The Terra Crash Underlines The Threat That Stablecoins Pose To Financial Stability.

According to a new ECB study, stablecoins are unsuitable as a medium of payment and their current form is unfit for usage in the actual economy.

The European Central Bank (ECB) has issued a report that examines the rise of the cryptocurrency market over the last decade as well as the risks it poses to the existing financial system.

A section of the paper devoted to stablecoins emphasized their critical role in the present ecosystem. Stablecoins are rapidly being utilized to connect different blockchain networks and serve an important role in providing liquidity to the decentralized finance (DeFi) ecosystem.

The report went on to examine whether these stablecoins could find a place in the traditional financial system, but concluded that a lack of regulatory oversight, combined with the recent failure of algorithmic stablecoin ecosystems such as Terra, indicates the financial system’s vulnerability to such stablecoins. According to an excerpt from the report:

“The largest stablecoins serve a critical function for crypto-asset markets’ liquidity, this could have wide-ranging implications for crypto-asset markets if there is a run-on or failure of one of the largest stablecoins.”

Not just algorithmic stablecoins were affected by the May crypto market fall; centralized stablecoin Tether (USDT) lost its peg for a while and saw around 10% outflows.

The ECB also dismissed the idea of utilizing stablecoins as a form of payment, noting that the speed, cost, and redemption terms and conditions had proven “inadequate for use in real economy payments.”

The ECB urged suitable supervisory and regulatory steps to ensure that cryptocurrency do not jeopardize European financial stability. The report does note, however, that stablecoin penetration in the region is limited because European payment service providers have not been very active in stablecoin marketplaces.

The European Union recently adopted the Markets in Crypto-Assets (MiCa) framework, which provides guidance for crypto asset service providers (CASPs) operating in Europe. The draft agreement covers guidelines for issuers of unbacked crypto assets, stablecoins, trading platforms, and crypto-wallets.

The ECB intends to limit stablecoin supply to e-money institutions and credit institutions in order to prevent investors from losing billions of dollars in a Terra-like scenario.

DISCLAIMER: The Information on this website is provided as general market commentary and does not constitute investment advice. We encourage you to do your own research before investing.

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