Is USD Coin (USDC) unstable and a threat to the Economy?

The popular USD Coin (USDC)?stablecoin could be unstable and a threat to the financial system Federal Reserve analysts claim.

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Stablecoins, including USD Coin, face more risks, including runs and collapse, a Federal Reserve Bank of New York study alleges. In particular, Fed analysts think problems with one stablecoin, such as Tether (USDT)?could bring down other stablecoins.

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“This substitution from Tether into USDC illustrates a bigger concern—namely, that resilient SCs (stablecoins) can amplify run risks from more fragile ones, as they provide a convenient instrument to run to,” The Financial Stability Implications of Digital Assets?alleges.

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Bank Runs and Stablecoins

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To explain, the only value stablecoins have is their ability to pay in fiat currency. For example, USD Coin pays in US dollars held in trust accounts. If holders cash all the coins out, USD Coin could have no value because there could be no dollars.

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Fed analysts believe USD Coin could collapse if problems at a competitor such as Tether or BinanceUSD (BUSD)?convince people USDC is unstable. Essentially, Fed analysts fear a bank run on a stablecoin or the entire stablecoin market.

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A bank run?occurs when many depositors withdraw all their funds from a financial institution. In the worst-case scenario, banks could collapse if depositors withdraw all the money. Bank runs were common in the USA until the Federal Deposit Insurance Corporation (FDIC)?began insuring US banks. The FDIC insures most US bank accounts of up to $250,000 or $1.25 million, depending on the account.

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Why The Federal Reserve thinks Stablecoins are unstable

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Runs threaten stablecoins because they do not insure most stablecoins, the Fed analysts think. Frighteningly, the analysts think the entire stablecoin market collapse.

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“If a sizable share of holders rushed to sell or redeem a large SC like Tether (USDT)?or US Dollar Coin (USDC), it could not only create instability in the digital asset ecosystem but also disrupt certain markets in the traditional financial system, as SC issuers would have to dispose of their reserve assets quickly to meet redemptions,”?The Financial Stability Implications of Digital Assets?speculates.

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Fed analysts think stablecoins are unstable because of their nature. In particular, the Fed identifies two kinds of stablecoins.

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In centralized stablecoins such as?US Dollar Coin (USDC), Tether (USDT),?and BinanceUSD (BUSD)?one institution holds all the money they peg the stablecoins to. This organization holds the fiat currency in accounts and makes the payments. If the organization runs out of money, the stablecoin could become worthless and collapse.

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Conversely, decentralized Stablecoins, such as TerraUSD (UST)?use complex blockchain systems to get fiat currency for payments. For some stablecoin platforms hold cash in cryptocurrencies, such as Bitcoin (BTC). When somebody makes a stablecoin payment, the platform sells Bitcoin to raise cash. If the system breaks down, payments stop.

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Tellingly, TerraUSD collapsed because of a run in May 2022.

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Is Tether (USDT) Unstable?

The New York Fed alleges Tether is unstable because it backs stablecoins with commercial paper.

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“In addition, for SC collateralized by traditional financial assets (“off chain”), a run could lead to liquidations and fire sales of the collateral assets,” The Financial Stability Implications of Digital Assets?alleges. At present, Tether (USDT)?is reportedly one of the largest commercial paper holders in the world. A fire sale due to liquidations of commercial paper to address redemptions could have significant financial stability implications.”

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Commercial paper?is a class of unsecured short-term debt instruments corporations and other entities issue to finance their day-to-day operations. Investors buy commercial paper because it pays higher interest rates. However, commercial paper is risky because it is unsecured.

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Could Tether (USDT) Collapse?

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Tether (USDT)?was one of the largest investors in the US commercial paper market?in June 2021,?The Financial Times?claims. Tether admitted to holding $30 billion worth of commercial paper in May 2021.

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That meant Tether held close to 30% of US paper at one time. To explain, the St. Louis Fed estimates the US commercial paper market was worth $1.23 trillion on 28 September 2022.

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Frighteningly, only 2.9% of Tether’s holdings were in cash in May 2021, The Financial Times?claims. Instead, commercial paper comprised almost half of Tether’s holdings. Tether held another 18% in fiduciary deposits, 12% in secured loans, and 10% in corporate bonds, funds, and precious metals.

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I think Fed analysts fear Tether could not sell or redeem enough assets to cover stablecoin payments. Hence, New York Fed analysts fear Tether could collapse like TerraUSD did.

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One danger facing Tether is the commercial paper market. If many companies cannot repay commercial paper because of an economic downturn. Tether could have no cash. Similarly, Tether could drag down commercial paper by selling off enormous amounts of commercial paper to prevent a run.

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However, Tether claimed to have cut its commercial paper holdings to under $50 million in September 2022. Instead Tether claims US Treasury bonds comprised 58.1% of its portfolio?on 30 September 2022,?CoinDesk?reports. Hence, Tether could be clean up its act by reducing commercial paper exposure.

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Tether vs. USD Coin?

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Tether is scary because of its size. For example, CoinMarketCap gave Tether (USDT)?a $68.072 billion Market Cap, a $70.164 billion Fully Diluted Market Cap, and a 24-Hour Market Volume of $42.573 billion on 5 October 2022. They base those numbers on a Circulating Supply of 68.06 billion USDT and a Coin Price of $1. Tether was CoinMarketCap’s third largest cryptocurrency on 5 October 2022.

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In contrast, USD Coin (USDC) was CoinMarketCap’s fifth largest cryptocurrency with a $46.468 billion Market Cap, a $46.47 billion Fully Diluted Market Cap and a 24-Hour Market Volume of $3.709 billion on 5 October 2022. They base numbers on a Circulating Supply of 46.465 billion and a $1 Coin Price.

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USD Coin claimed to have $48.8 billion in USDC reserves, $10.2 billion in cash, and $38.6 billion in short-duration US Treasuries (bonds) on 29 September 2022. They claim to have issued $1 billion in USDC and redeemed $2.3 billion USDC during the week of 22 September to 29 September 2022.

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Circle, the organization behind USDC, claimed to have $47 billion USD Coin in circulation and a $4 billion 24-Hour trading volume on 4 October 2022. They claim USD Coin was used in 6.23 trillion on-chain transactions as of 23 September 2022. There were 1.5 million USDC holders on 23 September 2022 and USDC Coin was used in over 190 countries on 23 September 2022.

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In contrast Tether claimed cash and short-investments comprised 79.62% of its reserves?on 5 October 2022. Corporate bonds, funds, and precious metals comprised 5.25% of Tesla reserves on 4 October 2022, secured loans comprised of 6.77% of Tether reserves on 4 October 2022, and a other investments (including “digital tokens) comprised 8.36% of Tether reserves on 5 October 2022.

Hence, both Tether and USD Coins seem to be fairly safe cryptocurrency. My guess is fear of federal regulation is driving stablecoin operators to be more responsible.

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However, I think there are still dangers in stablecoins especially the lack of insurance. I consider USDT and USDC good speculative coins, but investors need to be aware of the dangers.