Hong Kong fears that stablecoin volatility seeps into traditional finance

The Central Bank of Hong Kong considers that the current fluctuations in stablecoins could eventually affect the financial system. This is due to the interdependence between cryptocurrencies and monetary ecosystems and their vulnerability to systemic crises.

A study by the Hong Kong Monetary Authority (HKMA) found that instability in the crypto-asset market could spill over into traditional finance. This includes stablecoins backed by fiat currencies.

The collapse of large cryptocurrency trading companies, investment funds and various digital assets has raised concerns in regulators about the impact of cryptocurrency volatility on the global financial system.

The Hong Kong regulator has determined that there is a risk of liquidity mismatch in fiat-backed stablecoins. This may negatively affect its stability when “forced sale” events occur.

This type of event is associated with intraday fluctuations in cryptocurrency prices when investors buy these digital assets below the market price. Such action was observed with the fall of Terra USD.

The Hong Kong issuer notes that the interdependence of cryptocurrencies has increased the vulnerability of the cryptocurrency ecosystem to systemic crises. On the other hand, financial institutions are now more vulnerable to cryptocurrency crises due to the increased exposure to this type of asset.

The central bank noted that asset-backed stablecoins can magnify their inherent volatility and risk to the traditional financial system while increasing their size.

According to HKMA, fluctuations in the prices of stablecoins can cause these digital assets to have a reserve adjustment. This is based on the assumption that demand and supply for stablecoins generate strong fluctuations in their prices.

One of HKMA’s recommendations mentioned in the study is to provide regular disclosures that help regulators assess stablecoin liquidity conditions and risks.

Another recommendation is for regulators to strengthen the liquidity management of stablecoins, and to set certain restrictions regarding the composition of reserve assets.

The Hong Kong government recently announced its intention and willingness to participate in the discussion of global regulatory issues related to cryptocurrency trading.

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