IMF Report: Stablecoins Possible ‘Contagion Risk’ To Financial System
International Monetary Fund (IMF) joins the growing list of institutions that warn about the risks to the global financial system posed by the growing adoption of ‘stablecoins.’
IMF writes in its 2021 Global Financial Stability Report, that crypto doesn’t yet present a systemic threat to the international system but that “risks should be closely monitored given the global implications and the inadequate operational and regulatory frameworks in most jurisdictions.”
The entity suggests “global standards for crypto assets,” in order to address the inadequacies, which might help fend off a “contagion risk” to other markets.
The IMF is a finance heavy-weight – an intergovernmental body of 190 member states that promotes global trade, poverty reduction, and stable monetary policies. According to an April 2021 fact sheet, it has about $1 trillion available for loans (to its members who agree to the lean terms), a little under half of the total crypto market capitalization.
A chapter in this year’s report titled “COVID-19, Crypto, and Climate: Navigating Challenging Transitions” reflects the IMF’s point of view by putting the digital assets in the same basket with a pandemic and a potential catastrophe. Despite the title, the report itself is more balanced, and talks about “both opportunities and challenges” arising from digital assets’ growth.
The report cites service disruptions on exchanges, attacks to centralized platforms on which crypto is still dependent, and low transparency around the issuance and distributions of some tokens. It reads:
“The rapid growth of the ecosystem has been accompanied by the entrance of new entities, some of which have poor operational, cyber risk management, and governance frameworks.”
While all the above has led to losses that can wipe out investments for over-leveraged investors, they haven’t really had an impact on the current financial order. However, according to IMF, this could be changing, especially as most crypto trading volume takes place on a single exchange, Binance, and stablecoin Tether (USDT) is the primary means for making Bitcoin trades; attacks to either entity, either digitally or via regulatory pressure, could weaken the entire ecosystem, and along with it the legacy financial systems it all leans on.
The report describes in detail how stablecoins (pegged 1:1 to the US dollar or another fiat currency), pose a risk as they are regulated differently from jurisdiction to jurisdiction. Another concern the report says, is the fast growth of stablecoin adoption. The stablecoin market cap grew from $20 billion to well beyond $120 billion in the last year.
The regarding the the problems related to stablecoins, the report notes that the first is “poor disclosure” in some cases of how the stablecoin is backed. Tether, for example, has been criticized for its vagueness regarding how the stablecoin can be redeemed. After years of insisting that every USDT in circulation was backed by a dollar in the bank, it seemed that it may not have been the case. According to an August 2021 report from a Cayman Islands auditor, about half of Tether’s reserves were actually commercial paper, a type of debt, and certificates of deposit.
According to U.S. Federal Reserve Chair Jerome Powell testimony in front of Congress, commercial paper is usually liquid until it suddenly isn’t. This typically happens in times of sudden financial crisis. He believes stablecoins should be regulated in the same manner as money markets. This is something the IMF agrees.
IMF Director of Monetary and Capital Markets Tobias Adrian to Yahoo Finance Live:
“When you look at the market capitalization of stablecoins, they are of an order of magnitude with some of the largest offshore money market funds, so they are not small.”
The IMF report also points out that “some stablecoins can be subject to runs, with repercussions for the financial system.” Especially it mentions stablecoin IRON, whose algorithmically based ecosystem collapsed in June along with Mark Cuban’s investment in it. A run can be triggered by simply concerns that assets can’t be redeemed for their full value, which then could lead into a fire sale of the commercial paper held in reserve by those stablecoin treasuries.
According to the IMF report:
“The contagion risk can be much higher where reserve assets are concentrated in particular issuers or sectors. Although this risk might be Tether-specific for now, given its size and types of holdings, this kind of contagion risk could evolve for other stablecoins in the future.”
Regarding how to solve these problems, the IMF isn’t, however, proposing a ban or a clamping down. Adrian commented:
“We would urge regulators to take a closer look at stablecoins and introduce regulation so investors know what kind of reserves are backing the claims of stability.”
Steven Kelly, a research associate at the Yale Program on Financial Stability, doesn’t agree with the IMF stance. He argued in a Twitter thread that “the instability concerns go beyond the commercial paper, etc. holdings.”
2/ Shifting assets away from commercial paper into short-term Treasuries is often characterized as making stablecoins more run-proof. See, e.g.:https://t.co/MkSHIr99M1 Or USDC emphasizing the shift in its portfolio: https://t.co/bCc9zOE6nE
While placing them into short-term Treasury holdings is one solution or even cash, both options have their own limitations. Kelly wrote in a tweet:
“Stablecoins shifting into Treasuries could also tie some of the banking system to the fate of stablecoins, which have questionable infrastructure and risk management, limited Street relationships, and are exposed to events in crypto.”
