Hong Kong believes stablecoin volatility may spill over to traditional finance

According to the Hong Kong Central Bank, the interconnectedness of crypto assets has made the crypto ecosystem more vulnerable to systematic shocks.

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The fall of crypto giants this year has rekindled 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 instabilities in crypto assets, including asset-backed stablecoins, can potentially ripple through the traditional financial system.

The HKMA's assessment on asset-backed stablecoins highlighted the risks of liquidity mismatches, which negatively impact their stability during "fire selling" events. A fire sell event is related to a momentary price fluctuation when investors can buy stablecoins cheaper than their market price - a phenomenon seen during the Terra crash.

According to the Hong Kong Central Bank, the interconnectedness of crypto assets has made the crypto ecosystem more vulnerable to systematic shocks. In addition, financial institutions' increased crypto exposure may be subject to ripple effects due to sharp cryptocurrency price movements:

“The growing size of asset-backed stablecoins, along with their inherent risks, could make asset-backed stablecoins a potential amplifier for the spread of volatility from crypto to traditional financial assets.”

The flowchart shared by HKMA suggests that fluctuations in the price of asset-backed stablecoins could cause stablecoins to adjust reserves. This is primarily driven by the assumption that the demand and supply of stablecoins can trigger volatility in their price.

Illustration of Tether's transaction mechanism and the overflow channel from crypto to traditional financial assets. Source: HKMA

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