Stablecoin market capitalization has increased by 90% since late 2023, exceeding $230 billion. These digital tokens maintain a steady value by being backed by reserves.

While their increasing use in international transactions strengthens the US dollar’s position as the dominant global currency, critics warn that stablecoins could also introduce systemic risks reminiscent of past financial crises.

During market turmoil, stablecoin holders may rush to redeem their tokens for cash, forcing issuers to sell rapidly off their reserve assets. This could create instability in financial markets.

The same happened in 2008. Then, the Reserve Primary Fund, a major money-market fund (MMF), broke its dollar peg due to exposure to Lehman Brothers’ collapsed debt. That event triggered widespread panic and a broader run on MMFs, disrupting the global financial system.

According to Federal Reserve Governor Lisa D. Cook, the same risks could apply to stablecoins.

“If a run on a large stablecoin were to occur, liquidation of the assets backing the stablecoin could be disruptive, especially if those assets were linked to other funding markets,” she said at a recent financial conference.

Lawmakers are now pushing to regulate stablecoins through legislative efforts like the GENIUS Act and the STABLE Act. These bills aim to integrate stablecoins into the financial system. Issuers must be licensed and back their tokens with approved assets such as cash, US Treasury bills, and MMFs to do this.

However, critics argue that the GENIUS Act lacks key safeguards to prevent financial instability. Senator Elizabeth Warren has been particularly vocal, warning that the bill would allow stablecoin issuers to invest in risky assets.

“Under this bill, stablecoin issuers can invest in the very assets that were bailed out in 2008. Anyone who thinks the US taxpayer won’t be called on to bail these guys out is kidding themselves,” Bloomberg reported, citing Warren’s speech during a recent Senate hearing.

While the risks are clear, stablecoins have also been instrumental in reinforcing the US dollar’s dominance. Significant global stablecoin transactions occur in dollar-backed tokens like Tether (USDT) and USD Coin (USDC).

This widespread adoption enhances the dollar’s role in international trade, increasing demand for US assets. China, however, has expressed concerns that the US’s growing influence in digital currencies could undermine its financial sovereignty.

“Once the US dollar stablecoin links the international credit of the US dollar with the application scenarios of the virtual world more closely, it may greatly consolidate the hegemony of the US dollar,” said Zhang Ming, a Chinese economist.

Against this backdrop, Beijing has accelerated its development of the digital yuan. This is intended to reduce dependence on dollar-based stablecoins in cross-border transactions. The European Union shares the same sentiment.

The stablecoin industry is also facing disruption from traditional financial institutions. Major banks, including Bank of America, are reportedly exploring their stablecoin offerings. This follows recent regulatory developments that allow US banks to provide crypto and stablecoin services.

This new competition could erode the market dominance of private issuers like Tether and Circle. However, it could also integrate stablecoins more deeply into the mainstream financial system.

As stablecoins expand, their impact on the financial system grows more significant. On the one hand, they offer benefits such as increased payment efficiency and cross-border transactions. On the other hand, their potential to trigger financial instability cannot be ignored.

Policymakers and financial institutions must tread carefully, ensuring regulatory frameworks promote innovation while mitigating risks.

The lessons of 2008 are a stark reminder that even seemingly stable financial instruments can unravel with alarming speed.

The post Why Stablecoins Could Trigger a “Bank Run” Akin to 2008 Financial Crisis appeared first on BeInCrypto.

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