skip navigation
Blog

Stay up to date on timely topics and market events. Subscribe to our Blog now.

MARKETS
November 29, 2021

The Unstable Future for Stablecoins

By Jason Straker

Stay up to date on timely topics and market events. Subscribe to our Blog now.

On November 1, 2021, the President’s Working Group on Financial Markets in conjunction with the Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency published a detailed report on the stablecoin market called the PWG Report.1 Stablecoins are one of the latest financial products to join the global digital ecosystem which already includes many buzzword-worthy digital innovations that have dominated the financial and mainstream media headlines in recent years.

Superficially, stablecoins are just another type of digital asset used predominately as a short-term stopgap for investors trading in—or between—other longer-term speculative digital assets, such as cryptocurrencies or non-fungible tokens (NFTs). When comparing the digital-only world with the more traditional investment fund industry, stablecoins are often likened to money market funds. Just like constant net asset value (CNAV) money market funds, stablecoins are designed to maintain a stable value relative to a fiat currency such as the US dollar. This perceived stability offers investors a safe harbor when switching among assets in their digital wallets while earning a small amount of interest.

The utilization of the stablecoin market has been swift and widespread. By October 31, 2021, total market capitalization of the top three stablecoins rose to more than $114 billion with the majority of this growth witnessed in the past 12 months (Exhibit 1).

Exhibit 1: The Rise of Top Stablecoins by Market Cap
The Rise of Top Stablecoins by Market Cap
Source: Coin Metrics (coinmetrics.io), January 1, 2020-October 31, 2021. As of 23 Nov 21. Select the image to expand the view.

The assumed stability of value is really where the comparison with CNAV money market funds ends. Unlike those types of funds, stablecoins are currently largely unregulated. While sponsors of money market funds must adhere to a variety of strict regulations covering the underlying investment types—NAV accounting practices, portfolio liquidity and stress testing—providers of stablecoins are not bound by such rules and restrictions.

An investment in a CNAV money market fund represents a share of the value of the underlying portfolio, and the fund is managed in such a way that that value is essentially equal to one unit of currency. Conversely, no such relationship exists between the value of the stablecoin token and its underlying portfolio, which can be invested in both low-risk securities permitted for money market funds (e.g., T-bills), as well as in other assets not permitted, such as lower-quality corporate bonds. This funding gap was one of three major risks and regulatory gaps highlighted by the PWG Report:

  1. Loss of value: Risks to stablecoin users and stablecoin runs
  2. Payment system risks
  3. Risks of scale: Risk and concentration of economic power

The potential for a run on a stablecoin is not just a concern for the stablecoin investors, it also creates nervousness for managers of traditional money market funds. If an underlying stablecoin portfolio holds large volumes of money market instruments, such as commercial paper, then a sudden and dramatic liquidation could result in downward price pressure in the broader market. This is something a money market fund manager would be keen to avoid.

The PWG Report makes a number of recommendations to address each of the three concerns we mention, most significantly that issuance of stablecoins be limited to banks only. This would lessen the potential for destabilizing, confidence-driven runs as banks would have access to the various safety nets offered by official institutions, such as the Federal Reserve.

Whatever form stablecoins may end up taking in the future, investors deserve the information they will need to make informed decisions regarding investment risks—and this will undoubtedly be facilitated by the involvement of regulators.

ENDNOTES
1President’s Working Group on Financial Markets, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency: Report on Stablecoins: https://home.treasury.gov/system/files/136/StableCoinReport_Nov1_508.pdf

© Western Asset Management Company, LLC 2024. The information contained in these materials ("the materials") is intended for the exclusive use of the designated recipient ("the recipient"). This information is proprietary and confidential and may contain commercially sensitive information, and may not be copied, reproduced or republished, in whole or in part, without the prior written consent of Western Asset Management Company ("Western Asset").
Past performance does not predict future returns. These materials should not be deemed to be a prediction or projection of future performance. These materials are intended for investment professionals including professional clients, eligible counterparties, and qualified investors only.
These materials have been produced for illustrative and informational purposes only. These materials contain Western Asset's opinions and beliefs as of the date designated on the materials; these views are subject to change and may not reflect real-time market developments and investment views.
Third party data may be used throughout the materials, and this data is believed to be accurate to the best of Western Asset's knowledge at the time of publication, but cannot be guaranteed. These materials may also contain strategy or product awards or rankings from independent third parties or industry publications which are based on unbiased quantitative and/or qualitative information determined independently by each third party or publication. In some cases, Western Asset may subscribe to these third party's standard industry services or publications. These standard subscriptions and services are available to all asset managers and do not influence rankings or awards in any way.
Investment strategies or products discussed herein may involve a high degree of risk, including the loss of some or all capital. Investments in any products or strategies described in these materials may be volatile, and investors should have the financial ability and willingness to accept such risks.
Unless otherwise noted, investment performance contained in these materials is reflective of a strategy composite. All other strategy data and information included in these materials reflects a representative portfolio which is an account in the composite that Western Asset believes most closely reflects the current portfolio management style of the strategy. Performance is not a consideration in the selection of the representative portfolio. The characteristics of the representative portfolio shown may differ from other accounts in the composite. Information regarding the representative portfolio and the other accounts in the composite are available upon request. Statements in these materials should not be considered investment advice. References, either general or specific, to securities and/or issuers in the materials are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendation to purchase or sell such securities. Employees and/or clients of Western Asset may have a position in the securities or issuers mentioned.
These materials are not intended to provide, and should not be relied on for, accounting, legal, tax, investment or other advice. The recipient should consult its own counsel, accountant, investment, tax, and any other advisers for this advice, including economic risks and merits, related to making an investment with Western Asset. The recipient is responsible for observing the applicable laws and regulations of their country of residence.
Founded in 1971, Western Asset Management Company is a global fixed-income investment manager with offices in Pasadena, New York, London, Singapore, Tokyo, Melbourne, São Paulo, Hong Kong, and Zürich. Western Asset is a wholly owned subsidiary of Franklin Resources, Inc. but operates autonomously. Western Asset is comprised of six legal entities across the globe, each with distinct regional registrations: Western Asset Management Company, LLC, a registered Investment Adviser with the Securities and Exchange Commission; Western Asset Management Company Distribuidora de Títulos e Valores Mobiliários Limitada is authorized and regulated by Comissão de Valores Mobiliários and Brazilian Central Bank; Western Asset Management Company Pty Ltd ABN 41 117 767 923 is the holder of the Australian Financial Services License 303160; Western Asset Management Company Pte. Ltd. Co. Reg. No. 200007692R is a holder of a Capital Markets Services License for fund management and regulated by the Monetary Authority of Singapore; Western Asset Management Company Ltd, a registered Financial Instruments Business Operator and regulated by the Financial Services Agency of Japan; and Western Asset Management Company Limited is authorised and regulated by the Financial Conduct Authority ("FCA") (FRN 145930). This communication is intended for distribution to Professional Clients only if deemed to be a financial promotion in the UK as defined by the FCA. This communication may also be intended for certain EEA countries where Western Asset has been granted permission to do so. For the current list of the approved EEA countries please contact Western Asset at +44 (0)20 7422 3000.