The Potential Impact of Stablecoins on the Economy
The Federal Reserve Banks of Boston and New York have released a data-driven report examining the potential effects of stablecoins on the broader economic landscape. The 49-page report, titled “Runs and Flights to Safety: Are Stablecoins the New Money Market,” compares stablecoins to traditional finance vehicles like money market funds (MMFs).
According to the report, stablecoins and MMFs offer money-like assets to investors by engaging in liquidity transformation. However, similar to bank deposits, continuous liquidity provision may make them susceptible to runs.
The study includes a case analysis of stablecoin runs, specifically focusing on incidents involving USDT and USDC in 2022 and 2023. It identifies similarities and differences between these events and the runs experienced by money market funds in previous years.
The research reveals that stablecoins are vulnerable during downtrends in the cryptocurrency market or when unexpected issues arise. If stablecoins become closely intertwined with critical financial markets such as short-term funding, they could pose a risk to the overall economic system.
Furthermore, the report highlights that stablecoins exhibit a wider range of risk profiles compared to MMFs. Some stablecoins are backed by safe assets like cash and U.S. Treasuries, while others rely on riskier collateral such as other crypto assets or corporate debt.
In cases where the collateral supporting certain stablecoins loses value, they may deviate from their peg and cause significant loss. Even stablecoins that maintain their pegs through demand-supply algorithms are not immune to such risks and may experience runs if investor confidence deteriorates.
The report also emphasizes stressful events that have already resulted in billions of dollars in losses, including the collapse of Terra in May 2022 and USDC’s connection to the now-liquidated Silicon Valley Bank.
Another significant finding is that investors tend to sell off stablecoin assets when their value drops from $1 to $0.99, causing the asset to completely depeg and crash for remaining investors. Similarly, MMFs are typically valued at $1.00 and experience an automatic decrease when the market price falls below a threshold of $0.995.
The Safe Haven Status of Stablecoins in Question
At the beginning of 2023, there were signs of a broader market recovery. However, uncertainties arose due to litigations faced by top exchanges like Binance and Coinbase. The U.S. Securities and Exchange Commission (SEC) accused them of trading unregistered securities and providing uncleared literature about certain assets.
Stablecoins, which are commonly seen as a safe haven during market turbulences for hedging inflation and mitigating losses, are now considered ineffective by investors.
According to a recent CCData report, the total market capitalization of stablecoins was $124 billion in July, reflecting an 11.6% decline after an 18-month period of stagnation that affected various asset sectors.
Several factors contributed to this downturn, including Binance.US suspending fiat deposits due to legal actions initiated by the SEC and MakerDAO’s decision to delist USDP because it failed to generate additional revenue.
In addition, global exchange Binance has announced its plan to delist all stablecoins in Europe by June 30, 2024.
If negative activities continue to impact the stablecoin sector, investors may seek alternative options, potentially leading to the collapse of a once-thriving market.
Hot Take: The Uncertain Future of Stablecoins
The data-driven report from the Federal Reserve Banks of Boston and New York raises important concerns about the impact of stablecoins on the economy. It highlights the vulnerabilities of stablecoins during downtrends in the cryptocurrency market and their potential to pose risks to the overall financial system if they become closely integrated with critical markets.
The report also emphasizes the broader spectrum of risk profiles exhibited by stablecoins compared to traditional money market funds. The reliance on different collateral types and the possibility of deviating from their pegs can result in significant losses for investors.
Furthermore, recent events, such as the collapse of Terra and USDC’s connection to a liquidated bank, demonstrate the real-world consequences of unstable stablecoins.
As uncertainties surrounding exchanges and regulatory actions persist, stablecoins are losing their status as safe havens for investors. The decline in market capitalization and potential delistings further contribute to the uncertainty surrounding stablecoins’ future.
In conclusion, stablecoins face significant challenges that could ultimately lead to their collapse if negative activities continue to plague the sector.
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