📊 [Analysis] On The (in)Stability of Stablecoins - Bob McElrath

Bob McElrath identifies fractional reserve policies with stablecoins as the key creator of volatility and systematic risk. Stablecoins are synthetic assets pegged against other currencies, typically fiat, to create stable purchasing power relative to other goods. Stablecoins have existed for quite sometime, just not cryptocurrency versions. To date, 66 countries back their currency by U.S.D. and 25 by the Euro. These pegged currencies are kept stable by buying and selling treasury bonds which are IOU's to the government of origin. As McElrath demonstrates, stablecoins operate in a similar manner, but with an unfortunate caveat. To maintain stability, say around one percent of the underlying asset it is tied to, the central authority behind a stablecoin must buy and sell the underlying asset which is often done via algorithm. Yet, algorithms fall short. The amount the authority buys depends on the price and price depends on the variance of the distribution. In financial markets, this distribution is infinite by nature. So, you never know how much to buy because you cannot pin down the variance. The only tenable solution, therefore, is keeping a full reserve of the underlying asset for each synthetic asset on the market.