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While the cryptocurrency industry sees uncertainty amidst the fall of crypto exchange FTX, Hong Kong Monetary Authority (HKMA) believes that the volatility in the digital assets space could have an impact on the traditional financial industry too.
According to an assessment conducted by the HKMA, there are risks associated with liquidity in both cryptocurrencies and stablecoins like Tether that can negatively effect the stability of fiat currencies. This might happen during “fire-sale” events, relating to sudden price jumps when traders can buy tokens at a massive discount than their usual price. This was seen during the crash of the Terra token. As per HKMA:
“These stablecoins bear liquidity mismatch risks similar to money market funds, which may expose them to a fire-sale of reserve assets in times of crypto ecosystem instability and in turn increase the volatility of these reserve assets.”
The central bank of Hong Kong pointed out that crypto assets linked to fiat currencies throughs stablecoins has made the fiat system more susceptible to price surges:
“The growing size of asset-backed stablecoins, together with their inherent risks, could make asset-backed stablecoins a potential magnifier of the volatility spillover from crypto to traditional financial assets.”
How to lessen the impact of stablecoin movements on the fiat currency
The HKMA predicts that swings in the price of stablecoins – an occurrence that shouldn’t happen owing to the nature of stablecoins – results in the reserve adjustments by stablecoins. This change in the reserve collateral to back up the price of the digital asset can impact the price of the underlying currency.
To avoid this, HKMA suggests that putting standardised disclosure in place will assist regulatory bodies to evaluate liquidity and risks in the price of the market. The HKMA also recommends that regulators should look to strengthen the stablecoin’s liquidity management with restrictions on how the reserve asset pinning the price of the stablecoin is used.