Latest Federal Reserve Report Express concern over “Structural Fragility” of Stablecoin

Key Takeaways

  • According to the report, stablecoins not backed by safe and sufficiently liquid assets and not subject to appropriate regulatory standards create risks to investors.
  •  Stablecoins, popularly used as collateral for leverage trading, could potentially “amplify market volatility” and heighten risks of non-redemption by issuers, the report states.

The Federal Reserve Board released its twice-yearly monetary policy report on Friday, highlighting ‘the structural fragilities’ of crypto. The report, which mentions stablecoins and the risks they pose to the financial system’s stability, points that stablecoins not backed by safe and sufficiently liquid assets and not subject to appropriate regulatory standards create risks to investors. The Federal Reserve reiterated that stablecoins could potentially strain the financial system, including susceptibility to potentially destabilizing runs.

The monetary report also warned that stablecoins are popularly used as collateral for leverage trading, could potentially “amplify market volatility,” and heighten risks of non-redemption by issuers. The report furthermore criticized the lack of transparency among stablecoin issuers concerning risk and reserve liquidity.

The Federal Reserve Board points to the 2021 President’s Working Group on Financial Markets report, in which officials said legislation was “urgently needed to comprehensively address the prudential risks posed by payment stablecoin arrangements “ .President’s Working Group on Financial Markets report wanted stablecoin issuers to be held to the same standards as insured depository institutions. 

The latest report came in advance of Fed Chair Jerome Powell’s testimony in Congress beginning from June 22. Powell is now expected to outline the Fed’s plans to tackle the increasing inflation rates. The Federal Reserve’s report comes against the backdrop of the recent TerraUSD collapse. Terra-a stablecoin plummeted to new lows last month. Terra’s Collapse triggered an $83 Billion Decentralized Finance(DeFi) Slump and made investors increasingly wary of algorithmic stablecoins.

Many officials have also expressed concerns of stablecoins “instability” recently. Treasury Secretary Janet Yellen asked for a “consistent federal framework” on stablecoins by 2022 end, pointing to “risks to financial stability.” Recently a bipartisan crypto bill was presented by U.S. Sens. Cynthia Lummis (R-Wyo.) and Kirsten Gillibrand (D-N.Y.) to seek regulatory clarity for cryptocurrencies, including stablecoins.

Saniya Raahath
Saniya Raahath

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