Cryptocurrency, particularly in the form of stablecoins and other crypto-assets, increasingly interacts with the global financial system, raising concerns about potential systemic risks to global finance. Systemic risk refers to the possibility that the failure or distress of one financial institution or market segment could trigger widespread instability or collapse across the entire financial system. Whether cryptocurrencies pose such a risk depends on several factors including their scale, interconnectedness with traditional finance, regulatory environment, and the nature of the crypto-assets themselves.
Stablecoins, which are digital assets pegged to traditional currencies like the US dollar, have grown rapidly in market capitalization, more than doubling since mid-2023. This growth is partly driven by policies encouraging the adoption of US dollar-denominated stablecoins. Stablecoins are increasingly intertwined with traditional finance because the reserves backing their value are often held in commercial banks. This creates a channel through which problems in the stablecoin market could spill over into the banking sector and vice versa. The European Systemic Risk Board (ESRB) has expressed concern about stablecoins issued jointly by entities inside and outside the European Union, emphasizing the need for high-quality, liquid reserve assets to back these coins to mitigate risks[1].
The Financial Stability Board (FSB), an international body coordinating financial regulation, has highlighted that crypto-assets and stablecoins could threaten global financial stability if they grow large enough and become deeply interconnected with traditional financial institutions. The crypto ecosystem is complex and evolving, with segments such as unbacked crypto-assets (like Bitcoin), stablecoins, and decentralized finance (DeFi) platforms all interrelated. This complexity makes it necessary to assess risks holistically. The FSB has developed a comprehensive regulatory framework aimed at addressing these risks, focusing on regulation, supervision, and oversight of crypto-assets and global stablecoin arrangements. Despite progress, significant gaps and inconsistencies remain in implementation across jurisdictions, which could allow regulatory arbitrage and complicate oversight[2][4].
One of the key vulnerabilities of stablecoins is their uninsured nature and the risk of investor runs. Unlike traditional bank deposits, stablecoins often lack formal insurance or guarantees, making them susceptible to rapid withdrawals if confidence falters. The stablecoin market is highly concentrated, with two major players, Tether’s USDT and Circle’s USDC, accounting for over 80% of the $300 billion market capitalization. Most stablecoin transactions are linked to speculative crypto trading rather than conventional payments. Moreover, stablecoins have been used extensively for illicit activities, including money laundering, ransomware payments, tax evasion, and transactions by sanctioned regimes and terrorist groups. This illicit use raises additional regulatory and financial stability concerns[3].
Stablecoins also have some legitimate uses, especially in developing countries with unstable currencies and unreliable banking systems. In these contexts, dollar-linked stablecoins can provide a more stable currency alternative, a secure payment method, and a hedge against inflation. However, their use in these economies is still limited, and some governments view stablecoins as a threat to monetary sovereignty, considering restrictions or bans[3].
The ESRB has warned that in times of crisis, central banks might be forced to intervene to support banks involved with stablecoins or even the stablecoins themselves to prevent broader financial instability. This potential for central bank intervention underscores the growing integration of crypto-assets with the traditional financial system and the systemic risks that could arise from this link[5].
In addition to stablecoins, other crypto-asset investment products are becoming more accessible to both institutional and retail investors, further integrating the crypto sector into mainstream finance. This growing integration increases the potential for shocks in the crypto market to affect traditional financial markets, especially if crypto-assets are held widely by financial institutions or used as collateral in lending and trading activities[1].
Regulatory challenges remain significant. The global nature of crypto-assets and their rapid evolution make consistent regulation difficult. Different countries are at varying stages of implementing regulatory frameworks, leading to gaps and inconsistencies that could be exploited. The FSB and other international organizations continue to work on improving coordination and closing these gaps to reduce systemic risks[2][4].
Beyond financial stability, crypto-assets raise broader policy issues such as consumer and investor protection, market integrity, anti-money laundering, combating the financing of terrorism, tax evasion prevention, and avoiding circumvention of capital controls. These issues, while not the primary focus of financial stability bodies, are critical to the overall safe functioning of crypto markets and indirectly affect systemic risk[2].
In summary, cryptocurrency, especially stablecoins, poses systemic risks to global finance primarily through their growing scale, concentration, and increasing interconnectedness with traditional financial institutions. The uninsured nature of many crypto-assets, their use in illicit activities, and regulatory gaps exacerbate these risks. However, ongoing international regulatory efforts aim to mitigate these risks by improving oversight, ensuring high-quality reserve backing for stablecoins, and enhancing cross-border cooperation. The situation remains dynamic, requiring continuous monitoring and adaptation of regulatory frameworks to prevent crypto-assets from becoming a source of systemic financial instability.