Unlike crypto critics who attack bitcoin and other cryptocurrencies for being too volatile, the Federal Reserve is increasingly sounding the alarm over investigating the coins that set out to be far more boring: stablecoins.
As their name suggests, stablecoins are cryptocurrencies that set out to remain stable over their lifetimes and try to maintain a value as close to $1 (or other base currencies) as possible.
Tether, the largest stablecoin in the world with a market cap of more than $60 billion, originally purported to be backed 1-for-1 by cash holdings. Earlier this year, after a settlement with the New York Attorney General’s office, it was revealed to only have about 5% of its collateral in cash. Most of its portfolio is actually invested in commercial paper, or short-term corporate debt, making Tether similar to a prime money market fund in the eyes of some Fed officials.
As Boston Fed President Eric Rosengren explained in a recent interview on Yahoo Finance, prime money market funds have gotten into trouble during the last two major recessions, requiring the Fed to intervene both times. But recently, more money has been flowing exponentially into stablecoins, like Tether, relative to prime funds, which have seen a drop in popularity since the financial crisis.
“I do worry that the stablecoin market that is currently pretty much unregulated, as it grows and becomes a more important sector of our economy, that we need to take seriously what happens if people run from these type of instruments very quickly,” he said. “Just like the money market funds caused a bad disruption in credit markets, I think a future financial stability problem could be occurring if we don’t start thinking carefully about what happens to things like stablecoins next time we have a market difficulty.”
Of course, it didn’t take much to spark panic among investors to begin a rush to withdraw their funds from one of the largest money market funds back in 2008. Despite the fact that the Reserve Primary Fund, which was roughly the same size as Tether today, held only 1.5% of its assets in Lehman Brother’s commercial paper, the fear of Lehman going bust caused customers to withdraw nearly two-thirds of the fund in just 24 hours. When the value of the fund’s shares “broke the buck” to trade at just 97 cents, the Fed stepped in to save the day. Confidence was restored and businesses could once again access short-term liquidity through commercial paper that helps fund daily liquidity and payroll needs.
According to Rosengren, Tether in a way is just a riskier example of a money market fund. It even holds assets like longer term corporate debt and precious metals, which a normal, regulated fund would not. But as Tether has swelled in size, it has also now presented a new risk to the financial system as it’s become one of the largest single holders of commercial paper. As a recent JPMorgan note pointed out, its holdings firmly place it in the top 10, even close to Vanguard.
But for Fed watchers like Avanti Bank founder Caitlin Long, who spent 22 years on Wall Street before crossing over into the world of crypto to win one of the first crypto banking charters, the new warning around stablecoins like Tether is a ramping up of a call to regulate them. As she told Yahoo Finance Wednesday, it’s the first time she’s seen a Fed speaker mention one of the stablecoins by name.
“I can’t think of another example when the Federal Reserve mentioned a company as a potential systemic risk before there was…