Given the increased rate of digitalization, blockchain technology and the Crypto sector have found more applications in the traditional finance sector. Cryptocurrencies have provided new digital payment systems, broader financial inclusion, and innovation. However, digital assets are highly volatile, posing a challenge to their use as stores of value and means of payment.

This volatility led to the introduction of stablecoins. These digital assets have gained more traction over the years due to faster remittance payments. But stablecoins have also proven volatile during extreme market conditions.

A report disclosed that the Hong Kong Central Bank is concerned that stablecoins and digital assets may negatively impact the fiat currency system.

The Hong Kong Monetary Authority (HKMA) assessed the situation. In their findings, they observed that the instabilities of digital assets and asset-backed stablecoins could spill over to the traditional finance system.

Details Of HKMA’s Assessment

The asset-backed stablecoins assessment highlighted the risk of liquidity mismatch, which affects their stability during sell-out (fire-sale) events. A fire sale event is a time of monetary price fluctuation when investors can buy stablecoins lower than the market price.

According to the Central bank of Hong Kong, the correlation of crypto assets has rendered the crypto industry susceptible to systematic shocks. In addition, the increased exposure of financial institutions to crypto may cause them to be prone to shut-down effects from sudden changes in cryptocurrency prices.

The HKMA explained further with a flowchart, showing the spillover effects of crypto on traditional finance assets. The flowchart suggests that the price fluctuations of asset-backed stablecoins could trigger reverse adjustments on stablecoins. The hypothesis steers the adjustment that the demand and supply of stablecoins can cause price volatility.

A Flowchart illustrates the transaction mechanism of Tether stablecoin and the spillover channel from crypto to traditional financial assets.

The HKMA studied the collapse of USD Terra (USDT), which caused a massive price decline in Tether stablecoin. The Hong Kong bank suggested the institutionalization of regular financial disclosures to enable regulators to keep tabs on the liquidity conditions of crypto firms.

The HKMA also recommended that regulators reinforce the asset-backed stablecoins’ liquidity management by placing restrictions on the Composition of reserve assets.

Hong Kong Welcomes Crypto ETF Offerings

Meanwhile, the Securities and Futures Commission (SFC) of Hong Kong gave comments that support the HKMA’s recommendations. The commission advised that management companies that want to offer exchange-traded fund (ETFs) offerings should have a good track record of regulatory compliance.

In a new update, the HKEX Group released a tweet welcoming the SFC’s announcement as permission to list ETFs with virtual assets. The exchange stated that the information would facilitate the growth of Hong Kong as Asia’s leading ETF marketplace.

The Hong Kong-based exchange remarked that listing ETFs would strengthen Hong Kong’s role as an international finance center.

Featured image from Pixabay, chart from TradingView.com