The European Systemic Risk Board (ESRB) published a report on Thursday outlining the top 3 nightmare scenarios in which a crypto industry crisis could bleed in and pose “systemic risk” to the broader financial system.
The top risk listed is a potential run on a “large reserve-backed stablecoin,” such as Tether (USDT) or USD Coin (USDC).
Crypto’s Connection to TradFi
In its 77-page report, the ESRB argued that as the volatile crypto industry grows, so too does its connection to the mainstream financial world.
The board doesn’t believe this interconnectedness poses any sort of “systemic risk” to “fundamental services” in the immediate future, noting “only sporadic correlation between the booms and busts of crypto-assets and traditional finance.”
That said, there are a variety of ways that this risk can manifest down the line. These include a failure to identify how forms of interconnectedness develop, and further adoption of crypto technologies within traditional finance itself.
Right now, one of the main connections between crypto and TradFi are reserve backed stablecoins. These are crypto-assets that remain price pegged to a relatively price-stable, non-crypto asset like fiat currency or gold, and are backed by reserves containing those assets.
“A run on a reserve-backed stablecoin would generate forced selling of marketable debt and withdrawals from banks,” wrote the ESRB. “There is always the possibility that this could turn into a broader panic.”
Stablecoin panic is nothing new to the crypto industry. In May 2022, Tether suffered withdrawal pressure within the billions of dollars in May 2022, but still managed to keep its peg to the dollar. USDC depegged for multiple days in March 2023 after the collapse of Silicon Valley Bank, which held much of the reserves backing the coin, prompting many holders to flee into USDT.
Crypto is also connected to TradFi through banks and other institutions that facilitate conversions between crypto assets and fiat currency. The board noted that these institutions can also face runs and fail – much like Silicon Valley Bank, Silvergate bank, and Signature Bank in March.
“Overall, at this stage, this report concludes that the connections between the crypto-asset and traditional financial worlds remain extremely modest.”
Aside from a stablecoin run, the board claimed that a rise of prominence in crypto assets within the payment system could cause risk to transmit into the TradFi world. The International Monetary Fund (IMF) has warned of similar risks surrounding El Salvador, to which it recommends abandoning Bitcoin as legal tender.
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