The European Central Bank (ECB) Just Issued a Major Warning About Stablecoins. Should Crypto Investors Be Concerned?
Cryptocurrencies, like Bitcoin (BTC -2.11%), have become a hot topic on Wall Street since their introduction. At first seen as a novelty, crypto use has expanded, and the crypto model has shifted in important ways. Today, so-called stablecoins appear to offer investors and businesses a new tool to support global operations. The European Central Bank (ECB), meanwhile, is working on its own alternative. Here’s what you need to know.
Cutting out all the middlemen
One of the main features of cryptocurrencies is that they aren’t backed by countries, as are fiat currencies. Moreover, cryptocurrencies like Bitcoin trade hands between individual crypto users, so you don’t even need to use a bank to facilitate transactions. This represents a complete overhaul of the traditional money system that underpins the global economy.
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Early on, Crypto was dominated by small investors enamored of modern technology. Then it became a hot investment theme, where investors bought because they believed they could get rich quickly. The truth is, traditional cryptocurrencies are only worth what their owners are willing to pay. By comparison, a stock is backed by the assets of the company that issued the shares. This dynamic makes crypto a high-risk investment at best, and total speculation at worst.
The potential solution to this problem is stablecoins, which are backed by assets such as fiat currencies or precious metals. Examples here are Tether (USDT -0.01%), which is linked to the U.S. dollar, and Tether Gold (XAUT -0.87%), which is linked to gold. Tether could theoretically eliminate the need for banks to handle financial transactions. Tether Gold could theoretically eliminate the need for fiat currencies.
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The banking industry isn’t pleased
The disruption to the global economic system hasn’t gone unnoticed. Recently, the European Central Bank has warned that the crypto market, particularly stablecoins, poses a major threat to banks and the entire financial system. The big problem is that customers shifting to crypto and stablecoins could drain reserves from the banking system, making the banking system less stable. Such a shift could also, perhaps not coincidentally, make banks less profitable.
The problem is that companies can save money by stepping outside the traditional banking system. So that’s what they are doing, when they can. The ECB is working on a digital euro test, which would essentially be a stablecoin backed by the traditional banking system and governments. It could be the next evolution of the crypto market. This isn’t the only such effort taking shape.
This development has material implications for investors who own cryptocurrencies. At this point, crypto investing, even stablecoins, is not appropriate for risk-averse investors. The entire segment needs further maturation before it is appropriate for conservative investors, noting that crypto may never reach a point where it is “safe” enough for so-called “widows and orphans.”
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If you own crypto, however, you should watch stablecoins very closely. That includes the ECB’s own stablecoin efforts. If stablecoins prove to be the next evolution of crypto, older crypto, perhaps even Bitcoin, could end up being worthless as users shift to a newer style of coin. They are, by nature, highly speculative. While one of the big benefits of crypto is operating outside traditional financial systems, stablecoins backed by precious metals, rather than the ECB’s digital euro, would still offer that. Meanwhile, fiat-backed stablecoins, such as a digital euro, would provide an entry point for businesses and investors who want to remain within the current banking system.
That said, regulators are getting involved in the stablecoin space. That may slow the development of stablecoins, but it is unlikely to derail stablecoins over the long term. The banking system appears to recognize the need to adapt, as highlighted by the ECB’s own efforts, which should ultimately push regulators to allow the necessary change.
Nothing may not be the best reserve
At the end of the day, the biggest risk for older cryptocurrencies could be the evolution of the crypto industry itself. The next logical step appears to be stablecoins, including those backed by fiat currencies and the traditional banking system. If you are an aggressive investor and own crypto, your biggest risk may be failing to keep pace with the broader industry as it shifts.
And the trend that may matter most could be transitioning from purely speculative cryptocurrencies backed by nothing but the enthusiasm of their owners to stablecoins backed by physical assets. While some speculative cryptos may remain, the extensive list in place today could easily be winnowed. The ECB’s warning, meanwhile, highlights that the traditional banking system will support the evolution of crypto, with the ultimate goal of protecting its role in the economy and finding ways to profit from crypto. Don’t underestimate the risk this poses to older cryptocurrencies or the opportunities it could create in the future.
