Concerns that stablecoin surge from Hong Kong will spread to traditional finance

The collapse of crypto giants in 2022 has rekindled concerns about the stability of cryptocurrencies and their impact on fiat ecosystems. The Hong Kong Monetary Authority (HKMA) assessed the situation and found that instabilities in crypto assets, including asset-backed stablecoins, could potentially spill over into its traditional financial system.

HKMA’s assessment of Asset-backed stablecoins pointed to the risks of liquidity mismatch. According to the evaluation, the events of being sold for nothing adversely affected the assets. The sell-off event is about a momentary price volatility where investors can buy stablecoins at less than the market price. This event occurred especially during the Terra (LUNA) disaster.

According to the Hong Kong Central Bank, the interconnection of crypto assets has made the crypto ecosystem even more vulnerable to systematic shocks. In addition, the increase in investments in crypto assets indirectly by financial institutions may be subject to negative effects caused by sudden developments in crypto currency prices.

The Central Bank of Hong Kong made the following statements on the subject:

“The rise in asset-backed stablecoins comes with risks, making asset-backed stablecoins a potential risk from the volatility spilling over from crypto to traditional financial assets.”

The flow chart shared by the HKMA suggests that fluctuations in the price of asset-backed stablecoins can cause stablecoins to adjust for reserves. This stems from the assumption that the supply and demand of stablecoins can trigger volatility in their prices.

Concerns that stablecoin surge from Hong Kong will spread to traditional finance
Tether’s transaction mechanism and its spread from crypto to traditional financial assets. Source: HKMA

This work also commemorates the collapse of Terra USD (UST), the algorithmic stablecoin by Terraform Labs. However, the HKMA recommended regularization of regular disclosures that could help regulators examine liquidity conditions and risks.

The second recommendation of the HKMA to regulators was to strengthen the liquidity management of asset-backed stablecoins through restrictions on reserve assets.

The Hong Kong Securities and Futures Commission also recommended that management companies wishing to submit exchange-traded fund (ETF) offerings must have a good track record in regulatory compliance, among other requirements.

Finally, the SFC circular came as part of a policy update announcing Hong Kong’s readiness to work with global crypto exchanges on regulatory matters.

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