The third type of stable coin, which is uncollateralized, has this problem in spades. Here the platform issues not just crypto-coins but also crypto-bonds. If the price of the coins begins to fall, the platform buys them back, in exchange for additional bonds. The bonds are supposed to appeal to investors because they trade at a discount – so that, in principle, their price can rise – and because the issuer promises to pay interest to the bondholders, in the form of additional coins. That interest is to be funded out of the income earned from future coin issuance.

Here, too, the flaw in the model will be obvious to even a novice central banker. The issuer’s ability to service the bonds depends on the growth of the platform, which is not guaranteed. If the outcome becomes less certain, the price of the bonds will fall. More bonds will then have to be issued to prevent a given fall in the value of the coin, making it even harder to meet interest obligations.

Under plausible circumstances, there may be no price, however low, that attracts willing buyers of additional bonds. Again, the result will be collapse of the peg.

All of this will be familiar to anyone who has encountered even a single study of speculative attacks on pegged exchange rates, or to anyone who has had a coffee with an emerging-market central banker. But this doesn’t mean that it is familiar to the wet-behind-the-ears software engineers touting stable coins. And it doesn’t mean that the flaws in their currently fashionable schemes will be familiar to investors.

Barry Eichengreen is professor of economics at the University of California, Berkeley; Pitt Professor of American History and Institutions at the University of Cambridge; and a former senior policy advisor at the International Monetary Fund. His latest book is "Hall of Mirrors: The Great Depression, the Great Recession, and the Uses – and Misuses – of History."

​©Project Syndicate

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