• J Markezic and M Bacina

US Fed report on financial stability critiques crypto



Earlier this week the US Federal Reserve (Fed) published its semi-annual Financial Stability Report which criticised stablecoins, central bank digital currencies (CBDCs) and cryptocurrency generally.


The report has a special emphasis on stablecoins, alongside other money market funds and bonds, as being prone to risks in the current financial system - particularly having regard to funding. According to the report:-

Some types of money market funds (MMFs) and stablecoins remain prone to runs... Funding risks at domestic banks are low, but structural vulnerabilities persist at some money market funds, bond funds, and stablecoins.

The report further cites the rapid growth of stablecoins to a market capitalisation of $180 billion. The report notes that during times of economic stress, the backing assets that underlie a stablecoin have the propensity to become illiquid which places difficulty on owners who seek to redeem them.


Prior to the report, concerns with respect to stablecoins have been previously expressed in regards to collateralised and fiat-backed stablecoins as opposed to their algorithim-based counterparts. Concerns have also been raised as to the quality of the assets that back the collateralised Tether stablecoin.


Briefly, whereas fiat-backed stablecoins utilise collateral, an algorithm-based stablecoin utilizes arbitrage to seek maintain a peg to the fiat currency. The Fed's report fails to mention Terra USD (UST) - an alogirthm-based stablecoin - which became the third largest stablecoin domestically in the US that has a market capitalisation exceeding $18 billion. In the recent cryptocurrency market volatility, UST de-pegged to 60 cents on the US Dollar before rebounding to above 90 cents and then cratering to 20c at the time of press.


What is clear from the report is that the Fed's outlook is pessimistic. The Fed makes constant reference to a potential worsening of market liquidity:-

According to some measures, market liquidity has declined since late 2021 in the markets for recently-issued U.S. cash Treasury securities and for equity index futures...

The report further notes external influences abroad:-

While the recent deterioration in liquidity has not been as extreme as in some past episodes, the risk of a sudden significant deterioration appears higher than normal... In addition, since the Russian invasion of Ukraine, liquidity has been somewhat strained at times in oil futures markets, while markets for some other affected commodities have been subject to notable dysfunction.

Given the recent attack on/collapse of the Terra stablecoin, the US Fed is sure to be looking even more closely at this issue and attendant risks.