Warning: A Stablecoin Collapse Can Severely Impact U.S. Bond Market

One area where U.S. regulators are keeping a close watch is the widely expanding crypto stablecoin market. The stablecoin market has already grown to more than $200 billion in size last year. However, one academic has warned that a major stablecoin collapse could severely impact the U.S. bond market.

Stablecoins are basically digital assets pegged to fiat currencies like the U.S. Dollar. Some of the most popular stablecoins currently used in the market are Tether (USDT), USD Coin (USDC), and Binance USD (BUSD).

Stablecoins have been the go-to choice for crypto investors looking to trade in and out of different digital assets or convert them into fiat money. Eswar Prasad, an economics professor at Cornell University said that he has spoken to a few regulators who are worried about the impact stablecoins could have on traditional financial markets.

Stablecoins Pose Risks to U.S. Bonds and Treasury

To understand why a stablecoin run could impact the market, let’s take a look deeper. Currently, USDT stablecoin issuer Tether has more than 58% of its reserves held in U.S. Treasuries which account for a staggering $39.7 billion. Similarly, USDC stablecoin issuer Circle has around $12.7 billion worth of Treasurys in its reserve. BUSD issuer Paxos on the other hand has $6 billion of U.S. Treasury bills.

Now any case of a potential run on a stablecoin would cause users to redeem their crypto assets for fiat. This in turn would cause the issuer to sell-off their assets in the reserves which could, in turn, lead to them selling large amounts of U.S. Treasurys. Speaking to CNBC at Crypto Finance Conference in St. Moritz, Switzerland, Prasad said:

“And I think [the] concern of regulators is if there were to be a loss of confidence in stablecoins … then you could have a wave of redemptions, which will in turn mean that the stablecoin issuers have to redeem their holdings of Treasury securities.

And a large volume of redemptions even in a fairly liquid market can create turmoil in the underlying securities market. And given how important the Treasury securities market is to the broader financial system in the U.S. … I think regulators are rightly concerned.”

He also mentioned that the bond market sentiment is already fragile in the U.S. currently. Thus, any such incident of a stablecoin run could lead to a multiplier effect and create a large selling pressure on Treasurys.

The collapse of the TerraUSD stablecoin already sent shockwaves in the broader crypto space last year. Last year the Fed warned that “stablecoins remain prone to runs, and many bond and bank loan mutual funds continue to be vulnerable to redemption risks”.