Stablecoins, such as Tether and USDC, continue to raise concerns within the Federal Reserve due to their potential impact on the financial system. Despite attempts to provide stability by pegging their value to real-world assets like the US dollar, these digital currencies present several challenges that worry policymakers.
Stablecoins turn into Fed’s worst crypto nightmare
Stablecoins are crypto tokens whose value is often tied to a currency, such as the US dollar. They provide a means for traders to easily switch between more volatile coins and something close to cash and a way to hold or send money without using a bank.
Additionally, stablecoins can track a regular currency in several ways, the most common of which is to hold assets such as cash or government bonds to support the coin’s value.
Last year saw the demise of long-standing traditional banks in the United States. When Silicon Valley Bank failed in March of last year, crypto startup Circle Internet Financial Ltd. had $3.3 billion in cash reserves supporting its USD. The coin was parked in the bank and could not be removed.
With approximately 8% of USDC reserves stranded in a failing bank, the stablecoin had its panic. Traders rushed to sell, driving the price well below $1 during the crucial weekend when regulators decided what to do about SVB. After the government intervened to compensate all of the bank’s depositors, USDC’s price recovered.
The crisis demonstrated how stablecoins can be affected by issues related to the traditional financial realm. However, some believe that stablecoins, which had a total market value of $136 billion as of late January, may have the capacity to disrupt real-world markets in return.
As of today, the global crypto market cap stands at $1.9 trillion, up 2.53% in the last 24 hours and 78.21% in the last year. As of today, Bitcoin’s (BTC) market cap is $946 billion, signifying a 49.72% dominance. Meanwhile, stablecoins’ market cap is $138 billion, with a 7.28% part of the entire crypto market cap.
The interconnectedness of stablecoins and traditional finance
This interconnectedness persists despite the return of the crypto craze that culminated in 2022. The largest asset manager in the world, BlackRock Inc., is currently in charge of USDC reserves – the Bank of New York Mellon Corporation manages them.
One expert, Hilary Allen, a law professor at American University Washington College of Law, states that “They are becoming more interconnected, more interlinked with the traditional financial system.”
Why should stablecoins bother the Fed? Why are they of any interest? One reason for the interest is that stablecoins and similar products based on blockchain ledgers can enable issuers to join new markets, such as cross-border payments and trade settlements.
Another: There is money on the table. Stablecoin issuers can now earn more than 4% by investing in US Treasuries and other traditional financial assets as the Federal Reserve raises interest rates. According to its website, Tether alone has direct or indirect exposure to $80.3 billion in US Treasury bills as of the end of the fourth quarter.
These investments are making regulators worried. In a September paper, researchers at the Federal Reserve Bank of New York compared stablecoins to money-market funds, noting that in 2008, investors abandoned funds with higher exposures to Lehman Brothers and asset-backed commercial paper.
Should stablecoins continue to grow and become more interconnected with key financial markets, such as short-term funding markets, they could become a source of financial instability for the broader financial system.Fed paper research
There are substantial worries. Stablecoin issuers, particularly the most prominent participant, are frequently criticized for their lack of transparency. The US Commodities Futures Trading Commission penalized Tether in 2021 after discovering that its promises to be fully backed by US currency were false. Tether agreed to pay without acknowledging or disputing the claims.
Cantor Fitzgerald CEO Lutnick claims that his company has evaluated Tether’s assets. There are also regulatory concerns, even when issuers hold licenses or charters to act as asset custodians or money transfers.