A collapse in stablecoins could ripple through the US bond market: Academic

A collapse in stablecoins could ripple through the US bond market: Academic

A collapse in stablecoins could ripple through the US bond market: Academic

Stablecoin run could impact traditional financial markets, professor warns

The nearly $1.4 trillion crypto market crash in 2022 has not harmed traditional assets like stocks or the real economy.

But an academic has warned that the failure of a major stablecoin could impact the US bond market, marking a potential new area for investors to watch as the contagion continues to sweep through the industry.

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Stablecoins are a type of digital currency that is supposed to be pegged individually with fiat currency such as the US dollar or Euro. Examples include attached (USDT), USD coin (USDC) and BinanceUSD (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 needing 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 users can exchange their token one-for-one with a real asset.

Tether says more than 58% of its reserves are held in US Treasuries, worth around $39.7 billion. Circle, the company behind USDC, has about $12.7 billion in treasury bills in its reserve. Paxos, which issues BUSD, said it has about $6 billion in US Treasuries. All of these numbers come from the latest company reports released in November.

But while there are no signs of major stablecoins collapsing, Eswar Prasad, a professor of economics at Cornell University, said regulators he spoke to were worried because of the impact this could have on traditional financial markets. Indeed, a potential run on a stablecoin – where large swathes of users seek to exchange their digital currency for fiat – would mean the issuer must sell its stash assets. This could mean dumping large amounts of US Treasuries.

“And I think [the] the concern of regulators is if there were to be a loss of confidence in stablecoins…then you could have a wave of redemptions, which in turn would mean that stablecoin issuers have to redeem their holdings of securities from the Treasury,” Prasad told CNBC at the Crypto Finance conference in St. Moritz, Switzerland this week.

“And a large volume of redemptions, even in a relatively liquid market, can create turbulence in the market for the underlying securities. And given the importance of the Treasury securities market to the broader financial system in United States…I think regulators are rightly worried.”

A growing number of voices have warned of the impact a “run” on stablecoins could have on traditional financial markets.

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Prasad advises regulators around the world on cryptocurrency policy.

The academic warned that if such a run were to occur when bond market sentiment was “very fragile as it is in the United States at the moment”, there could be a “multiplier effect” thanks to a strong selling pressure on Treasuries.

“If you have a big wave of redemptions, it can really hurt the liquidity of 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 rein in runaway inflation. The US bond market had its worst year on record in 2022.

Stablecoins are about $145 billion in value out of the $881 billion that the entire cryptocurrency market is worth, so they are significant. And there have already been failures.

Last year, a coin called terraUSD crashed. It was dubbed an algorithmic stablecoin, so called because it maintained its parity with the US dollar via an algorithm. It was not fully backed by real assets such as bonds such as 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 runs, and many bond and bank mutual funds continue to be vulnerable to redemption risk.”

More pain ahead for crypto, but bitcoin has been resilient, says VC Bill Tai

Bill Tai, a well-known venture capitalist and crypto industry veteran, said he doesn’t think there will be a crash of any of the major stablecoins, but said the scrutiny of this type of cryptocurrency “has risen for good reason”.

“I think just like in our traditional financial industry, where people were caught off guard by some hidden contagion inside the subprime mortgage market during the great financial crisis, there could be a pocket or two of downside effect. leverage on some of the assets that claim to back the stablecoin,” Tai told CNBC in an interview on Thursday.

Tai compared a potential stablecoin explosion to a surprise event like the subprime mortgage crisis, which began in 2007. Lenders offered mortgages to borrowers with poor credit, leading to defaults and contributing to the financial crisis. It was a bit of a surprise.

“And if one of these (stablecoins) goes down, there will be another downdraft,” Tai added.

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