The European Systemic Risk Board (ESRB) released a report on Thursday outlining the top 3 nightmare scenarios in which a crypto industry crisis could leak out and pose “systemic risk” to the broader financial system.
The main risk listed is a potential run on a “big reserve-backed stablecoin” such as Tether (USDT) or USD Coin (USDC).
Connecting Crypto to TradFi
In its 77 pages reportthe ESRB argued that as the volatile cryptocurrency industry grows, so does its connection to the mainstream financial world.
The board does not believe that this interconnection poses any kind of “systemic risk” to “critical services” in the immediate future, noting “only a sporadic correlation between the booms and busts of crypto assets and traditional finance.”
That being said, there are a variety of ways this risk can manifest in the future. These include a lack of identification of how forms of interconnection play out and increased adoption of cryptographic technologies within traditional finance itself.
Right now, one of the main connections between cryptocurrencies and TradFi is reserve-backed stablecoins. These are crypto assets whose price remains pegged to a relatively stable priced non-crypto asset, such as fiat currency or gold, and are backed by reserves that hold those assets.
“A run on a reserve-backed stablecoin would trigger forced sales of tradable debt and bank withdrawals,” the ESRB wrote. “There is always the possibility that this could turn into a broader panic.”
The stablecoin panic is nothing new for the cryptocurrency industry. In May 2022, Tether suffered withdrawal pressure within the billions of dollars in May 2022, but still managed to maintain its parity with the dollar. USDC was unpegged for several days in March 2023 after the collapse of Silicon Valley Bank, which held much of the reserves backing the currency, prompting many holders to flee to USDT.
Crypto is also connected to TradFi through banks and other institutions that facilitate conversions between crypto assets and fiat currency. The board noted that these institutions may also face runs and failures, as did Silicon Valley Bank, Silvergate Bank and Signature Bank in March.
“Overall, at this stage, this report concludes that the connections between crypto assets and the traditional financial worlds remain extremely modest.”
In addition to a run on stablecoins, the board claimed that an increase in the prominence of crypto assets within the payment system could cause risk to be passed on to the TradFi world. The International Monetary Fund (IMF) has warned of similar risks around El Salvador, to which recommends abandon Bitcoin as legal tender.
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