European Central Bank: Stablecoins are not a "safe haven" from US monetary policy, posing real internal and external risks

The European Central Bank (ECB) questions the ability of stablecoins to provide investors with a hedge during market instability, citing their significant exposure to U.S. monetary policy. The ECB's latest study shows that stablecoins are vulnerable to impacts from within the cryptocurrency market and the broader financial system, particularly when there are changes in U.S. Federal Reserve decisions.

US Monetary Policy Poses Risks to Stablecoins

In this research report, the European Central Bank explores the complex relationship between US monetary policy, Money Market Funds (MMFs), and stablecoins. The analysis shows that US monetary policy, especially policies related to the US dollar, has become a crucial link between the crypto market and traditional financial markets, challenging the view that stablecoins can serve as a buffer against market volatility.

Stablecoins are often pegged to fiat currencies, with many stablecoins anchored to the US dollar to maintain a fixed price. However, the ECB's research indicates that changes in US monetary policy, such as interest rate adjustments, significantly impact the value of stablecoins. For instance, when the US government raises interest rates, it usually leads to a decrease in the market value of stablecoins.

How Does an Increase in Interest Rates Affect Stablecoins?

ECB research based on data from 2019 shows that an increase in US interest rates can cause a roughly 10% decrease in the market value of stablecoins within 12 weeks. In contrast, Money Market Funds (MMFs) experience inflows during this period, indicating that investors prefer low-risk options during interest rate hikes, reducing interest in speculative assets like stablecoins.

MMFs are known for their conservative nature, typically investing in short-term debt securities such as US Treasury bills. They are considered a safe investment option during monetary tightening, making them more attractive than stablecoins in times of market uncertainty.

Tightening Rates Will Reduce Demand for Stablecoins

The research report also emphasizes that a tightening monetary policy will decrease investors' demand for stablecoins.

As interest rates rise, the opportunity cost of holding assets that do not generate interest, such as stablecoins, increases. Therefore, investors tend to shift towards traditional assets that offer returns, like bonds or MMFs. This dynamic demonstrates that despite being part of the crypto market, stablecoins are closely interconnected with the broader financial ecosystem.

Crypto Markets Vulnerable to Shocks

In addition to the impact of monetary policy, the ECB also analyzed stablecoins' response to significant events in the crypto market. The study found that during "crypto shocks," such as sudden drops in Bitcoin's value due to events like Tesla ceasing Bitcoin payments, China's regulatory crackdown on cryptocurrencies, TerraUSD/LUNA's collapse, and unexpected bankruptcies of crypto exchanges like FTX, stablecoin market values typically experience a significant decline. On average, stablecoin market values drop by around 4% after such events.

These examples of shocks highlight the instability of the crypto market, where even seemingly stable assets like stablecoins are not immune to impacts.

Which Has a Greater Impact on Stablecoins: Monetary Policy or Crypto Events?

Ultimately, the ECB's research suggests that changes in US monetary policy have a larger impact on stablecoins than internal turmoil within the crypto market. For example, during the 2021 "crypto winter," the market value of stablecoins like Tether decreased significantly, but the extent of loss was less than that of non-US dollar-pegged cryptocurrencies like Bitcoin.

Interestingly, the study also notes that while stablecoins are influenced by events in the crypto market, traditional financial markets, including MMFs and US stock prices, are largely insulated from these fluctuations. The research found a lower correlation between major crypto events and movements in traditional financial assets, indicating a segregation between these two markets.

Study Focuses on US Policy, Not Global Central Banks

It is important to note that the ECB's analysis primarily focuses on the impact of US monetary policy on stablecoins and does not delve into the potential effects of policies from other major central banks. Therefore, the results of this study reflect the significance of US financial decisions in the dynamics of the stablecoin market. However, further research is needed to understand the effects of global monetary policies on these digital assets.