The stablecoin market has quickly expanded in recent years, becoming more intertwined with the traditional financial system. What does that mean for financial stability?

This was a key question researchers, regulators, and industry participants explored at the virtual Conference on the Financial Stability Implications of Stablecoins, which the Federal Reserve Banks of Boston and New York hosted Friday.

In different sessions, presenters discussed past investor “runs” on stablecoins and similarities between stablecoins and traditional financial products. They also shared high-level recommendations for the global regulation of stablecoins.

In welcoming remarks, Boston Fed President and CEO Susan M. Collins said stablecoins could be thought of as a form of “private money,” and central banks should be interested in them.

“Stablecoin issuers are not prudentially regulated or supervised,” she said. “This highlights the importance of policymakers and market participants understanding and considering (their) key features.”

How do stablecoin investors react to shocks in the crypto market?

In one of the first sessions, Pablo Azar – a financial research economist at the New York Fed – presented a working paper he co-authored with colleagues at the Boston Fed and in academia called “Runs and Flights to Safety: Are Stablecoins the New Money Market Funds?”

Stablecoins are digital assets designed to maintain a stable price – usually pegged to the U.S. dollar. Azar first described the different types of stablecoins, based on the collateral that backs them. Both money market funds and stablecoins aim to maintain price stability. But, unlike stablecoins, money market funds are regulated by the U.S. Securities and Exchange Commission.

“Stablecoins have grown very rapidly since 2020 … and they’re one of the few direct links between the crypto world and traditional finance,” Azar said. “We want to understand the financial stability risks.”

By using data about the daily prices of 12 stablecoins from Jan. 1, 2021 – March 15, 2023, Azar and his co-authors found that investors tend to redeem from the stablecoins they perceive as “risky” following negative shocks and flow toward less risky ones. This pattern is also consistent with investor behavior in money market funds during stressful periods, Azar said.

Q&A: Former SEC Division of Investment Management director shares views on stablecoins

Kenechukwu Anadu, a vice president in Supervision, Regulation & Credit at the Boston Fed, moderated a discussion with William Birdthistle, the former director of the Division of Investment Management at the U.S. Securities and Exchange Commission.

Birdthistle highlighted the investor protection concerns related to stablecoins, as seen after the collapse of the stablecoin Terra in May 2022.

In the worst runs on money market funds, investors lost a penny or two on the dollar, he said. But stablecoin prices can “fall to zero.”

If the stablecoin industry continues to grow, it may also pose risks to the financial system, he said. But he added that it’s very difficult to predict the extent to which these risks will materialize over the next 10 years.

Keynote address: Regulating stablecoins requires global cooperation

John Schindler, secretary-general of the Financial Stability Board, or FSB, presented the conference’s keynote address, “Stablecoins: Some Policy Considerations.” The FSB coordinates the work of the national financial authorities who set supervisory and regulatory policies in their own countries.

Schindler said FSB members are working on an international policy framework for regulating crypto assets. He discussed the FSB’s high-level recommendations to regulatory and supervisory authorities and stablecoin issuers to mitigate crypto asset stability risks.

“We want a global framework, so it has to be flexible … (and) therefore adaptable as this technology continues to develop,” he said.

Since crypto asset activity can easily move across national borders, Schindler stressed the importance of international cooperation and shared standards on regulation and oversight. Authorities should also ensure that stablecoin issuers comply with set rules and regulations before allowing them to operate within their country, he said. Finally, Schindler said stablecoin issuers should have a clearly-defined governance structure, as well as concrete frameworks for managing risks and data collection.

“These (recommendations) are ‘common sense,’ … but they’re not as commonplace in the stablecoins space … (and) in the crypto asset space as we would like,” he said.

Marco Cipriani, conference co-organizer and head of Money and Payments Studies at the New York Fed, concluded the conference by thanking the presenters and participants for joining the event.

“The study of digital assets and their impact on financial stability is a new branch of financial economics, which is likely to grow in prominence in the years ahead,” he said. “The Federal Reserve Banks of New York and Boston will continue to provide a venue for these discussions in the coming years.”

Papers and presentations shared during the conference

The conference included six paper presentations, a keynote address, and a discussion session. The titles of each paper and session are listed below and available on bostonfed.org:

• “Anatomy of a Run: The Terra Luna Crash,” presented by Igor Makarov (London School of Economics)
• “Runs and Flights to Safety: Are Stablecoins the New Money Market Mutual Funds?” presented by Pablo Azar (Federal Reserve Bank of New York)
• “Stablecoin Runs and the Centralization of Arbitrage,” presented by Yiming Ma (Columbia University)
• “Discussion with the Former Director of the Securities and Exchange Commission's Division of Investment Management,” moderated by Kenechukwu Anadu (Federal Reserve Bank of Boston)
• “Stablecoins: Some Policy Considerations,” presented by John Schindler (Financial Stability Board)
• “Stablecoins (Self)Regulation,” presented by Francesca Carapella (Federal Reserve Board)
• “Can Stablecoins Be Stable?” presented by Quentin Vandeweyer (University of Chicago)
• “Leverage and Stablecoin Pegs,” presented by Elizabeth Klee (Federal Reserve Board)