redeemable collateral that’s in escrow and can’t be run away with. But part of the question, even with Tether, is whether it really is 100% collateralized. And is all that collateral really liquid? If you have to sell in fire-sale conditions, even a “100% collateralized” asset may not turn out to be so.
What are the long-term prospects for cryptocurrencies?
There will be a lot of shakeout. The stable coins that have the greatest market confidence concerning the legitimacy and liquidity of their collateral will win out. Meanwhile, if you think about the literally thousands of initial coin offerings, all the tokens, all the cryptocurrencies—90% of them will be valueless in 10 years, in my judgment.
How are cryptocurrencies evolving?
Many of the big central banks are saying they will launch a digital currency in the next five years. My prediction is in 10 years we will have three or four important stable-coin digital currencies based in blockchain and issued by central banks. They will live more in the traditional regulated banking system, filling in the continuum.