Federal Reserve identifies “structural fragilities” in stablecoin market

As instances of financial stability issues, the US Federal Reserve cites the recent collapse of TerraUSD and other algorithmic stablecoins.

In its monetary policy report released on June 17, the Federal Reserve identified stablecoins as a potential threat to financial stability. Even though the Fed has previously raised worries about stablecoins, it now has evidence to support its position, citing “The drop in value of some stablecoins and recent stresses faced by markets for other digital assets as evidence of the fragility of such systems.”

The most significant collapse occurred on May 1st when the value of TerraUSD (UST) and the associated cryptocurrency Luna plummeted by more than $40 billion. The occurrence has become a focal point of political inquiry.

The Federal Reserve was already engaged in the preparation of the November report by the President’s Working Group on stablecoins, which pushed for restricting stablecoin issuance to “insured depository institutions.” The Federal Reserve’s most recent report continues to support this consensus assessment.

The paper states, “Stablecoins that are not backed by secure and adequately liquid assets and are not subject to proper regulatory norms pose dangers to investors and perhaps the financial system, including vulnerability to potentially disruptive runs.” Indeed, a larger debate remains as to whether algorithmic stablecoins can keep their value.

The PWG’s proposals did not handle algorithmic tokens comprehensively, instead of focusing on the more recognisable fiat-backed tokens. The Fed paper, while it does not mention Terra or UST by name, mentions the concentration of the stablecoin market among fiat-backed issuers “Tether, USD Coin, and Binance USD.”

Several officials, including Treasury Secretary Janet Yellen and Pat Toomey, the ranking Republican on the Senate Banking Committee, said that stablecoins posed no threat to the broader financial system in the aftermath of the collapse of the United States Treasury (UST).

As the present crypto bear market eliminates an increasing number of enterprises, this test of systemic significance will continue to dictate policymaker reactions.

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