Stablecoins present risk to traditional financial system says TD

Senior economist Vikram Rai says that the burgeoning asset class may be relatively safer than cryptos but are not without risk

Stablecoins present risk to traditional financial system says TD
Steve Randall

Digital assets are here to stay and many investors, especially those new to investing, are being tempted by their potential.

But while celebrity-backed NFTs and cryptocurrencies such as Bitcoin grab the headlines, those looking for a less volatile digital option might consider stablecoins.

But is the suggestion that these digital assets are ‘stable’ belying the risk of these assets and the potential impact on the traditional financial system?

TD Economics’ senior economist Vikram Rai says that there are issues that could spill over to other asset classes if the stablecoins market fails to maintain confidence.

Stablecoins, unlike cryptos, are pegged to another asset’s value, typically the US dollar. This gives some element of stability. Depending on the structure of the stablecoin, they may also be backed by the issuer holding assets equivalent to its exchange-rate value.

Rai highlights the risk for a stablecoin is that weak market confidence, resulting in large-scale redemptions, could be greater than the assets held by the issuer, reducing the value to nothing.

The recent collapse of Terra has raised concerns. As a stablecoin that was always meant to be worth US$1, its collapse to nothing resulted in billions of dollars being lost by investors.

Asset devaluation

Even the market’s largest stablecoin, Tether, suffered redemptions as a result of the Terra collapse. While this coin’s issuers say that it is fully backed by traditional assets, transparency is a concern.

TD’s Rai notes that “in mid-2021, Tether appeared to be an oversized player in the commercial paper market, leading some to question as to whether those assets could be sold without deflating their price.”

The TD economist concludes that, while the stablecoins market is currently small, as it grows and intensifies links with other asset classes, risk and volatility will grow.

With this potential to have a significant impact on the wider financial system, regulators are keen to consider how to mitigate this burgeoning risk.

“We expect that there will continue to be significant attention from investors and regulators alike for the crypto market,” Rai concludes.