New York Fed Says Stablecoins Pose Threat to Financial System

The volatility of digital assets has been largely confined to the digital ecosystem and has had little effect on the traditional financial system.

But that could change if the digital asset ecosystem becomes more interconnected with the traditional financial system and if it begins providing significant financial services outside that ecosystem, according to a staff report released by the Federal Reserve Bank of New York.

In “The Financial Stability Implications of Digital Assets,” the authors said the digital asset ecosystem has many of the same vulnerabilities as the traditional system but has fewer regulations while also introducing new risks.

Among the risks are automated transactions and decentralized governance of some platforms, which together make it difficult to intervene during instability. In addition, stablecoins may cause disruptions in the traditional financial markets, the authors said.

“At present, the potential spillovers from runs on stablecoins that are backed by money market instruments represent the most salient financial stability risk,” the authors wrote. “Should the digital financial system become more interconnected with the traditional system or expand its provision of financial services, financial stability risks could quickly become material.”

In May, U.S. Treasury Secretary Janet Yellen called for new regulations on stablecoins, citing the dramatic fall of the Terra token.

Read more: Yellen: Terra’s Fall Shows Stablecoin Dangers

Speaking to the U.S. House Financial Services Committee on May 12, Yellen said: “I wouldn’t characterize it at this scale as a real threat to financial stability, but they’re growing very rapidly and they present the same kind of risks that we have known for centuries in connection with bank runs.”

In November 2021, Consumer Financial Protection Bureau (CFPB) Director Rohit Chopra cited a Report on Stablecoins issued by the President’s Working Group on Financial Markets and said the agency would be taking action on stablecoins.

Read more: CFPB’s Chopra: Stablecoins May ‘Create Stress’ on US Financial System Without ‘Oversight’

“The report highlights how stablecoins could be vulnerable to runs and fire-sales in ways that could create stress on the broader financial system absent adequate oversight,” Chopra said Nov. 1, 2021, in a press release.