According to a research report published by American investment banking company Morgan Stanley on February 13, stablecoins play an important part in cryptocurrency trading, and their products might possibly compete with the traditional banking system.
The institution mentions that authorities in the United States have started placing restrictions on stablecoin products—referring to the recent crackdown on BUSD issuer Paxos—and adds that the issuing of stablecoins is essential for cryptocurrency dealers.
According to the findings of the research, a declining market capitalization for stablecoins is a sign of declining cryptocurrency liquidity and leverage. This is the same thing as quantitative tightening for the cryptocurrency market.
The balance sheet of the Federal Reserve began to shrink at the same time as the market capitalization of stablecoins began to decrease, according to Morgan Stanley.
The price of bitcoin (BTC) led to the increase in stablecoin market capitalization during the bull market in cryptocurrencies that happened in 2021; however, the research highlighted that the reverse occurred during the bear market that occurred in 2022.
The increasing prices on the market attracted traders to employ greater leverage in the form of borrowing stablecoins, which they subsequently used toward the purchase of further cryptocurrency.
According to the research, the drop in cryptocurrency liquidity that resulted when traders closed their long crypto positions was the primary factor that led to the falling market prices. This was followed by redemptions of the stablecoin that was received.
The financial institution anticipates that regulatory efforts in the United States will center on the regulation of stablecoins and believes that issuers will probably be required to register and verify that they own sufficient liquid assets to back the stablecoins that they issue.
Stablecoins are a subset of cryptocurrencies whose value is linked to that of a preexisting asset, such as the U.S. dollar, gold, or even another cryptocurrency.
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