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Preventing a Stablecoin Liquidity Crisis

There is no sound argument for applying lender-of-last-resort protection to privately issued cryptocurrencies. But regulators can prevent the all-too-predictable liquidity squeeze caused by a run on stablecoins – including by regulating them out of existence if necessary.

LONDON – Liquidity is to the modern economy what lubricant is to a car engine. Provide enough of it, and things run smoothly; come up short, and the result is a red-hot, smoke-spewing mess. But whereas lubricating oil is easy to gauge, financial liquidity is here today and gone tomorrow. A financial crisis is always around the corner, and the next one could result from the rapid rise of cryptocurrencies – and especially so-called stablecoins.

A financial crisis is another name for the sudden drying up of liquidity. Before the 2008 global financial meltdown, private financial institutions were busy creating it, slicing and dicing low-quality mortgages and combining them into financial assets that were liquid and attractive to hold – until one day they weren’t. Panic-gripped financial players suddenly began dumping everything in their portfolios, including apparently ultra-safe money-market funds that “broke the buck,” a phenomenon equivalent to bank depositors being unable to withdraw their funds in full.

There was another run on money-market funds in early 2020, as panic over COVID-19 spread. Even US Treasuries have recently been subject to runs. The infamous 2013 “taper tantrum,” and the short-lived but intense repo-market tremors of September 2019 and March 2020, all involved spikes in Treasury yields. In March and April of this year, bond prices again swung wildly as markets digested the implications of the most recent US stimulus package.

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