Stablecoins have long been marketed as a “safe haven” from market turbulence.
While they are perfect for this role and can maintain their pegs during market uncertainty, the European Central Bank challenges this idea.
According to the ECB, stablecoins are highly vulnerable to the effects of U.S. monetary policy.
When the US raises interest rates, the total stablecoin market cap drops by an average of 10% over the next 12 weeks.
Stablecoins also see an average drop of around 4% during crypto market shocks like the Terra and FTX collapse.
One of the biggest marketing points for stablecoins is that they are a safe haven asset for investors during market turbulence.
As their name implies, stablecoins maintain their pegs to an underlying currency or fiat (usually the US dollar).
This means that during market crashes (or rallies) they maintain the $1 price tag.
In essence, they are the perfect asset for hedging against the crypto market’s volatility—but are they though?
A recent working paper from the European Central Bank (ECB) has challenged this belief.
The Bank’s findings show that stablecoins are highly vulnerable to the ripple effects of U.S. monetary policy.
Here’s why the stablecoin market might not be as “stable” as previously thought.
The ECB’s study explored the relationship between U.S. monetary policy, money market funds (MMFs) and stablecoins.
Its findings showed that monetary policy (especially concerning the U.S. dollar) is the central hub between the crypto market and traditional financial systems.
Put simply, the European Central Bank believes that stablecoins might be immune to crypto market fluctuations. However, they are not immune to shifts in the broader financial environment.
One of the report’s key findings was that stablecoins react strongly to changes in U.S. interest rates.
For example, the ECB observed that since 2019 when the U.S. government raised interest rates, stablecoin market caps dropped by approximately 10% over the following 12 weeks.
At the same time, traditional financial products (like money market funds) saw a large influx of capital.
This typically happens as investors seek safer, interest-bearing alternatives.
The rise in interest rates
For example, data from TradingEconomics shows that the US raised interest rates steadily between October 2022 and July 2023 as illustrated above.
Total stablecoin market cap
DefiLlama data also shows that within this timeframe, the total stablecoin market cap declined steadily from above $150 billion to around $120 billion.
The report also shows that money market funds are often seen as one of the safest places to store capital.
Keep in mind that money market funds simply invest in short-term debt securities like U.S. Treasury bills.
The bank’s findings also show that as U.S. monetary policy tightens, these conservative financial instruments attract more investment.
On the flip side, demand for stablecoins falls.
So why this shift in interest?
Said report shows that the shift happens because higher interest rates make it less attractive to hold non-interest-bearing assets like stablecoins.
Investors simply prefer to seek out traditional products that offer steady returns as interest rates rise.
In other words, when interest rates rise, the opportunity cost of holding stablecoins follows.
This pushes investors towards “safer” and more regulated options.
While U.S. monetary policy plays a major role in influencing stablecoins, other events within the crypto world also contribute to these market cap fluctuations.
The ECB paper examined how stablecoins like USDT and USDC responded to major crypto market disruptions or “crypto shocks.”
Stablecoins see an average drop of around 4% during such shocks.
One big example was the May 2021 Tesla decision to stop accepting Bitcoin.
Another was China’s crackdown on crypto and the high-profile collapse of TerraUSD/LUNA.
Finally, we had the FTX bankruptcy that wiped out a significant part of the market’s total capitalization (including stablecoins).
Interestingly, the ECB’s findings show that stablecoins are affected by crypto-specific events.
However, U.S. monetary policy still has a heavier influence on their performance. During the “crypto winter” of 2021/2022 when prices plunged across the board, major “stablecoins” like Tether were affected as well.
Despite the relationship between stablecoins and traditional finance, the ECB found that fluctuations in the crypto market had low effects on traditional financial assets.
Big events in the crypto space—like sudden drops in Bitcoin’s value had muted correlation with U.S. stock market prices.
This means that while stablecoins are heavily influenced by external forces, crypto market volatility doesn’t have that much effect on the wider economy—for now.
Overall, the ECB’s research provides a "flashback to reality" of sorts, for stablecoin proponents who market it as a "safe haven asset".
While they are highly suitable for avoiding volatility compared to other cryptos, they are far from being immune to outside economic forces.
Additionally, while crypto shocks affect stablecoins but not traditional financial systems.
For investors who turn to stablecoins during times of uncertainty, it might help to start considering broader economic factors when making decisions.
One more thing to keep in mind is that while the ECB paper focused mainly on U.S. policy, it did not mention how other major economies influence stablecoins.
Stablecoin investors must remain aware that while stablecoins are "stable" enough, several other factors remain at play when it comes to maintaining the value of one's investments.
Disclaimer: Voice of Crypto aims to deliver accurate and up-to-date information, but it will not be responsible for any missing facts or inaccurate information. Cryptocurrencies are highly volatile financial assets, so research and make your own financial decisions.