Fitch warned that the rapid growth of stablecoin issuance could threaten the functioning of the short-term credit market stablecoin holders all rushed to convert their cryptocurrencies into money market securities at the same time.
Stablecoins, typically digital tokens pegged to traditional currencies, could pose “contagion risks” over time, the credit ratings service said in a report.
Potential asset contagion risks linked to the liquidation of stablecoin reserve holdings “could increase pressure for tighter regulation of the nascent sector,” according to a new Fitch report.
The bond ratings agency considered contagion risks to be primarily associated with “collateralised stablecoins, varying based on the size, liquidity, and riskiness of their asset holdings, as well as the transparency and governance of the operator.”.
There is less risk associated with coins that are fully backed by safe, highly liquid assets, although authorities may still be concerned if the footprint is potentially global or systemic. For example, USD Coin, the second-largest US dollar-linked stablecoin, is backed by one-for-one by US dollars held in custody accounts, according to Fitch.
The bond ratings agency said stablecoins that use fractional reserves or adopt higher-risk asset allocation may face a greater run risk. “Whereas stablecoins that use fractional reserves or adopt higher-risk asset allocation may face a greater run risk.”
Run risks were highlighted when a partially collateralised stablecoin, Iron, broke its peg in June.
Fitch noted that Tether, the largest stablecoin issuer, holds only 26.2 percent of its reserves in cash, fiduciary deposits, reverse repo notes, and government securities, with a 49.6 percent in commercial paper.
Tether’s commercial paper holdings amounted to $20.3 billion on March 31, according to Fitch. Total assets associated with its US-dollar linked stablecoin reached US$ 62.8 billion on 28 June. “These figures suggest its commercial paper holdings may be larger than those of most prime money market funds in the US as well as in Europe, Middle East, and Africa.
Rushing to the exit
The Fitch report suggests that a sudden mass redemption of stablecoin could affect the stability of short-term credit markets particularly if it was associated with wider redemptions of other stablecoins that hold reserves in similar assets.
With the total value of stablecoins outstanding now at US$108 billion, Fitch thinks the regulators might step in and force a gradual migration of stablecoin collateralisation reserves to less risky assets.
” Projects that could rapidly become systemic have drawn the attention of regulators also noted that entities with asset allocations like that disclosed by Tether may not be stable if short-term credit spreads widen significantly, as has occurred in times of financial stress.”
But while regulators would likely step in to help large fund managers in the event of a crisis, they are unlikely to do the same for stablecoin providers, Fitch said. “We believe authorities are unlikely to intervene to save stablecoins in the event of a disruptive event.”