Last Updated on 45 mins by cryptoevent

While the cryptocurrency industry is seeing uncertainty amid crypto exchange FTX’s decline, the Hong Kong Monetary Authority (HKMA) believes that volatility in the digital asset space could also impact the traditional financial industry.

According to an assessment conducted by the HKMA, there are risks associated with liquidity in both cryptocurrencies and stablecoins such as Tether, which can negatively impact the stability of fiat currencies. This can happen during “fire sale” events, which refer to sudden price jumps when traders can buy tokens at a massive discount from their usual price. This was seen during the Terra token crash. According to HKMA:

“These stablecoins pose similar liquidity mismatch risks to money market funds, which exposes them to a fire sale of reserve assets during times of crypto ecosystem instability, and in turn can increase the volatility of those reserve assets.”

The Central Bank of Hong Kong pointed out that crypto assets linked to fiat currencies through stablecoins have made the fiat system more vulnerable to price jumps:

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

How to reduce the impact of stablecoin movements on fiat currency

The HKMA predicts that fluctuations in the price of stablecoins — an event that should not happen due to the nature of stablecoins — will result in reserve adjustments by stablecoins. This change in reserve collateral used to hedge the price of the digital asset may affect the price of the underlying currency.

To avoid this, HKMA suggests that introducing standardized disclosure will help regulators assess liquidity and risk in market price. The HKMA also recommends that regulators should seek to strengthen the stablecoin’s liquidity management with restrictions on how the reserve assets that drive the stablecoin’s price are used.

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