3 - 6 minute read
The Bank of International Settlements (BIS) has released a working paper that highlights the stability issues surrounding stablecoins and their implementation as tokenized money. The paper argues that the singleness of money, which ensures public and private money trade at the same rates, is crucial to maintaining stability in the market. This means that even small differences between public and private money rates have the potential to cause a ripple effect across transactions.
Tokenization is the process of representing claims in digital form and allows them to be transacted on programmable platforms using smart contracts. Stablecoins, which operate as a bearer instrument where the claim on the issuer is transferred without affecting the issuer’s balance sheet, is one example of tokenized money. However, the paper argues that the use of stablecoins raises concerns, as the stability of the token will depend on market forces and can result in depegging on permissionless exchanges.
“Bearer instruments were prevalent in the days of ‘free banking’ in the United States before the creation of the Federal Reserve, when money could be discounted by its receivers,” the authors of the paper wrote. “They drew a parallel between that situation and stablecoins depegging on permissionless exchanges.”
Alternatively, non-bearer instruments are another form of tokenized money, where the sender is debited, and the receiver is credited on their respective balance sheets as the settlement is made in central bank money. The commercial banking system currently operates on this model, which ensures a consistent exchange rate.
Maintaining singleness between digital money and cash would depend on regulation. “Singleness between private tokenized money and cash would be supported in the same way it is now for commercial bank deposits, provided all private tokenized money issuers comply with the same regulatory standards and have access to the same safeguards,” the BIS paper stated.
Bank of International Settlements likes ERC-20 https://t.co/noHmGUbJ8I pic.twitter.com/rz3FEZMkpo— Mikko Ohtamaa 🐮 (@moo9000) April 11, 2023
The paper suggests the use of central bank money to settle tokenized money that is a non-bearer instrument to mitigate issues of stability. This model requires that both public and private forms of tokenized money are available on the same platform. The continuum of challenges and benefits from tokenization is dependent on the nature of the underlying assets, according to the second BIS working paper that examined tokenization.
As the market for tokenized money continues to develop, traders should be cautious of the risks associated with stablecoins. Stablecoins are generally pegged to a fiat currency, and their stability is dependent on the value of the currency they are pegged to. In the event of significant fluctuations, traders who hold stablecoins may face loss.
“The biggest risk with a stablecoin is, of course, the stability of the underlying asset,” says Chantelle Armitage, CEO of the cryptocurrency exchange, Quantex. “If the underlying asset—whether it’s a currency, a commodity, or a security—loses value, then the stablecoin comes under pressure, and the value can drop.”
While tokenization continues to garner interest in the market, traders should be mindful of the risks associated with stablecoins. The BIS working paper highlights the importance of regulation and consistency to maintain singleness between digital money and cash. For traders, understanding the implications of stablecoins and their potential risks is crucial, and they should consider diversifying their portfolios to mitigate any potential loss.
The Bottom Line
Traders should be aware of the risks associated with stablecoins and consider diversifying their portfolios. The BIS working paper emphasizes the importance of regulation and consistency to maintain the singleness of money between digital and cash transactions.