Fitch notes potential asset contagion risks posed by stablecoins could lead to tighter regulations for the industry.
The growth of stablecoins that are not fully backed by safe assets could trigger a destabilization in short-term credit markets, rating agency Fitch has warned.
In a commentary note, the agency explained that coins that are fully backed by safe assets pose a lesser risk for the financial markets. The agency gives USD Coin (USDC), which is backed by United States dollars on a one-to-one basis held in custody accounts, as an example for fully backed stablecoins but warned that the authorities “may still be concerned if the footprint is potentially global or systemic.”
On the other hand, Tether held 26.2% of its reserves in cash, fiduciary deposits, reverse repo notes and government securities, according to the biggest stablecoin issuer’s March 2021 reserve disclosure. Fitch highlighted that Tether’s commercial paper (CP) holdings, which account for $20.3 billion — or nearly 50% of its reserve — “may be larger than those of most prime money market funds (MMF) in the United States and EMEA.”
“A sudden mass redemption of USDT could affect the stability of short-term credit markets if it occurred during a period of wider selling pressure in the CP market, particularly if associated with wider redemptions of other stablecoins that hold reserves in similar assets.”
The Facebook-backed stablecoin Diem is another example Fitch uses to explain the attention of regulators. Diem proposed to hold 80% of its reserves in government securities while holding 20% in cash with overnight sweeps into MMFs that invest in short-term government securities.
Fitch noted that projects with the potential to rapidly become systemic, such as Diem, could lead to tighter regulations for stablecoins. “Potential asset contagion risks linked to the liquidation of stablecoin reserve holdings could increase pressure for tighter regulation of the nascent sector,” the note reads.
Related: Tether mints more coins to break $60-billion market cap
Fitch noted United States regulators’ warning that entities with similar asset allocations to Tether might not remain stable if the short-term credit spreads widen significantly. “This contrasts with the way stablecoins are marketed to the public,” Fitch analysts added.
Last month, Boston Federal Reserve President Eric Rosengren expressed concerns regarding the exponential growth in stablecoins. “I do think we need to think more broadly about what could disrupt short-term credit markets over time, and certainly stablecoins are one element,” he said.
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