NY Fed Report Highlights Potential Risks Of Digital Assets To Financial Stability

According to Odaily, the New York Federal Reserve recently released a report examining the impact of digital assets on financial stability. The report concludes that, due to the limited size of the industry, the risks have been minimal so far. However, it warns that if the industry grows significantly, it could pose risks to the broader financial system. The report identifies several risks previously outlined in earlier reports, with some nuanced differences. The report highlights the significant boom and bust cycles experienced by digital assets, with various factors exacerbating price volatility. Among these factors are funding risks or the risk of runs. A range of digital asset participants, including centralized exchanges (CEX), cryptocurrency lending institutions, stablecoins, and even decentralized finance (DeFi) protocols, have faced such runs. Additionally, the industry employs high leverage, which amplifies other risks, and the crypto ecosystem is highly interconnected. The report notes that the lack of a robust and cohesive regulatory environment exacerbates these vulnerabilities, particularly because many cryptocurrency entities are based overseas or lack clear legal status, such as decentralized autonomous organizations (DAOs). While the focus of the assessment is on financial stability, the New York Fed does not extensively address the threat of stablecoins to monetary singularity. Instead, it emphasizes the interconnectedness of stablecoins within the crypto ecosystem and the mainstream economy. The report states, "They seem to not only exacerbate the instability of the digital ecosystem but also introduce systemic risks." The report suggests that if stablecoins have poor asset liquidity or longer maturities, maturity transformation could occur. It acknowledges that the asset quality of major stablecoins has improved over time. However, Tether still has 15% of its assets considered relatively risky. The ease of switching between stablecoins could amplify the risk of stablecoin runs. Decentralized stablecoins, such as DAI (now USDS), are deemed riskier because DAOs take longer to respond. Regarding interconnectedness, stablecoins are used in lending protocols, so a run on stablecoins could lead to users withdrawing loans, causing borrowing rates to spike. The report also points out that if large stablecoins suddenly liquidate a significant amount of U.S. Treasury securities, it could impact mainstream financial markets.