Stablecoins are vulnerable and can increase financial risks, says Fed

stablecoins are vulnerable to risks
  • The Federal Reserve places stablecoins in the category of high-risk investments.
  • The central bank is concerned about the lack of transparency over the assets backing stablecoins.

The United States Federal Reserve (Fed) once again expresses its concerns about the risks posed by stablecoins. This time the central bank has added a warning that the risk of sudden and desperate redemptions of stablecoins is similar to the risk of capital flight from money market funds.

The Fed itself believes that stablecoins have great growth prospects, but while this sector is growing rapidly, “there are still risks” as the assets used to peg them may lose value, causing insufficient liquidity.

Stablecoins are tokens issued on the blockchain whose value is linked to an external asset to guarantee a 1:1 exchange. Therefore, they function as digital representations of the dollar, the euro, and even gold.

In its report on the financial stability of the United States, the government agency adds that the vulnerabilities of stablecoins can be exacerbated by the lack of transparency regarding the risk and liquidity of the assets used to give them that so-called stability.

The increasing use of stablecoins to meet margin requirements for leveraged trading in other cryptocurrencies may increase volatility in demand for stablecoins and increase redemption risks.

Financial stability report issued by the Fed.

The report does not mention any specific stablecoin, but rather refers to the sector in general, which remains highly concentrated among three of these projects.

The three largest stablecoins by market cap are USDT from Tether, USDC from Circle, and BUSD from Binance and Paxos. Together they represent more than 80% of the total market value.

Stablecoins under the spotlight of regulators

While the warning was issued by the institution that acts as the Central Bank of the United States, the Terra stablecoin lost its peg to the dollar, falling below USD 0.85.

The crash began last weekend, forcing the Luna Foundation Guard (LFG), the entity behind Terra, to take action.

LunaUSDT Price chart

The Terra case once again puts the focus on these types of projects, although they have been under strong legal scrutiny for some time.

In September of last year, the Securities and Exchange Commission (SEC) and the United States Department of the Treasury considered taking measures to limit the growth of Tether (USDT) and other stablecoins.

Just as the Fed says now, back then their motive is that they see this type of crypto asset as a systemic risk to the dollar and the US economy.

Other concerns also tend to revolve around stablecoins, such as the fact that they are not entirely backed in dollars. In fact, Circle, the issuing company of the USDC currency, acknowledged this last August, when it reported that apart from the fact that it is not fully backed by dollars deposited in a bank, its reserves do not cover the total number of coins in circulation.

Leave a Comment