Even 'Safe' Stablecoins Might Pose Financial Stability Risk, New York Fed Says

The rise of Circle’s USDC stablecoin – as opposed to the controversial Tether (USDT) – is a threat to the broader financial system, as it could increase the chance of run risks from smaller issuers, researchers at the Federal Reserve Bank of New York wrote in a new paper published Monday.

“This substitution from Tether into USDC illustrates a bigger concern – namely, that resilient stablecoins can amplify run risks from more fragile ones, as they provide a convenient instrument to run to,” the report said.

Titled “The Financial Stability Implications of Digital Assets,” the paper comes in the same week that the U.S. Financial Stability Oversight Council – a group of regulators led by Treasury Secretary Janet Yellen – is poised to release a report in response to President Joe Biden's executive order calling for a plan to oversee crypto. The report is meant to explore the potential hazards that digital assets pose to the wider financial system.

The U.S. Congress is still in the process of taking action on cryptocurrencies, in particular stablecoins, as they pose the largest risk to the broader financial system due to its interconnection to traditional markets. Just today, stablecoin issuer Tether announced that it increased its holding of U.S. Treasury bonds to 58.1% of its total portfolio.

“The implications of stress in the crypto ecosystem on financial stability depend crucially on how interconnected it is with the traditional financial sector,” the paper said.

In the past, researchers have often pointed out the danger of stablecoins not being fully backed or being unable to maintain a 1:1 peg to the dollar. The latest report, however, seems more concerned with the risk that one large issuer could have the power to blot out competitors which could then result in a run on those coins.

To mitigate those risks, the Fed recommends that federal oversight should have the authority to implement laws that would facilitate interoperability among stablecoins and that they should consider a way to limit issuers’ affiliation with commercial entities.

The report also followed the President's Working Group’s recommendation that stablecoin issuers should be insured depository institutions.