6 Minutes to Read (Reuters) – LONDON (Reuters) – Regulators are concerned that the proliferation of’stablecoins,’ which are largely dollar-pegged crypto tokens, could cause more instability in wider financial markets than already hyper-volatile cryptocurrencies like Bitcoin. In this illustration, taken on June 29, 2021, representations of cryptocurrencies Bitcoin, Ethereum, DogeCoin, Ripple, and Litecoin are placed on a PC motherboard. Illustration by REUTERS/Dado Ruvic To date, Western central banks and watchdogs have mostly avoided cryptocurrencies, emphasizing transparency and a “caveat emptor” attitude toward what they regard as primarily speculative vehicles rather than transaction currencies per se. The increased engagement of conventional banks and asset managers has raised their profile, but tougher regulations do not appear to be on the horizon just yet. However, the rapid production of stablecoins, which has increased 18-fold to more than $100 billion since the outbreak, is a different story and has been raising alarms all year. Stablecoins are cryptocurrencies that are confirmed on decentralized public ledgers or blockchains, but are designed to have a steady value in comparison to physical currencies or gold to avoid the kind of volatility that makes bitcoin and other tokens unsuitable for most transactions. While they operate outside of traditional banking systems, the assets they use to ostensibly peg their value are what connects them to the actual world, much like a sci-fi gateway connecting the “upside-down” world of crypto to the material world that watchdogs are paid to be concerned about. The stablecoin universe has so far been controlled by two primary tokens, Tether and USD Coin, whether they are eventually used for online payments or simply to grease the wheels of the so-called Decentralised Finance of crypto credit markets. Facebook-backed Another project is Diem, originally known as Libra. However, because to extensive government investigation and criticism over its potential magnitude and systemic hazards, it has yet to debut. Tether, which was launched in 2014, has already accounted for more than 60% of the current $100 billion in issuance. Regulators are irritated by what it uses as reserves to achieve the promised one-to-one peg with the dollar. It’s a mix of commercial paper, bills, bonds, and loans, not just dollar cash, as many people believe. Tether said that at the end of March, nearly half of its reserves ($20 billion) were in commercial paper, 12% in secured loans, and 10% in corporate bonds, funds, and precious metals. Only 2.9 percent of the money was in dollars. Although it acknowledged that models differed and USD Coin – which accounts for more than 20% of the stablecoin complex – ensures its dollar peg with cash in custody accounts, Fitch credit rating agency warned this month that the rapid growth of stablecoins could have destabilizing effects on short-term credit markets. “Potential asset contagion risks associated to the liquidation of stablecoin reserve holdings could boost pressure for tighter regulation of the young industry,” it said, adding that Tether’s CP holdings are likely to be higher than those of most US or European prime money market funds. “A sudden mass redemption of USDT (Tether) could affect the stability of short-term credit markets if it occurred during a period of greater selling pressure in the CP market, particularly if it was associated with wider redemptions of other stablecoins that hold reserves in similar assets,” Fitch said, citing the recent peg break of collateralised stablecoin Iron. At the very least, this is where the Federal Reserve is concentrating its efforts. Last month, Boston Fed President Eric Rosengren emphasized the “exponential” growth of stablecoins and the possible issues with Tether’s reserve composition. “In effect, this is an extremely dangerous prime fund,” Rosengren said at an OMFIF financial stability conference, emphasizing that U.S. prime money market funds would be prohibited from holding many of these assets, such as longer-term equities or precious metals. “A stablecoin with this kind of attribute… will not be stable in times when we see spreads gapping out in a substantial degree,” Rosengren noted, noting that prime funds ran into problems during the previous two recessions. “As they develop, there is a concern about financial stability, and we need to look at regulation and what’s been promoted to the general people,” he said. Focusing on any expansion of stablecoin use as a payment method, such as in the case of Diem, the Bank of England urges that they be regulated in the same way as commercial bank money, with equal capital and liquidity standards and deposit insurance. In May, Diem announced that its intended dollar stablecoin would be issued by California-based Silvergate Bank, after relocating its plans from Switzerland to the United States. Silvergate would be in charge of the company’s reserves, which Fitch estimates would be at least 80% in low-risk short-term government securities and 20% in cash parked in money market funds on a regular basis. Stablecoin and reserve management legislation has been introduced in the United States and Europe since late last year, according to Fitch, which might lead to better transparency and reporting, as well as less hazardous reserve collateral. However, there appears to be no clarification on the status or timing for any of these initiatives. “We believe authorities, partially due to moral hazard, are unlikely to intervene to save stablecoins in the case of a disruptive event,” Fitch said. “Authorities could step in to support dealers and prime MMFs if stablecoin redemptions lead to or magnify a larger CP sell-off, affecting market liquidity and preventing future CP issuance,” the report noted. If a hands-off approach to digital money and crypto finance was previously chosen because it was deemed insufficiently systemic, the stablecoin boom may have necessitated a shift in strategy. The author is Reuters News’ finance and markets editor-at-large. Any opinions he expresses are his own. Mike Dolan, @reutersMikeD, @reutersMikeD, @reutersMikeD, @reutersMikeD, @reutersMikeD, @reutersMikeD/n
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