- A crashed stablecoin could pose a threat to the wider financial system, a Cornell professor warned.
- Many stablecoin issuers hold US Treasurys in reserve to keep their token’s price at a fixed level.
- That means a collapse poses a risk of crashing other assets, Eswar Prasad said Thursday.
Stablecoins — cryptocurrencies designed to weather volatility — risk crashing other financial markets if they fail, given they’re backed by traditional assets, a Cornell University professor has warned.
The companies that issue stablecoins would have to redeem their government bond holdings if the digital tokens fail, Eswar Prasad said Thursday. That means they pose a threat of spreading any crypto turmoil into the wider financial system.
“The key aspect of stablecoins that keeps their value stable is the fact that they are backed up by reserves of fiat currencies, and typically these reserves are in the form of liquid government securities,” Prasad told CNBC International.
“The concern of regulators is if there were to be a loss of confidence in stablecoins — maybe because some exchanges come down, or for other reasons — then you could have a wave of redemptions,” he added.
Stablecoins are cryptocurrencies with a fixed value, offering investors a cushion from high levels of volatility. Dollar-pegged stablecoin issuers like Tether and USD Coin hold cash and other liquid assets like short-term Treasury bills to keep their tokens’ price fixed at $1.
Furthermore, the US Treasury market is worth $22.1 trillion in total, according to the St Louis Fed . That means any ripples in the asset class are felt throughout the global financial system.
“A large volume of redemptions, even in a fairly liquid market, can create turmoil in the underlying securities market,” Prasad said.
Rising interest rates and the collapse of high-profile companies like the now-bankrupt exchange FTX and tokens like Terra’s UST stablecoin have roiled crypto markets over the past year.
The turmoil hasn’t yet spilt over into traditional financial markets, but financial watchdogs are worried that stablecoin issuers’ government bond holdings pose that risk, according to Prasad.
“Given how important the tertiary securities market is to the broader financial system in the US — and this is true in many other countries as well — regulators are rightly concerned,” he said.
“The fact that we haven’t had spillovers from this part of the financial ecosystem into traditional financial markets or into the real economy certainly seems to be suggestive of the fact that there is a firewall,” he added.
“But that firewall may not last.”
