The Fed stresses dangers of risky assets and stablecoins

The US central bank maintains that stablecoins are ‘susceptible to runs’

The Federal Reserve has issued a further warning about the state of runaway prices for risky assets and the potential threat posed by digital currencies that are pegged to assets, so-called stablecoins. 

Financial Stability Report

Publishing its biannual Financial Stability Report, the US central bank observed that the price of “risky assets” had “generally increased” in the past six months. 

“Asset prices remain vulnerable to significant declines should investor risk sentiment deteriorate, progress on containing the virus disappoint, or the economic recovery stall,” the Fed stated in the report.

Although the Fed recognised that house prices in the world’s largest economy “have increased rapidly since May”, it maintained: “Little evidence exists of deteriorating credit standards or highly leveraged investment activity in the housing market.” 

In the financial sector, the Fed found that “leverage continued to be high by historical standards at life insurance companies and hedge fund leverage remained somewhat above its historical average”. 

Households and businesses

The US central bank observed that key measures of vulnerability for businesses and households “have largely returned to pre-pandemic levels”. 

While the Fed noted that “household balance sheets have benefited from… extensions in borrower relief programs, federal stimulus and high aggregate personal savings rates”, it said that “the Delta variant appears to have slowed improvements in the outlook for small businesses”. 

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Cryptocurrencies and stablecoins

The paper was published only hours before the likes of Bitcoin and Ethereum rose to new all-time highs. Although the Fed said that the report “focuses on equity market developments” and not on cryptocurrencies, it did recognise recent “episodes of volatility in crypto-asset markets”. 

However, cryptocurrencies and stablecoins did feature in the report’s survey of 26 market contacts. The survey assesses the most-cited potential shocks that may threaten markets in the next 12 to 18 months. The burgeoning sector rose to fifth, having ranked ninth in a list of the 14 largest threats in spring of 2021. 

The main danger associated by the Fed with stablecoins was the potential inability of their issuers to meet redemptions at the promised stable value if the asset it is pegged suffers a profound and sudden fall.

As such the Fed warned: “Stablecoins have structural vulnerabilities similar to those discussed earlier for certain money market funds and are susceptible to runs. These vulnerabilities may be exacerbated by a lack of transparency and governance standards regarding the assets backing stablecoins. The potential use of stablecoins in payments and their capacity to grow can also pose risks to payment and financial systems.”

Shortly before noon on Tuesday, the market capitalisation of Tether (USDT), the world’s largest stablecoin, rose to a new record high of $73.3bn (£54bn), having stood at $17.4bn only 12 months earlier.

Further reading: Exodus of lower-paid workers cashing in on crypto profits

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