Problems with indirect convertibility

Tether a few times has been bouncing well below a dollar in value, even though it is supposed to be backed by plenty of high-quality assets.

I am reminded of some of my monetary theory writings with Kroszner in the late 1980s.  He and I wrote one essay, later published in our book, on how indirect convertibility may not be entirely stabilizing.  Let’s say you peg an asset at the value of one dollar, but redeem that asset in terms of gold bars rather than dollars.  You offer the redeemer enough gold bars to be equal in value to a dollar.

But what if the price of gold falls below its equilibrium value, if only temporarily?  To honor your peg strictly, you now have to make your dollar worth all the more gold bars.  But that in effect is “pegging” the value of gold at its new, temporarily wrong and distorted market price.  Your pegged price and the medium-term market value of gold will conflict.  If the pegged price wins out and itself drives the market price, you have to offer excess gold to meet the peg (that equilibrium seems unlikely to me, though you might also add redemption charges and fees).  In essence you are offering too much gold to a redeemer.  If the true medium-term value of gold is going to win out over the temporary distortion, for some modest while your peg is not complete and fully valid.  You are offering the same amount of gold you used to, but at least temporarily it is not enough for you to be promising full and complete convertibility.  The market may or may not mind this, to varying degrees.

It is not transparent to me what is going on with Tether at this moment, but I wonder if some version of this logic might apply.  That is, Tether could be, by all reasonable standards “adequately backed,” yet in a time of volatile and sometimes disequilibrium market prices for the backing assets, Tether won’t always be equal in value to a dollar either.

Of course gold is just an example, the backing assets could be different altogether.  To the extent they are heterogeneous, perhaps this problem is amplified somewhat?

Is there a place where the crypto community discusses these issues?  They gave Kroszner and me big headaches many years ago.


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