The possibility of the collapse of yet another major stablecoin is sounding the alarm bell even for the US bond market, says Cornell University economics professor Eswar Prasad.
Although stocks and the broader economy were unaffected by the $1.4 trillion loss of the crypto market the academic points to the risks of a possible repeat of a collapse of TerraUSD’s magnitude.
Stablecoins are a type of digital currency that are theoretically pegged one-to-one with fiat currencies such as the dollar or euro, with the three largest being tether, USD and Binance USD.
These types of currencies have become the “backbone” of the crypto-economy by allowing people to make cryptocurrency transactions without having to convert their money into an actual currency.
The companies that issue stablecoins claim to be backed by real assets, such as fiat currencies or bonds, so users can redeem their coin one-for-one with a real asset.
Read Also: Tether to eliminate borrowing from its stablecoin backing fund
Tether says more than 58% of its reserves are held in US Treasury bills, equivalent to about $39.7 billion. Circle, the company behind USDC, has about $12.7 billion worth of bonds in its reserve.
Paxos, which issues the BUSD, said it has about $6 billion in US Treasury bills. All of these figures come from the companies’ latest reports issued in November.
However, while there are no signs of a collapse of the large stablecoin, Eswar Prasad said it is something regulators are concerned about because of the impact it could have on traditional financial markets.
That’s because a potential collapse of a stablecoin – where large groups of users would try to cash out their digital currency in fiat – would mean the issuer would have to sell the assets it holds in its reserve, which could mean dumping large volumes of US bonds.
“And I think the concern for regulators is if there is a loss of confidence in stablecoins… then we could have a wave of liquidations, which in turn would mean that stablecoin issuers have to liquidate their holdings in Treasury bonds,” Prasad told CNBC.
“And a large volume of liquidations even in a fairly liquid market can create turmoil in the underlying securities market. And given how important the Treasury bond market is to the broader financial system in the U.S. I think regulators are rightly concerned.”
The economist warns that if this happens when bond market sentiment is “very fragile as it is in the US at the moment“, it could have a “multiplier effect” thanks to strong pressure on government bonds.
The US bond market in 2022, after the Fed’s continuous rate hikes, had its worst year on record.
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