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

Over the past decade, private cryptocurrencies have emerged as the latest iteration of money. This is especially true for stablecoins, which the 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 crypto as separate from the legacy system, there is a degree of entanglement between the two. For example, the US dollar supports all three major stablecoins.

As economists continue to sound the alarm about the worsening macroeconomic outlook, this raises questions about what may happen to stablecoins in the event of a currency collapse.

The rise of stablecoins

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

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

At the beginning of 2017, Tether’s market capitalization was around $15 million. In May 2022, it peaked at $83 billion, which is equivalent to an increase of more than 5,500 times in five and a half years.

In theory, since Tether tokens can be redeemed for dollars, the company should have an equivalent amount of cash to meet its redemptions. But throughout its existence questions have been raised as to whether the company’s reserves would be enough to cover its token issuance.

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

Despite that, to date, all stress tests performed on Tether have resulted in a pass. Furthermore, it still manages to maintain its position as the leading stablecoin, consistently delivering more trading volume than any other token on a daily basis.

For various reasons, stablecoins have caught the attention of the authorities, who seek to regulate and control them under the mandate of consumer protection. Considering the unpegging of the Terra UST algorithmic stablecoin 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 must cover the entire ecosystem and all its key functions.” Similarly, the BIS proposed incorporating supervisory requirements in stablecurrency systems directly.

It’s unclear how these ideas would work in practice at this point, especially the concept of integrated supervision, which has overtones of central bank digital currency. However, it seems that the preferred strategy is to manage stablecoin issuers. Again, this raises several questions about jurisdiction and censorship.

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

Markets turn bearish for 2023 after FOMC meeting

On December 14, Fed Chairman Jerome Powell announced a 50 basis point (bps) rate hike, raising the fund rate to 4.5%.

Although markets expected a 50bp rise, Bitcoin reacted with an initial drop of 3.2%, and the selling momentum continued into the next day. Similarly, the Dow, S&P 500, and Nasdaq all suffered selloffs.

During the press conference, Powell’s comments took a decidedly aggressive tone, dismissing the idea of changing course anytime soon. He added that more signs that inflation is under control are needed before the central bank considers reversing course.

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

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

Also, after the press conference, it’s clear that Powell is asking for a lot more pain before changing 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.

Furthermore, history is littered with examples of coins returning to their intrinsic value, which, according to the French writer and public activist Francois-Marie Arouetbetter known by his pseudonym Voltaire, is Zero.

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

As talking heads downplay the seriousness of decades of cheap money and reckless money printing, a deeper look reveals large deficits, overvalued assets and high inflation, which can no longer be disguised as transitory or insignificant.

A recent ZeroHedge article titled “BlackRock: Prepare for Recession “Unlike Any Other”…and What Worked Before “Won’t Work Now” painted a dire picture of what can happen.

The article said that the global economy has already exploded after 40 years of stable growth and has moved towards greater instability. With that, macro volatility should be expected across the board.

Also, unlike previous cases of recession, BlackRock said central banks would not come to the rescue this time. This leaves one option, a deep recession, and some predict a painful depression.

The crises of the Weimar Republic in Germany after the First World War, Argentina in the late 1990s and Venezuela in 2016, to name a few, had something in common: people’s loss of faith in 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 stay afloat?

Tether co-founder Reeve Collins told CryptoSlate that if the worst were to happen, a dollar collapse would mean that Tether would no longer be backed, rendering it unable to fulfill its intended functions.

However, if such a scenario were to occur, there would be “bigger problems than fiat-backed stablecoins that are worthless,” Collins said.

The end of fiat-backed stablecoins?

Still, under this hypothetical scenario, Collins is optimistic that the existing cryptocurrency infrastructure offers an alternative out-of-the-box financial system and means to transact, negating the turmoil of a currency crash to some degree.

Case studies of currency crashes have shown that people switch to alternative currencies. For example, after the collapse of the bolivar, at one point, the dollar accounted for half of Venezuelan transactions and Bitcoin trading volumes also increased.

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

“I think at some point new algorithmic stablecoins will appear that will prove to be as stable as fiat-backed counterparts, but we’re not there yet.”

Although the reputation of algorithmic stablecoins, in general, was tarnished by the implosion of Terra UST, this was due to weaknesses in the design of LUNA’s peg 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 medium of exchange. With fiat out of the picture, what else could fulfill those functions better than an algorithmic stablecoin?