The collapse of the crypto market, which is close to $1.4 trillion in 2022, does not affect traditional assets like stocks or the real economy.
But one academic has warned that the failure of the main stablecoin could have an impact on the US bond market, signaling a potential new area that investors should keep an eye on as the contagion continues to spread in the industry.
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Stablecoins are a type of digital currency that is supposed to be pegged one-to-one with fiat currencies such as the US dollar or the euro. Examples include tether (USDT), USD coins (USDC) and Binance USD (BUSD), which are the three largest stablecoins.
The coin has become the backbone of the crypto economy, allowing people to trade in and out of various cryptocurrencies without having to convert money into fiat.
The stablecoin issuer says it is backed by real assets such as fiat currency or bonds so users can exchange their tokens one-for-one for real assets.
Tether says more than 58% of its reserves are held in US Treasury Bills, about $39.7 billion. Circle, the company behind the USDC, has about $12.7 billion worth of Treasurys in reserve. Paxos, which issues BUSD, said it has about $6 billion in US Treasury bills. All these figures are from the company’s latest report published in November.
But while there are no signs of major stablecoins collapse, Eswar Prasad, professor of economics at Cornell University, said it is something that regulators say is worried because of the possible impact on traditional financial markets. That’s because the open potential in stablecoins – where large swathes of users appear to redeem digital currency for fiat – means that issuers have to sell off their assets in reserve. This could mean spending a lot of US Treasurys.
“And I thought [the] the regulator’s concern is that if there is trust in stablecoins … then you can have a wave of redemptions, which will mean that stablecoin issuers will have to redeem their holdings of Treasury securities,” Prasad told CNBC at the Crypto Finance Conference in St Moritz, Switzerland, this week.
“And a large volume of redemptions even in a fairly liquid market can create turmoil in the underlying securities market. And given the importance of the Treasury securities market to the broader U.S. financial system … I think regulators are rightly concerned.”
A lot of voices have warned about the impact that the “run” in stablecoins can have on the traditional financial market.
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Prasad advises regulators around the world on policies related to cryptocurrencies.
The academic warned that if this happens when bond market sentiment is “very fragile as it is now in the US,” there could be a “multiplier effect” due to massive selling pressure on Treasurys.
“If you have a big wave of redemptions that can cause liquidity in that market,” Prasad said.
The Federal Reserve raised interest rates several times in 2022 and is expected to continue doing so this year as it tackles high inflation. The US bond market had its worst year in 2022.
Stablecoins account for about $145 billion of the $881 billion that the entire cryptocurrency market is worth, so they’re significant. And there have been failures.
Last year, a coin called terraUSD collapsed. It is called an algorithmic stablecoin, so called because it maintains a one-to-one peg with the US dollar through an algorithm. It is not fully backed by real assets such as bonds as USDC, BUSD and USDT. The algorithm failed and terraUSD collapsed, sending shockwaves through the crypto market.
The US Federal Reserve also warned in a report in May 2022 that “stablecoins remain vulnerable to volatility, and many mutual funds bond and bank loans continue to be vulnerable to redemption risks.”
Bill Tai, a well-known venture capitalist and veteran of the crypto industry, said that there will not be a collapse of any of the main stablecoins, but he said that the scrutiny on this type of cryptocurrency “has risen for a good reason.”
“I think in our traditional financial industry, where people are caught by the contagion hidden in the subprime market during the great financial crisis, there may be a pocket or two of influence in some of the assets that supposedly support stablecoins,” Tai told CNBC in an interview Thursday. .
Tai likens the potential stablecoin explosion to a shock event like the subprime mortgage crisis, which began in 2007. Lenders offered mortgages to borrowers with bad credit, which led to defaults and contributed to the financial crisis. It came as a bit of a surprise.
“And if one of the (stablecoins) goes down, there will be another downdraft,” Tai added.