The nearly $1.4 trillion crypto market crash in 2022 did not affect traditional assets like stocks or the real economy.
But one academic warned that the failure of a major stablecoin could have an impact on the US bond market, marking a potential new area for investors to watch as the contagion continues to spread through the industry.
Stablecoins are a type of digital currency that is supposed to be pegged one-to-one to a fiat currency such as the US dollar or the euro. Examples include I tie (USDT), USD coin (USDC) and Binance USD (BUSD), which are the three largest stablecoins.
These types of coins have become the backbone of the crypto economy, allowing people to trade in and out of different cryptocurrencies without the need to convert their money to fiat.
The issuers of these stablecoins say they are backed by real assets such as fiat currency or bonds so that users can redeem their token one-to-one with a real asset.
Tether says more than 58% of its reserves are held in US Treasury bills, which is about $39.7 billion. Circle, the company behind the USDC, has about $12.7 billion worth of government bonds in its reserve. Paxos, which issues BUSD, said it has about $6 billion in US Treasury bills. All of this data is from the companies’ latest reports, published in November.
But while there are no signs of major stablecoins collapsing, Eswar Prasad, an economics professor at Cornell University, said it’s something regulators he’s spoken to are worried about because of the impact it could have on traditional financial institutions. markets. That’s because a potential launch of a stablecoin — where large groups of users want to redeem their digital currency for fiat — would mean the issuer would have to sell off the assets in its reserve. This could mean dumping large amounts of US Treasuries.
“I think too [the] the concern of regulators is that if there is a loss of confidence in stablecoins … then you may have a wave of buybacks, which in turn will mean that stablecoin issuers have to buy back their holdings of government securities,” Prasad told CNBC at the Crypto Finance Conference in St. Moritz, Switzerland this week.
“And a large volume of repurchases even in a relatively liquid market can create turmoil in the underlying securities market.” And given how important the Treasury securities market is to the broader U.S. financial system … I think regulators are rightly concerned.”
A growing number of voices are warning about the impact the stablecoin “run” could have on traditional financial markets.
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Prasad advises regulators around the world on policy related to cryptocurrencies.
The academic warned that if such a move were to occur when bond market sentiment is “very fragile, as it is in the US at the moment”, there could be a “multiplier effect” thanks to heavy selling pressure on government bonds.
“If you have a big wave of buybacks, that can really hurt liquidity in that market,” Prasad said.
The Federal Reserve has raised interest rates several times in 2022 and is expected to continue to do so this year as it seeks to tame rampant inflation. The US bond market had its worst year on record in 2022.
Stablecoins represent about $145 billion worth of the $881 billion the entire cryptocurrency market is worth, so they’re significant. And there have already been failures.
Last year, a coin called terraUSD crashed. It was called an algorithmic stablecoin, so named because it maintained its one-to-one relationship with the US dollar through an algorithm. It was not fully backed by real assets like bonds like USDC, BUSD and USDT. The algorithm failed and terraUSD crashed, sending shockwaves through the crypto market.
The US Federal Reserve also warned in a May 2022 report that “stablecoins remain prone to flight and many bond and bank loan mutual funds remain vulnerable to redemption risks.”
Bill Tye, a prominent venture capitalist and crypto industry veteran, said he doesn’t think there will be a collapse of any of the major stablecoins, but said scrutiny of this type of cryptocurrency “has increased for good reason.”
“I think that just like in our traditional financial industry, where people were caught off guard by a hidden contagion in the subprime market during the great financial crisis, there may be a pocket or two of leverage on some of the assets that purport to support stablecoin, Tai told CNBC in an interview Thursday.
Tai likened the potential explosion of the stablecoin to a surprise event like the subprime crisis that began in 2007. Lenders offered mortgages to borrowers with bad credit, leading to defaults and contributing to the financial crisis. It was somewhat of a surprise.
“And if one of these (stable coins) goes down, there will be another downward flow,” Tai added.