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The downturn of large firms in the crypto space has sparked numerous questions concerning the stability of cryptocurrencies and their effects on the fiat ecosystem. The Hong Kong Monetary Authority (HKMA) analyzed the situation and found that the volatility of crypto assets (particularly stablecoins) can affect the traditional financial system.

Regarding stablecoins, the HKMA noted the numerous risks involved in liquidity mismatch that’s spurring negative impacts on the stability of these coins during fire-sale events.

For perspective, the fire sale event is a short price shift that allows investors to purchase stablecoins at a much cheaper rate than the actual market price. This event was one of the reasons that led to the Terra (LUNA) collapse.

Hong Kong’s central bank remarked that the interlink among digital assets could make the crypto ecosystem more susceptible to systemic shock. Additionally, sudden disruptions in cryptos’ prices can affect financial institutions as more of them become exposed to the digital asset space.

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Part of HKMA’s research notes reads, “the inherent risks in stablecoins could be the primary reason the volatility in crypto would affect the traditional financial assets.”

Price Volatility Effects Of Stablecoins 

According to the flowchart shared by HKMA, the volatility in the price of stablecoins could make it necessary to adjust stablecoin reserves. This can happen because the supply and demand for these stablecoins can ignite price fluctuations.

A study on the crash of the Terra USD (UST) further confirmed this information. The TerraUSD was an algorithmic stablecoin issued by Terraform Labs, which can be redeemed for Tether-issued USDT stablecoin.

Hence, the HKMA recommended that consistent regulatory disclosures would be helpful to regulators when inspecting liquidity conditions and risk factors of crypto firms. The central bank also advised regulators to strengthen the stablecoins’ liquidity management by establishing restrictions on the structure of reserved assets.

Meanwhile, Hong Kong’s financial watchdog instructs all asset managers aiming to start offering exchange-traded funds (ETF) to have a track record of compliance with regulatory policies. It claimed that this is the first step before having other requirements.

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George Ward

By George Ward

George Ward is a crypto journalist and market analyst at Herald Sheets, known for his engaging articles on the latest digital currency trends. With a background in finance and journalism, he presents complex topics accessibly. George holds a degree in Business and Finance from the University of Cambridge.