Federal Reserve issues stablecoin warning amidst a sinking UST

Saif Naqvi
Federal Reserve
Source: Pixabay

The United States Federal Reserve has cited stablecoins as a potential threat to financial stability, saying that they remain prone to customer runs.

The statements were picked out from the Federal Reserve’s financial stability report for May which headlined certain conditions that affect the stability of the U.S. financial system.

In it, the Fed said that stable coins ‘remain prone to runs’ and their redemptions risks are similar to those of money market funds since the virtual currencies were backed by assets that could lose value or become illiquid during periods of stress.

“These vulnerabilities may be exacerbated by a lack of transparency regarding the riskiness and liquidity of assets backing stablecoins. Additionally, the increasing use of stablecoins to meet margin requirements for levered trading in other cryptocurrencies
may amplify volatility in demand for stablecoins and heighten redemption risks”.

A ‘run on the fund’ is a situation in which a hedge fund, or other asset pool, faces a growing number of requests for redemptions from investors. Although a run on the fund could happen for several different reasons, it is usually the result of the poor performance of underlying assets.

The Fed’s comments coincided with a crypto bloodbath on Tuesday, after which Terra’s algorithmic stablecoin TerraUSD (UST) lost its peg against the U.S. dollar. Efforts to restabilize the peg resulted in an extreme sell-off on the native token, LUNA.

On 12 May, the fiasco spiraled further when Tether (USDT) also lost its peg against the dollar following another selling frenzy among investors. At press time, USDT was hovering around the $0.94-mark.

Janet Yellen On stablecoins

Speaking about the recent UST stumble, Treasury Secretary Janet Yellen appealed to Congress once again to authorize the regulation of stablecoins.

“I think that simply illustrates that this (stablecoins) is a rapidly growing product and that there are risks to financial stability…We really need a consistent federal framework,” said Janet Yellen in a senate hearing on Tuesday.

On being asked whether legislation could be finalized by the end of the year, Jannet Yellen said the goal would be ‘highly appropriate’.