Stablecoin transactions linked to higher exchange rate volatility in EMEs
A Hong Kong Monetary Authority study finds that increased stablecoin transaction flows significantly raise exchange rate volatility in emerging market economies. The research indicates that instability in stablecoin prices can transmit to the foreign exchange market, warranting policy measures.
Stablecoin flows fuel EME currency volatility
A study by the Hong Kong Monetary Authority (HKMA) reveals a direct link between stablecoin trading and exchange rate volatility in emerging market economies (EMEs).
The research, focusing on USD Tether (USDT) flows against 12 EME currencies, finds that stronger transaction flows correlate with increased exchange rate volatility, even after accounting for other factors.
Specifically, a one-standard-deviation increase in transaction flows leads to a median increase of approximately 3.6 percent in historical volatility for EME currencies with strong USDT exposure, significantly higher than the 0.35 percent observed for currencies with low flows.
This dynamic occurs because stablecoin transactions involving EME currencies ultimately necessitate conversions between these local currencies and the US dollar in the foreign exchange (FX) market, thereby amplifying FX activity and potential volatility.
EMEs drawn to dollar-pegged digital assets
The stablecoin market has experienced rapid growth, with US dollar-pegged stablecoins, led by USD Tether (USDT), comprising about 99 percent of its total market capitalization.
This market offers an attractive avenue for investors in emerging market economies (EMEs), given their less developed financial markets and constraints on accessing foreign assets.
Cryptocurrency exchanges facilitate direct transactions between EME currencies and USD stablecoins.
The HKMA study suggests that this expanding stablecoin adoption in EMEs could significantly influence exchange rate volatility, underscoring the need for policy measures like capital adequacy and reserve liquidity requirements to reduce stablecoin price instability.
A new frontier for financial stability
This study provides crucial empirical evidence on a rapidly evolving financial risk.
The direct link between stablecoin instability and EME currency volatility highlights a clear regulatory gap.
Policymakers must now consider targeted measures to mitigate these emerging cross-market transmission channels.