(Bloomberg Markets) — Sometimes a stablecoin is anything but. When Silicon Valley Bank collapsed in March of last year, crypto company Circle Internet Financial Ltd. had $3.3 billion of cash reserves backing its USD Coin parked in the bank and couldn’t get it out. Stablecoins are crypto tokens whose value is typically pegged to a currency such as the US dollar. They offer a way for traders to quickly move between more volatile coins and something approximating cash or a way to hold or send money without using a bank. They can track a normal currency in a variety of ways—chiefly by holding assets such as cash or government bonds to support the value of the coin.
Most Read from Bloomberg
With about 8% of USDC’s reserves stuck in a failing bank, the stablecoin experienced its own panic. Traders raced to get out, dragging its price well below $1 over the dramatic weekend when regulators were figuring out what to do about SVB. After the government stepped in to make all of the bank’s depositors whole, USDC’s price recovered. “Following last year’s banking crisis, Circle upgraded the market infrastructure behind USDC to be the strongest, safest, most transparent digital dollar on the internet today,” a Circle spokesperson says.
The crisis showed how stablecoins can be buffeted by troubles in the traditional financial world. But some worry that stablecoins, with a total market value of $136 billion as of late January, could have the potential to rock real-world markets in return. “They are becoming more interconnected, more interlinked with the traditional financial system,” says Hilary Allen, a law professor at American University Washington College of Law.
That interconnectedness continues as the crypto mania that peaked in 2022 is returning. BlackRock Inc., the world’s biggest asset manager, now manages USDC reserves. Bank of New York Mellon Corp. custodies them. Circle filed for an initial public offering in January. Cantor Fitzgerald LP oversees “ many, many” of the assets of the largest stablecoin, Tether, says Chief Executive Officer Howard Lutnick. Mastercard Inc. and MoneyGram International Inc. enable stablecoin payments. PayPal Holdings Inc. introduced its own stablecoin in August. And JPMorgan Chase & Co.—notwithstanding CEO Jamie Dimon’s crypto skepticism—is exploring a stablecoin-like product for moving deposits.
One reason for the interest: Stablecoins and similar products that use blockchain ledgers can allow issuers to enter new areas, such as cross-border payments and trade settlement. Another: There’s money on the table. Thanks to the Federal Reserve’s rate hikes, stablecoin issuers can collect yields of more than 4% by investing in US Treasuries and other traditional financial instruments. Tether alone had direct or indirect exposure to $80.3 billion in US Treasury bills at the end of the fourth quarter, according to its website.
Such investments are making regulators nervous. In a September paper, researchers at the Federal Reserve Bank of New York compared stablecoins to money-market funds—noting how in 2008 investors fled funds with larger exposures to Lehman Brothers and asset-backed commercial paper. “Should stablecoins continue to grow and become more interconnected with key financial markets, such as short-term funding markets, they could become a source of financial instability for the broader financial system,” the paper says.
Runs on various stablecoins have happened multiple times already. One important risk is that such a rush for the exits could harm markets for the assets that back stablecoins. There’s also the danger that, over time, crypto tokens could change the very structure of the financial system. Stablecoins might start cannibalizing bank deposits, an important source of cheap funding for lenders, says Austin Campbell, an adjunct assistant professor specializing in crypto and finance at Columbia Business School. “The true risk is unbundling payments from lending,” he says.
Along the way, crypto tokens could also erode consumer protections. “Stablecoins purport to have convertibility one-for-one with the dollar but in practice have been less secure, less stable and less regulated than traditional forms of money,” Federal Reserve Governor Michelle Bowman said in an Oct. 17 speech at Harvard University.
When it comes to transparency, stablecoin issuers are often seen as lacking—especially the biggest player. The US Commodities Futures Trading Commission fined Tether in 2021 after finding its claims of being fully backed by US dollars were untrue. Tether agreed to pay without admitting or denying the allegations. Cantor Fitzgerald CEO Lutnick says his firm has reviewed Tether’s assets. “They have the money…
Read More: Why Crypto Stablecoins Still Worry the Fed