What happens to Tether, stablecoins in the event of dollar collapse?

Over the past decade, private cryptocurrencies have emerged as the latest iteration of money. This is especially true for stablecoins, which Harvard Business Review deemed “a private form of money,” offering an efficient alternative to state-sanctioned fiat.

While a common industry narrative seeks to portray cryptocurrencies as separate from the legacy system, a degree of entanglement between the two exists. For example, the U.S. dollar backs the top three stablecoins.

With economists continuing to sound the alarm on the worsening macroeconomic landscape, this poses questions about what may happen to stablecoins should a currency collapse occur.

The rise of stablecoins

Stablecoins are digital currencies pegged to another asset, which may include fiat, gold, or a cryptocurrency token (such as in the case of algorithmic stablecoins), to stabilize its price. They offer investors a means to cycle in and out of crypto tokens and counter market volatility.

In recent years, stablecoin market caps have grown exponentially, demonstrating their rising popularity and influence over time.

At the start of 2017, Tether’s market cap was around $15 million. In May 2022, this peaked at $83 billion, equating to a more than 5,500x increase in five and a half years.

In theory, as Tether tokens are redeemable for dollars, the company must hold an equivalent amount in cash to honor its redemptions. But throughout its existence, doubts about the company’s reserves being sufficient to cover its token issuance have been raised.

“All Tether tokens (USD₮) are pegged at 1-to-1 with a matching fiat currency and are backed 100% by Tether’s reserves. We publish a daily record of the current total assets and reserves.”

Despite that, to date, every stress test levied at Tether has resulted in a pass. Further, it still manages to retain its position as the leading stablecoin, consistently turning over more trading volume than any other token daily.

For various reasons, stablecoins have caught the attention of authorities, who seek to regulate and control them under the mandate of consumer protection. Taking into account the de-peg of algorithmic stablecoin Terra UST in June, which is estimated to have lost $42 billion, some say this is the right thing to do.

When it comes to regulating stablecoins, a common theme among global authorities is to legislate for stablecoin systems, not just the token itself. For example, the IMF said, “requirements on stablecoins should cover the entire ecosystem and all its key functions.” Similarly, the BIS proposed embedding supervisory requirements into stablecoin systems directly.

How these ideas would work in practice is unclear at this time, especially the concept of embedded supervision, which has shades of Central Bank Digital Currency to it. Nonetheless, it appears the favored strategy is to manage stablecoin issuers. Again, this sparks several questions about jurisdiction and censorship.

The takeaway here is that global authorities recognize stablecoins as “their own,” at least in their minds, and seek to bring them into the fold, further blurring the lines between stablecoins and legacy finance.

Markets flip bearish for 2023 following the FOMC meeting

On Dec. 14, Fed Chair Jerome Powell announced a 50 basis point (bps) rate hike, increasing the fund rate to 4.5%.

Even though markets expected a 50 bps hike, Bitcoin ( $66,966.00 ) reacted with an initial 3.2% drop, with sell-side momentum continuing into the following day. Likewise, the Dow, S&P 500, and Nasdaq all saw sell-offs.

During the press conference, Powell‘s comments took a decidedly hawkish tone, putting paid to the idea of pivoting anytime soon. He added that more signs of inflation coming under control were needed before the central bank would consider reversing course.

“To the extent we need to keep rates higher and keep them there for longer.”

Based on this, markets understood that GDP growth for 2023 will be minimal, and the terminal rate is now likely higher than the previously touted 5%.

Moreover, following the press conference, it is clear that Powell is calling for a lot more pain before U-turning on interest rates.

Currency crisis

The collapse of a major currency, such as the dollar, is unthinkable from the perspective of faith in the social order. But recent events, including the cost of living crisis and the draconian response to Covid, have shaken people’s faith in the establishment.

What’s more, history is littered with examples of currencies reverting to their intrinsic value, which, according to the French writer and public activist François-Marie Arouet, better known by his pseudonym Voltaire, is zero.

“all paper money eventually returns to its intrinsic value: zero.”

Despite talking heads downplaying the seriousness of decades of cheap money and reckless money printing, a look deeper throws up large deficits, asset overvaluation, and high inflation, which can no longer be whitewashed as transitory or insignificant.

A recent article from ZeroHedge titled “BlackRock: Prepare For Recession “Unlike Any Other”… And What Worked Before “Won’t Work Now” painted a dire picture of what may come.

The article said the global economy has already bolted from 40 years of stable growth and moved into heightened instability. With that, macro volatility across the board should be expected.

What’s more, unlike past instances of recession, BlackRock said central banks would not be coming to the rescue this time. This leaves one option, a deep recession, with some predicting a painful depression.

The crises of the Weimar Republic in Germany after World War I, Argentina in the late 1990s, and Venezuela in 2016, to name a few, all shared one commonality – the people’s loss of faith in the currency.

With that in mind, central banks are walking a dangerous line. And with economic warning signs flashing red, how much longer can fiat currencies continue to tread water?

Tether co-founder Reeve Collins told CryptoSlate that if the worst were to happen, a dollar collapse would mean Tether ceases to be backed, thus rendering it incapable of fulfilling its intended functions.

However, if such a scenario played out, there would be “bigger problems than fiat-backed stablecoins not having any value,” said Collins.

The end of fiat-backed stablecoins?

Even so, under this hypothetical scenario, Collins is optimistic that the existing cryptocurrency infrastructure offers a ready-to-go alternative financial system and means to transact, negating the turmoil of a currency collapse to some extent.

Case studies of currency collapses have shown people switching to alternative currencies. For example, post-bolivar collapse, at one point, the dollar accounted for half of Venezuelan transactions, and Bitcoin ( $66,966.00 ) trading volumes also spiked.

Does a dollar collapse mean the end of stablecoins? Not entirely, as the void left by defunct fiat-backed stablecoins could be filled with algorithmic stablecoins, presumed Collins.

“I do believe, at some point, new algorithmic stables will come along which will prove to be as stable as the fiat-backed counterparts, but we are not there yet.”

Although the reputation of algorithmic stablecoins, in general, was tainted by the Terra UST implosion, this was down to weaknesses in the design of the LUNA pegging system, and not a flaw in the concept of pegging to a cryptocurrency per se.

With that in mind, in a post-apocalyptic world, people will trade using whatever they have faith in to store wealth, offer a unit of account, and provide a means of exchange. With fiat out of the picture, what else could better fulfill those functions than an algorithmic stablecoin?

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