Moody warns of stablecoin adoption risk

In its latest report, Moody’s Investors Service has warned that the recent instability in the traditional banking sector could have a negative impact on the adoption of stablecoins. The credit rating agency has highlighted the risks that fiat-backed stablecoins like USDC face, stating that the reliance of stablecoin issuers on a small set of off-chain financial institutions limits their stability. The depegging of USDC on March 10, which was caused by the sudden collapse of Silicon Valley Bank, has highlighted this risk.

Circle Internet Financial, the issuer of USDC, had $3.3 billion in assets tied up in the bank, and over the span of three days, the company cleared roughly $3 billion in USDC redemptions as the value of its stablecoin plunged to a low of around $0.87. However, USDC quickly regained its peg after the Federal Deposit Insurance Corporation announced that it would backstop all deposits held at Silicon Valley Bank.

Moody’s analysts believe that regulators are likely to pursue more stringent oversight of the stablecoin sector moving forward, given the recent market volatility and the potential risks associated with stablecoins. The credit rating agency has also warned that if USDC had not regained its peg, it could have suffered from a run and been forced to liquidate its assets. Such a scenario could have caused more runs on banks holding Circle's assets, which could have led to the depegging of other stablecoins.

Despite the collapse of Terra, which led to calls for the regulation of stablecoins, Moody’s believes that fiat-backed stablecoins like USDC operate differently from algorithmic tokens and are less likely to fail. Nevertheless, the credit rating agency warns that stablecoin issuers must take steps to reduce their reliance on a small set of off-chain financial institutions to improve their stability.

In conclusion, the recent instability in the traditional banking sector and the depegging of USDC have highlighted the potential risks associated with stablecoins. While Moody’s believes that fiat-backed stablecoins are less likely to fail than algorithmic tokens, the credit rating agency warns that stablecoin issuers must take steps to reduce their reliance on a small set of off-chain financial institutions. With regulators likely to pursue more stringent oversight of the stablecoin sector moving forward, stablecoin adoption could be negatively impacted.