Ask most people what makes a stablecoin stable and they will point straight to the peg, yet a recent BIS bulletin suggests the more revealing attribute is how holders are actually being paid, and it separates the ways that yield is generated into two very different models. In the first model the return simply passes through the income earned on the issuer's reserve assets, so the yield tracks prevailing policy rates and behaves much like the interest on a cash-management account. In the second model, the return is funded by the exchange's own trading and lending activity, which makes the yield considerably more volatile and, as the authors note, closer to a risky investment than to anything resembling stable money. The central core of the problem remains: are many of the products currently promoted as stablecoins truly deserving of the name?

 

Before going further, it helps to name where stablecoins sit within the wider arc of this industry. Stablecoin is the buzzword of the moment, occupying the position once held by initial coin offerings, then by the rush for every company to launch its own exchange, and then by non-fungible tokens. Each of those waves arrived with the same certainty that it represented the permanent future, and each of them eventually consolidated into something far smaller and more orderly than the noise around it had suggested. History tends to repeat itself, and the traditional markets already show us the destination, because stock exchanges were once scattered and effectively decentralized before collapsing over time into the handful of venues that dominate globally today. There is little reason to assume that stablecoins will escape that same gravitational pull toward consolidation.

 

Within that context, the proliferation of yields and yield types is worth reading for what it actually is, which is a competitive game. Offering a headline return is one of the more direct ways for a provider to manufacture a sense of superiority over its rivals and to pull balances onto its own platform. The number printed on the marketing page tells you very little on its own. The only thing worth examining is the investment sitting underneath it, because that underlying asset is what determines whether you are holding something sound or something precarious.

 

The test I apply is straightforward in principle. If the yield is generated by US treasuries, then the coin is a representative value of those treasuries and nothing more exotic than that, and you ought to be able to audit the backing in real time. If the yield is generated by something else, then it can be whatever that something else happens to be, and at the far end of that spectrum it can be a Ponzi scheme dressed in more respectable language. The responsibility falls on the holder to look under the sheet rather than to accept the label at face value, because the label has become the easiest part of the whole arrangement to print.

 

There is a further complication worth acknowledging, which is that the line between a stablecoin and a tokenized asset grows blurry the moment you inspect the backing. If a so-called stablecoin is secured by the value of a particular company's stock, it becomes difficult to explain what separates it in any real sense from simply tokenizing that stock outright. At that point you are no longer dealing with stable money that happens to earn a modest return, you are dealing with an investment position wearing the costume of one.

 

My own view is that a stablecoin should be tied to a fiat equivalent and should earn only whatever yield is available on that fiat equivalent, and nothing beyond it. Once the return begins arriving from somewhere other than the fiat instrument the coin claims to represent, the product has quietly stopped behaving like a stablecoin and started behaving like an investment, and it ought to be understood and regulated as one. This is precisely the fork that the BIS authors identify when they contrast a yield tracking benchmark rates against a yield driven by the volatility of exchange activity, and it is the question every holder should be putting to the product sitting in their own wallet.

 

None of this amounts to a reason to dismiss the category, any more than the excesses of earlier cycles were a reason to dismiss the underlying technology. It is simply a reminder that the popular term of the day is being applied generously, exactly as the earlier terms were, and that all of those earlier terms were eventually cleaned up as the market matured and the weaker constructions fell away. The same cleaning up is coming for stablecoins. The holders who fare best through it will be the ones who learned early to look past the word on the label and examine what is actually holding the value in place.