Collapse of Stable Currencies May Spread to US Bond Market: Academic

The professor warns that the operation of stablecoins may affect traditional financial markets

The $1.4 trillion cryptocurrency market crash in 2022 did not affect traditional assets such as stocks or the real economy.

But an academic warned that the failure of a major stablecoin could have an impact on the US bond market, pointing to a potential new area that investors need to watch as contagion continues to spread across 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 Rope (USDT), dollar coin (USDC) and Binance USD (BUSD), which is the three largest stablecoin.

These types of coins have become the backbone of the crypto economy, allowing people to trade in and out of various cryptocurrencies without having to convert their money into fiat currency.

The issuers of these stablecoins say they are backed by real assets such as fiat currencies or bonds so that users can exchange their token for 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 USDC, has approximately $12.7 billion in Treasurys in its reserves. Paxos, which issues BUSD, said it has about $6 billion in US Treasuries. All of these figures are from the company’s latest November reports.

But while there are no signs of a major stablecoin collapse, Eswar Prasad, a professor of economics at Cornell University, said it is something regulators are worried about because of the impact it could have on traditional financial markets. That’s because the potential operation of a stablecoin – where a large number of users look to exchange their digital currency for fiat – means that the issuer must sell the assets in its reserve. This could mean dumping large amounts of US Treasury bonds.

“I think [the] The concern of the regulators is if there is 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 treasuries,” Prasad told CNBC at the Crypto Finance conference in St. Moritz, Switzerland, this week.

“And a high volume of redemptions even in a fairly liquid market could cause turmoil in the underlying stock market. And given how important the Treasury market is to the broader financial system in the United States… I think regulators are rightly concerned.”

An increasing number of voices have warned of the impact of the stablecoin “run” on traditional financial markets.

Just_super | iStock | Getty Images

Prasad advises regulators around the world on crypto-related policy.

And the academic warned that if such a run occurred when bond market sentiment was “very fragile as it is in the US right now”, there could be a “multiplier effect” thanks to heavy selling pressure on Treasurys.

“If you have a big wave of redemptions it can hurt the liquidity in that market,” Prasad said.

The Federal Reserve raised interest rates several times in 2022 and is expected to continue to do so this year as it looks to tame rampant inflation. The US bond market experienced its worst year ever in 2022.

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

Last year, a coin called terraUSD crashed. It has been called an algorithmic stablecoin, so named because it maintained its single peg to the US dollar via an algorithm. They are not fully backed by real assets such as bonds such as USDC, BUSD and USDT. The algorithm failed and terraUSD crashed, sending shock waves through the cryptocurrency market.

The US Federal Reserve also warned in a May 2022 report that “stable currencies remain vulnerable to run-in, and many bond investment funds and bank loans remain vulnerable to redemption risks.”

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

Well-known venture capitalist and cryptocurrency industry veteran Bill Taye 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 gone up for good reason.”

“I think just as in our traditional finance industry, where people were surprised by the hidden infection within the mortgage market during the Great Financial Crisis, there could be a pocket or two of leverage on some assets that claim to support a stablecoin,” Taye told CNBC in an interview. Thursday interview.

Tai likened the potential for a stablecoin explosion to a sudden 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 was somewhat of a surprise.

“If one of these (stablecoins) falters, there will be another draw,” Tai added.

Leave a Comment