Federal news: Concerns of the stablecoin market

The United States Federal Reserve Board has released its semi-annual Financial Stability Report this week outlining several elements in the financial sector. In the report, the board commented on cryptocurrencies pegged to other assets (stablecoins) and how they are impacting the financial industry in the country.

As part of the report, the board noted the commodities market and its volatility, which comes as a result of the Russian attack on Ukraine as well as the continued Covid-19-related uncertainty that has plagued the market since 2020. The ever increasing inflation in the country was also addressed in the report in reference to the volatility, with the board noting inflation and decreasing the value of the dollar as a key factor of instability in the economy. As per the report:

[Uncertainty over the inflation outlook poses risks to financial conditions and economic activity. Against this backdrop, financial markets experienced high volatility and some strains on market liquidity.”

The report highlighted four factors that the Federal Reserve believes to be putting pressure on funding in the country:

Asset valuations

“Heightened uncertainty about the economic outlook led to notable fluctuations in financial markets.” 

According to the Reserve, asset prices across sectors are vulnerable to volatility with surging values and shocking drops affecting industries.

Household debt

The Reserve noted that there has been a rise in borrowing by businesses and households, leading to vulnerabilities that arise from debt, including a rise in debt-to-GDP ratios, gross leverage, and interest coverage ratios.

Leveraging in the financial sector

As per the report, banks have maintained ratios for risk-based capital above minimum regulation. This has led to low broker-dealer leverages but leverage at life insurance companies and hedge funds has seen record highs.

Funding risks (related to stablecoins and digital assets)

Banks have seen low funding risks because of a large number of investors holding liquid assets – which means a reduced reliance on short-term funding from investors. According to the Federal Reserve, there has been an increase in money market funds (MMF) and stablecoin investment, with the Fed noting the markets to be prone to runs. According to the Reserve, stablecoins have an aggregate value of $180 billion USD – with up to 80% of that investment made up of Tether, USD Coin, and Binance Coin. As the report notes, these assets – backed by the underlying asset they are pegged to – might lose value or become illiquid if the market is under pressure, which could lead to redemption risk if investors try to sell.

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