If a stablecoin collapses, the US bond market and the economy will suffer

In 2022, the crypto industry saw nearly $1.4 trillion lost in collapses.
Stablecoin shares a $145 billion market cap.
A collapse would affect the non-crypto market due to its pegging system.

Every financial instrument has inherent risks, and investors are advised to take the promises with a pinch of salt. 2022 has seen an almost $1.4 trillion collapse of the crypto market, one academic hint that if a major stablecoin fails, it could impact the US bond market.

The stablecoin market is expected to be around $145 billion, as they are pegged one-to-one with fiat currency, making them the backbone of the crypto economy. This feature allows people to easily trade in various cryptocurrencies and tokens without converting their fiat.

Issuers bet that these stablecoins are backed by real assets such as fiat currency or bonds. Liquid government securities back them. Although there are no signs visible on the horizon of a stablecoin collapsing, an economics professor at Cornell University, Eswar Prasad, shared some concerns regarding the impact it could have on the traditional financial market.

Suppose many users simultaneously convert their stablecoins to fiat, then the issuer has to sell their reserve assets, meaning dumping large amounts of US Treasurys.

Speaking to the media at a conference in St. Mortiz, Switzerland, the economist said that if people’s confidence in stablecoins is lost, there would be an influx of withdrawals, meaning more pressure on the issuer to sell their holding of Treasury securities.

Even if the market is fairly liquid, such an influx could create waves in the underlying securities market. Considering the importance of the Treasury securities market in the broader financial system, it’s a grave concern.

Suppose such an event were to occur, too, when the sentiments of the bond market are fragile; this could create a multiplier effect due to the large selling pressure on Treasurys. According to economists, cryptocurrencies are speculative financial assets without a clear valuation model backing them.

In May 2022, the US Federal Reserve warned that “stablecoins remain prone to runs, and many bond and bank loan mutual funds continue to be vulnerable to redemption risks.”

A well-known venture capitalist and crypto industry veteran Bill Tai, do not think any major stablecoin would collapse anytime soon. Still, scrutiny on them has gone up, and that is welcome. Further in the interview, Tai says:

“I think just like in our traditional finance industry, where people got caught off guard by hidden contagion inside the subprime market during the great financial crisis, there could be a pocket or two of leverage on some of the assets that purport to support stablecoin,”

Liking the possibility of a stablecoin blowup with surprise events like the subprime mortgage crisis, which began in 2007 and plunged the whole world into recession.

Now, as greats like Jeff Bezos had speculated that recession could be on the horizon, a massive blow to traditional finance or the economy could not be handled.