According to new research conducted by the Hong Kong Monetary Authority (HKMA), the cryptocurrency industry is deeply intertwined with the traditional financial system, particularly stablecoins, pegged 1:1 to the value of reserve assets.
However, such interconnection has made the financial industry more vulnerable to the spillovers of the market volatility associated with virtual assets.
The research titled, AN ASSESSMENT OF THE VOLATILITY SPILLOVER FROM CRYPTO TO TRADITIONAL FINANCIAL ASSETS: THE ROLE OF ASSET-BACKED STABLECOINS, was published on November 21, following the fall of crypto exchange FTX and blockchain project Terra LUNA, which stirred negative impacts on the global financial market.
Stablecoin Disclosures Could Aid Regulation
In a 22-page document, the authorities believe that implementing effective regulatory oversight on stablecoins could mitigate its potential risks to the financial sector.
“The growing size of asset-backed stablecoins, together with their inherent risks, could make asset-backed stablecoins a potential magnifier of the volatility spillover from crypto to traditional financial assets,” reads the document.
To this effect, the HKMA researchers outlined two essential steps that regulators may consider while implementing adequate regulatory measures to control stablecoins, such as requiring standardized and regular disclosures by stablecoin issuers and other asset-backed digital assets.
Authorities believe having the virtual asset’s developers disclose their entire reserve holdings will help regulators assess and compare their liquidity conditions and potential liquidity mismatch risk.
“This could enable regulators to consider, in a more timely manner, taking appropriate measures to reduce the spillover risk in times of market disruption,” reads the document.
The second step involves improving the asset-backed stablecoins’ liquidity management, which could be achieved by “imposing strict restrictions on the composition of reserve assets and requiring well-defined redemption rights, which may also help reduce the spillover risk.”
The HKM researchers noted that implementing the steps above will require the international cooperation of financial market watchdogs due to the decentralized nature of digital assets.
Meanwhile, since the implosion of TerraUST and its sister token LUNA, now rebranded as LUNC, authorities and financial institutions worldwide have shown interest in bringing the industry under the federal government’s purview to protect consumers’ interest.
Earlier this year, the Bank of England (BoE) called for stringent regulation of digital assets due to the crypto winter to protect the financial market against impending risks the assets could pose to the financial system.
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