The fall of the crypto giants this year has reignited questions about the stability of cryptocurrencies and their impact on fiat ecosystems. The Hong Kong Monetary Authority (HKMA) has assessed the situation and found that the volatility of crypto-assets, including asset-backed stablecoins, can potentially spill over into the mainstream financial system.
HKMA Assessment on asset-backed stablecoins pointed out the risks of liquidity mismatch, which negatively affects their stability during fire-sale events. A sell-off event refers to a momentary price fluctuation where investors can buy stablecoins cheaper than their market price — a phenomenon noted during Terra (MOON) crash.
According to the Central Bank of Hong Kong, the interconnection of cryptoassets has made the cryptoecosystem more vulnerable to systematic shocks. In addition, the increase in exposure to cryptocurrencies by financial institutions may be subject to the negative effects of sudden developments in cryptocurrency prices:
“The growing size of asset-backed stablecoins, along with their inherent risks, could make asset-backed stablecoins a potential lever for volatility spillovers from crypto to traditional financial assets.”
A flowchart shared by the HKMA suggests that fluctuations in the price of asset-backed stablecoins could lead to a reserve adjustment by stablecoins. The reason is primarily the assumption that the demand and supply of stablecoins can cause volatility in their price.
The study also recalled the fall of Terra USD (UST), the algorithmic stablecoin issued by Terraform Labs, which caused a mass buyout of Tether (USDT). In this light, the HKMA recommended standardizing regular disclosures that can help regulators monitor liquidity and risk conditions.
The second recommendation for regulators is to strengthen the liquidity management of asset-backed stablecoins by limiting the composition of reserve assets.
Hong Kong’s Securities and Futures Commission has advised management companies looking to offer exchange-traded funds (ETFs) to, among other things, “have a good record of compliance”.
HKEX welcomes today’s announcement by the SFC to allow the listing of ETFs with virtual assets as their underlying. This will support continued growth #Hong Kong as the Asian Prime Minister #ETF marketplace, further strengthening Hong Kong’s role as an international financial center. pic.twitter.com/zLRgAUV6iX
— HKEX Hong Kong Exchange (@HKEXGroup) 31 October 2022
The SFC circular came as part of a policy update from the Hong Kong government, which has announced its readiness to engage with global crypto exchanges on regulatory issues.