US Federal Reserve says stablecoins are risky as UST goes down

The Federal Reserve has released its latest Financial Stability report, with stablecoins coming under fire. The Fed stated that stablecoins were “prone to runs” amid a host of other risks that it identified in the 86-page report.

“Some types of money market funds (MMFs) and stablecoins remain prone to runs. Funding risks at domestic banks are low, but structural vulnerabilities persist at some money market funds, bond funds, and stablecoins,” reads the report.

The Federal Reserve noted the growth recorded by stablecoins as their market capitalization exceeded $180 billion by the start of March. The report identified that they are “backed by assets that may lose value or become illiquid during stress” and added that the vulnerabilities are amplified by a lack of transparency and the increasing usage to meet margin requirements.

The over-concentration of the stablecoin markets was also highlighted as a risk, with the trio of Tether (USDT), USD Coin (USDC), and Binance USD (BUSD) controlling over 80% of the market share. 

TerraUSD buckles under the pressure

The timing of the Federal Reserve’s report coincided with TerraUSD (UST) losing its peg to the U.S. dollar. UST fell as low as $0.30 as it lost more than two-thirds of its value, sending investors into panic mode.

“Every professional investor in crypto has one eye on UST today, watching to see if it can maintain its peg to the dollar,” said Matt Hougan, the chief investment officer at Bitwise Asset Management. Hougan added that “there is significant risk in the market.”

The reason for the decline of Terra’s stablecoin has been suggested as being deliberate and coordinated. 

“Massive 285m UST dump on Curve and Binance by a single player followed by massive shorts on Luna and hundreds of Twitter posts,” said Caetano Manfrini, Legal Officer at GEMMA. Pure staging. “The project is bothering someone.”

The Luna Foundation Guard (LFG) noted that the recent happenings related to UST are linked to the wider Bitcoin sell-off that led to liquidations running into billions of dollars. It assured investors that it will “proactively defend the stability of $UST peg & broader Terra economy, especially under volatility and the uncertainty of macro conditions in legacy markets.”

3/ Per the LFG’s mandate, the LFG will proactively defend the stability of the $UST peg & broader Terra economy, especially under volatility and the uncertainty of macro conditions in legacy markets.

— LFG | Luna Foundation Guard (@LFG_org) May 9, 2022

To protect the peg, the LFG has authorized the loan of $750 million worth of BTC to OTC firms and to loan 750 million UST to “accumulate BTC as market conditions normalize.”

4/ As a result, the LFG Council has voted to execute the following:

– Loan $750M worth of BTC to OTC trading firms to help protect the UST peg.

– Loan 750M UST to accumulate BTC as market conditions normalize.

— LFG | Luna Foundation Guard (@LFG_org) May 9, 2022

UST is an algorithmic stablecoin that maintains its peg to the U.S. dollar. UST is minted by destroying LUNA while using an arbitrage mechanism is an added functionality to help maintain the peg. The LFG grabbed headlines when it went on a Bitcoin accumulation spree that saw it add over 80,000 BTC to prop up the collateral reserves of UST.

Watch: CoinGeek New York panel, Tokenized Assets, Stablecoins and Custody with BSV