A stablecoin collapse could spill over into the US bond market: Academic

A stablecoin run could affect traditional financial markets, warns professor

The nearly $1.4 trillion collapse of the crypto market in 2022 did not make a dent in traditional assets like stocks or the real economy.

But an academic has 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 across the industry.

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Stablecoins are a type of digital currency that is supposed to be tied one-to-one with a fiat currency like the US dollar or the euro. Examples include tether (USDT), USD coin (USDC) and Binance USD (BUSD), which are the three largest stablecoins.

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

Issuers of these stablecoins say they are backed by real assets such as fiat currency or bonds, so users can redeem their token one-to-one with a real asset.

Tether says more than 58% of its reserves are contained in US Treasuries, equivalent to about $39.7 billion. Circle, the company behind USDC, has about $12.7 billion worth of Treasuries in its reserve. Paxos, which issues the BUSD, said it has about $6 billion of U.S. Treasuries. All these figures come from the companies’ latest reports, which were published in November.

But while there’s no sign of major stablecoins collapsing, Eswar Prasad, an economics professor at Cornell University, said it’s something regulators he’s spoken to are concerned about because of the impact it could have on traditional financial markets . That’s because a potential run on a stablecoin — where large swathes of users appear to be redeeming their digital currency for fiat — would mean the issuer would have to sell off the assets in their reserve. This could mean dumping large amounts of US government bonds.

“And I think [the] the regulators’ concern is that if there were to be a loss of confidence in stablecoins … then you could have a wave of redemptions, which in turn would mean stablecoin issuers having to redeem their holdings of government bonds,” 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 how important the Treasury bond market is to the broader financial system in the United States… I think regulators rightly are worried.”

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

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Prasad advises regulators worldwide on policy related to cryptocurrencies.

The academic warned that if such a run were to occur 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, that can really hurt 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 had its share worst year ever in 2022.

Stablecoins account for 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 collapsed. It was dubbed an algorithmic stablecoin, so called because it maintained its one-to-one peg to the US dollar via an algorithm. It was not fully backed by real assets such as bonds like USDC, BUSD and USDT are. The algorithm failed and terraUSD crashedsends shock waves across the crypto market.

The US central bank also warned in a report in May 2022 that “stablecoins remain prone to run and many bond and bank loan funds continue to be vulnerable to redemption risks.”

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

Bill Tai, a well-known venture capitalist and veteran of the crypto industry, said that he does not think there will be a collapse of any of the major stablecoins, but said that the investigation of this type of cryptocurrency “has increased Good reason.”

“I think, just like in our traditional financial industry where people were caught off guard by hidden spillovers inside the subprime market during the Great Financial Crisis, there could be a pocket or two of leverage on some of the assets that purport to back the stablecoin, Tai told CNBC in an interview Thursday.

Tai compared a potential stablecoin blowup to a surprise event like the subprime credit crisis that began in 2007. Lenders offered mortgages to borrowers with bad credit, leading to defaults and contributing to the financial crisis. It came as something of a surprise.

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

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