Following Terra’s spectacular breakdown, US government authorities closely monitor the stablecoin market.
According to a new Federal Reserve analysis, stablecoins represent a risk to the financial system because of their lack of transparency and often lack of “secure” assets.
Highlights from the Federal Reserve Risks of Stablecoin
The Federal Reserve has warned that stablecoins might jeopardize the banking system.
The Federal Reserve said in its Monetary Policy Report to Congress today that “the collapse in the value of certain stablecoins, as well as recent tensions in markets for other digital assets, indicate the fragility of such institutions.”
According to the research, stablecoins that are not backed by safe and adequately liquid assets and are not subject to acceptable regulatory norms pose dangers to investors and ultimately the financial system, including susceptibility to potentially disruptive runs.
Stablecoins are a sort of cryptocurrency that seeks to maintain a 1:1 relationship with an underlying asset, such as the US dollar. Some issuers accomplish this by backing their coin with reserves, while others use complicated algorithms. The stunning collapse of UST, an algorithmic stablecoin tied to the Terra blockchain, has drawn the attention of government authorities and regulators to stablecoins in recent weeks.
While the Federal Reserve‘s research did not specifically reference Terra, it appeared to allude to the protocol as an example of the type of damage stablecoins are capable of wreaking on markets.
The research also chastised stablecoin issuers for lack of transparency on risk and reserve liquidity. It also noted that stablecoins are frequently used as collateral for leveraged trading, which might “amplify [market] volatility” and increase the risk of non-redemption by issuers.
Treasury Secretary Janet Yellen is one of the numerous officials who have recently repeated the Federal Reserve‘s comments, and she had made it apparent that she wanted to build a regulatory framework for stablecoins even before Terra failed.
This month, a bipartisan cryptocurrency measure submitted in the Senate also called for “a strong, specialized regulatory framework for stablecoins,” which, if implemented, would force centralized stablecoin issuers to guarantee 100 percent reserve backing for their products.