Hong Kong Fears Stablecoin Volatility Spills Over Into Traditional Finance

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• The regulator of the Chinese autonomous territory believes that the financial system is exposed to crises in the crypto ecosystem.
• The interconnection of cryptocurrencies and banks has increased the vulnerability of the crypto ecosystem to systemic crises.
• HKMA recommends regulators strengthen the liquidity management of stablecoins.

The Hong Kong Central Bank considers that the current volatility of stablecoins could eventually affect the financial system. This is due to the interconnection of cryptocurrencies with fiat 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 fiat-backed stablecoins.

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

Liquidity mismatch risks

The Hong Kong regulator determined that there are liquidity mismatch risks in fiat-backed stablecoins. This could negatively impact their stability when “forced-sale” events occur.

This type of event is related to momentary fluctuations in the price of cryptocurrencies when investors purchase these digital assets for less than the market price. Such action was observed with the fall of Terra USD.

The Hong Kong issuer points out that the interconnectedness of cryptocurrencies has increased the vulnerability of the crypto ecosystem to systemic crises. On the other hand, financial institutions are now also more exposed to cryptocurrency crises due to greater exposure to this type of asset.

Asset-backed stablecoins could amplify their inherent volatility and risks towards the traditional financial system as their size increases, the central bank noted.

According to HKMA, fluctuations in the price of stablecoins could trigger a reserve adjustment of these digital assets. This is based on the assumption that the demand and supply of stablecoins generate strong volatility in their price.

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

The other recommendation is that regulators strengthen the liquidity management of stablecoins, establishing certain restrictions related to the composition of reserve assets.

On the Flipside

• The Chinese government banned cryptocurrency trading in 2019. It later launched a crackdown to prevent its circulation in September 2021.
• Cryptocurrencies are generally considered a rival to the digital yuan. The Chinese CBDC is already in its final tests.

Why You Should Care

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

You can read other articles related to the regulatory issue at the following links:

Hong Kong Released Crypto-Asset Regulatory Plan

Hong Kong Commences Public Consultation on Retail Access to Cryptocurrencies

See original on DailyCoin