Stablecoins Come Under Increased Scrutiny as Lawmakers Highlight Risks

Key Insights:

• Stablecoins come under increased scrutiny, with U.S. Treasury Secretary Janet Yellen and the Fed highlighting risks to financial stability.
• The de-pegging of TerraUSD (UST) from the dollar and failure to restore the peg over two days raises concerns on Capitol Hill.
• Lawmakers may look beyond stablecoins, following this week’s events, to formulate a more robust regulatory framework.

In late 2021, stablecoins came under scrutiny on Capitol Hill. The U.S. Senate Committee on Banking, Housing, and Urban Affairs held a hearing on stablecoins. An area of focus was their possible impact on financial stability.

This year, stablecoins took more heat. The U.S. House Committee on Financial Services followed up with its own hearing . During the hearing, the U.S. Treasury called for stablecoins to fall under the remit of ‘federally insured depository institutions.’

This week, crypto market activity has reignited the debate over stablecoins and financial stability.

The Federal Reserve Targets Stablecoins in Financial Stability Report

On Monday, the Federal Reserve released its Financial Stability Report, which listed stablecoins under ‘funding risks.’

According to the report,

“Structural vulnerabilities persist at monetary market funds and some other mutual funds, and the rapidly growing stablecoin sector is vulnerable to runs.”

The report added,

“The stablecoin sector continued to grow rapidly and remains exposed to liquidity risks.”

Other key points included,

• The aggregate value of stablecoins grew rapidly over the past year to more than $180 billion in March 2022.
• The stablecoin sector remained highly concentrated, with the three largest stablecoin issuers – Tether (USDT), USD Coin (USDC), and Binance USD (BUSD) – constituting more than 80% of the total market value.
• They typically aim to be convertible, at par, to dollars, but they are backed by assets that may lose value or become illiquid during stress; hence they face redemption risks similar to those of prime and tax-exempt MMFs.
• These vulnerabilities may be exacerbated by a lack of transparency regarding the risks and liquidity of assets backing such coins.
• Additionally, the increasing use of stablecoins to meet market requirements for levered trading in other cryptocurrencies may amplify volatility in demand for stablecoins and heighten redemption risks.

The Federal Reserve noted that the President’s Working Group on Financial Markets in conjunction with other groups have made recommendations to address prudential risks posed by stablecoins.

In the Fall of 2021, cryptocurrencies/stablecoins ranked fifth as the most cited potential risks over the next 12 to 18 months.

They ranked behind,

• Persistent inflation; monetary tightening.
• COVID-19.
• China regulatory/property risks.
• U.S. – China tensions.

In Spring 2022, cryptocurrencies/stablecoins ranked at a lowly twelfth.

The report coincided with the de-pegging of TerraUSD (UST) from the dollar and the resulting impact on Terra (LUNA) and Anchor Protocol (ANC).

TerraUSD (UST) De-Pegging from the Dollar Results in More Scrutiny

This week, the TerraUSD (UST) peg shattered, with UST tumbling to a current-year low of $0.6134 on Tuesday. After UST had fallen to $0.7494 on Monday, attempts to restore the peg failed, leading to the late UST slump to $0.61 levels on Tuesday.

News reports of UST’s demise caught the attention of U.S. Treasury Secretary and former Fed Chair Janet Yellen.

Speaking to lawmakers on Capitol Hill, Treasury Secretary Yellen said,

“I would note that there was a report just this morning in the Wall Street Journal that Stablecoin known as TerraUSD experienced a run and had declined in value.”

She added,

“I think that simply illustrates that this is a rapidly growing product and that there are risks to financial stability, and we need a framework that’s appropriate.”

UST makes Congressional testimony faster than it recovers its peg. pic.twitter.com/SS7sJy7UBV

— Nathaniel Whittemore (@nlw) May 10, 2022

Following the sub-committee hearings in late 2021 and February, more scrutiny is likely.

Whether lawmakers will differentiate between the different types of dollar pegs remains to be seen.