Sen. Elizabeth Warren of Massachusetts remains skeptical on the use cases of stablecoins and decentralized finance due to issues with asset backing and the unregulated nature of the sectors.
Stablecoins were the focus of a hearing of the Senate Banking, Housing, & Urban Affairs Committee on Dec 14, 2021. The hearing addressed three aspects of stablecoins: how they work, how they are used, and what risks they present. Alexis Goldstein, director of Financial Policy at the Open Markets Institute, and Hilary J. Allen, a law professor at American University Washington School of Law, were grilled by Senator Elizabeth Warren of Massachusetts.
Senator Warren succinctly outlined her view on stablecoins, explicitly highlighting the risks they pose as part of decentralized finance (DeFi) and the lack of audits and regulation for stablecoin issuers. Warren posed the following question to Goldstein, “Ms. Goldstein, let’s say that I won $10 worth of Tether or USDC. If I want to trade my $10 worth of these tokens, am I guaranteed to get $10 back?” Goldstein admitted that she may not. “You’re sort of dependent on the exchange where you’re trading it.”
A stablecoin’s value is pegged to a fiat currency, the price of a commodity like gold, or a group of assets. In the case of the USDC, the value of one coin should theoretically be exactly $1. Unfortunately, the value does fluctuate and does not always remain at exactly $1. Different exchanges may offer dollar values that are slightly less or more than $1. Stablecoins can be bought with fiat at exchanges. One stands to lose some money should the value be below $1. In the last year on crypto exchange Kraken, USDC reached highs and lows of $1.03 and $0.86.
Risks of unbacked stablecoins
Senator Warren also brought up the issue of stablecoin backing. The company responsible for issuing Tether recently got into hot water, as it failed to provide backing to 100% backing to its stablecoins. Tether claimed to have dollar reserves for 10% of stablecoins issued, while other assets back 90% of the coins issued.
Warren did point out that no one currently verifies claims of stablecoin issuers regarding the assets backing up their coins, highlighting the lack of audited financial statements or government regulations.
Role in DeFi
Warren then turned her attention to decentralized finance and what panic selling of stablecoins could do to the financial system. Her concern was if many users wish to exchange their stablecoins for fiat all at once, could that threaten the financial stability of the U.S.? Allen responded by saying, “So right now, I don’t think that would have systemic consequences. If stablecoin holders are only using them to speculate, they’re not really going to expect stability, and so runs will be less likely. But if a run did occur right now, I think the impact would probably be felt in the DeFi ecosystem.”
Warren responded by saying, referring to DeFi, “This is where the regulation is effectively absent and no surprise, it’s where the scammers and the cheats and the swindlers mix among part-time investors and first-time crypto traders.” She then asked whether DeFi threatens our financial stability and whether DeFi can continue to grow without stablecoins. Allen responded, “I don’t think DeFi can grow without stablecoins. I think it would struggle right now.”
Stablecoins are often used in “staking,” where tokens are locked into a piece of computer code called a DeFi smart contract to earn more assets or participate in governance. They are also used to obtain annual “yields” if deposited into a DeFi platform, an example of which is Compound Finance.
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