Stablecoin Regulation and Growth May Affect Securities Markets


Tuesday, October 19, 2021   / 07:59 AM / by Fitch Ratings / Header Image Credit: FX Empire

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Fitch Ratings believes stablecoins that approach a systemically important scale could come to play an important role in short-term securities markets, such as commercial paper (CP), while bringing new risks to these markets. However, this will depend on the evolution of regulations affecting the asset class.

The reserves that coin operators hold to at least partially back their currency can affect short-term markets, particularly as they increase in scale. Tether, for example, held 49% of its reserves in certificates of deposit and CP as of end-June 2021. Meanwhile, Diem, a global stablecoin backed by Facebook, but not yet released, has previously proposed to hold at least 80% of its reserves in short-term high-quality government securities and the remaining 20% in cash, with overnight sweeps into daily liquid government money market funds (MMF).

The rapid growth in stablecoins means these securities holdings are already relatively large; although Tether's annualised market value growth slowed to 45% in 2Q21, it has risen by 230% since the start of 2021 to 15 October to reach USD68.6 billion.

Current growth rates and reserve allocations suggest that stablecoins could become a significant investor group in the US CP market. For example, in a hypothetical scenario where stablecoin market value continues to grow at near current rates, and reserve holding allocations remain stable, their CP holdings could exceed those of money market funds within two or three years.

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The launch of the Diem US-dollar stablecoin could further spur the sector's market value growth. We believe it will not directly affect the CP market due to the government-securities focus of Diem's declared reserve allocation plan, but alternative allocation strategies remain possible and, depending on its scale, the operator may become an important participant in other short-term markets.

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Stablecoins could be disruptive for CP markets; for example, owing to run risks. Stablecoin-related turbulence could both affect the CP market itself and transmit shocks to other market participants. Risks could be aggravated if the infrastructure and partners used by stablecoin operators to engage with traditional markets lack a record in the smooth handling of transactions during periods of market stress or volatility.

Growth in stablecoins' market value has been volatile and their reserve asset allocations may change, making forecasts challenging; for example, the latest attestation from USD Coin (USDC) indicates that its CP holdings with maturities of 91 days to 13 months plunged to 2% of reserve assets in August, from 10% in June. Actual holdings remain opaque, even in the most transparent cases, and granular asset breakdowns are not readily available.

The regulatory approach towards stablecoins will affect how the sector develops, although the timeline and details of regulation in key markets - most notably the US and EU - remain unclear. The EU, for example, is negotiating new regulations on crypto assets that would require stablecoins that are intended to be used as a means of payment to invest their reserves in cash and very low-risk predominantly government securities.

A requirement for stablecoin operators to hold more reserves in safe and highly liquid assets could reduce allocations to CP, but raise the influence of stablecoins on the short-dated government market. Other initiatives, including the potential launch of central-bank digital currencies, could also significantly affect demand for stablecoins.

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