Federal Reserve Says Private Stablecoins Vulnerable to Runs in New Report

Federal Reserve Says Private Stablecoins Vulnerable to Runs in New Report

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The U.S. Federal Reserve is voicing concerns about the viability of cryptocurrency stablecoins and is suggesting the utility of government-backed alternatives.

In a wide-ranging report discussing financial stability across numerous economic sectors, the Fed identifies risks associated with so-called stablecoins, which advertise themselves as being pegged to the value of the US dollar.

While citing the susceptibility of associated digital assets and blockchain projects to lose liquidity, the Fed says of stablecoins,

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

Stablecoins 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 [money market funds].

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.”

Just this week, the TerraUSD (UST), which was intended to serve as a 1-for-1 peg to the US dollar, plummeted to as low as $0.74.

The Luna Foundation Guard (LFG), a non-profit organization built to support the Terra (LUNA) ecosystem, responded to the UST crash by allocating $1.5 billion in assets to shore up the price. UST has since recovered to $0.90 at time of writing.

The Federal Reserve’s report goes on to discuss the role that a central bank digital currency (CBDC) might play in fulfilling the intention of stablecoins while operating within a regulated framework.

“A CBDC has the potential to support financial stability. In a rapidly digitizing economy, the proliferation of new types of digital money, including stablecoins, could present risks to both individual users and the financial system as a whole.

A CBDC could provide the public with broad access to digital money that is free from credit and liquidity risk.”

Back in March, President Biden signed an executive order to address the rise of cryptocurrencies and associated risks. The order also identifies the need to determine whether the US should issue its own digital form of the US dollar.

“[The order intends to] explore a U.S. Central Bank Digital Currency (CBDC) by placing urgency on research and development of a potential United States CBDC, should issuance be deemed in the national interest. The Order directs the U.S. Government to assess the technological infrastructure and capacity needs for a potential U.S. CBDC in a manner that protects Americans’ interests.

The Order also encourages the Federal Reserve to continue its research, development, and assessment efforts for a U.S. CBDC, including development of a plan for broader U.S. Government action in support of their work.”

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