Federal Reserve highlights ‘structural fragilities’ in stablecoin market in new report

The US Federal Reserve is pointing to the recent collapse of TerraUSD and other algorithmic stablecoins as examples of financial stability risks. 

In its June 17 monetary policy report, the Fed noted stablecoins among financial stability risks. Though the Fed has expressed concerns over stablecoins in the past, it now has ammunition to cite, referring to “The collapse in the value of certain stablecoins and recent strains experienced in markets for other digital assets demonstrate the fragility of such structures.”

The most notable collapse was of TerraUSD (UST) and linked cryptocurrency Luna, which dropped over $40 billion in value early in May. The event has become a lightning rod for political scrutiny. 

The Fed was already involved in the creation of the President’s Working Group report on stablecoins from November, which argued to limit stablecoin issuance to “insured depository institutions.” This more recent report from the Fed continues to promote that joint shared conclusion.  

“Stablecoins that are not backed by safe and sufficiently liquid assets and are not subject to appropriate regulatory standards create risks to investors and potentially to the financial system, including susceptibility to potentially destabilizing runs,” the report says. There is, indeed, a broader lingering question of whether algorithmic stablecoins can truly maintain value.

The PWG’s recommendations did not thoroughly address algorithmic tokens, seeming to limit concerns to the more familiar fiat-backed tokens. The Fed report, though it does not name Terra or UST, specifically notes concentration in the stablecoin market to fiat-backed issuers “Tether, USD Coin, and Binance USD.”

In the wake of the UST collapse, several leaders including Treasury Secretary Janet Yellen and Pat Toomey, the leading Republican on the Senate Banking Committee, noted that stablecoins had not proved to be a risk to the more general financial system. 

As the current crypto bear market shakes out more and more firms, this test of systemic importance will continue to lead policymaker responses.