Could stablecoins fragment the financial system?

The total market cap of stable coins broke $100 billion at the end of May. The US administration and regulators are now expressing alarm for investors, as well as for the fact that large amounts of dollar equivalent stable coins are circumventing the US banking system. 

An article, released today by Bloomberg, highlighted how regulators and officials from the Federal Reserve are worried about the lack of protection for investors from stablecoins that may not have the backing they purport to have. 

In addition, the sheer size of the stablecoin market has led to much of it not even touching the US banking system, which regulators say can hide illegal transactions. 

Lev Menand, an academic from Columbia Law School, spoke about stablecoins in testimony to a Senate Banking subcommittee last week: 

“They’re dangerous to both their users and, as they grow, to the broader financial system,” 

Two strands of concern appear to be emanating from government; one, that investors do not realise they are not covered by Federal Deposit Insurance Corp. Secondly, nefarious actors could use stablecoins to transfer money without going through the banking system, and thereby avoid AML and commit illicit activities. 

Senator Elizabeth Warren, in the news over recent weeks for her anti cryptocurrency stance, called stablecoins “wildcat notes”. She called for a Federal Reserve issued digital currency, which would give the benefits of stablecoins, but without the associated risks. 

In fact, the Federal Reserve was the latest central bank to make it known that it is investigating the viability of its own central bank digital currency (CBDC). Jerome Powell, chairman of the Federal Reserve, said that stablecoins did pose risks to the financial system.  

Fed Governor Lael Brainard went a step further by suggesting that an increased usage of stable coins could fragment the financial system, saying that it could impact US households and businesses. 

The stablecoins with the largest market capitalisation are Tether, with $62 billion, and US Dollar Coin (USDC), with $24 billion. For years Tether has been dogged by accusations that it did not have 100% backing for its stablecoins. However, the company has said that its stablecoin is backed by various assets and not just cash. These include corporate bonds and precious metals. 

Disclaimer: This article is provided for informational purposes only. It is not offered or intended to be used as legal, tax, investment, financial, or other advice.