U.S. Economy

The dangers posed by stablecoins to the traditional market cannot be dismissed due to Tether's exposure to the U.S. credit system.

The cryptocurrency market has lost $1.9 trillion six months after it soared to a record high. Interestingly, these losses are bigger than those witnessed during the 2007's subprime mortgage market crisis — around $1.3 trillion, which has prompted fears that creaking crypto market risk will spill over across traditional markets, hurting stocks and bonds alike.

Stablecoins not very stable

A massive move lower from $69,000 in November 2021 to around $24,300 in May 2022 in Bitcoin's (BTC) price has caused a selloff frenzy across the crypto market.

Unfortunately, the bearish sentiment has not even spared stablecoins, so-called crypto equivalents of the U.S. dollar, which have been unable to stay as "stable" as they claim.

For instance, TerraUSD (UST), once the third-largest stablecoin in the industry, lost its dollar peg earlier this week, falling to as low as $0.05 on May 13.

Meanwhile, Tether (USDT), the largest stablecoin by market cap, briefly fell to $0.95 on May 12. But unlike TerraUSD, Tether managed to recover back to near $1, primarily because it claims to back its dollar peg using good old-fashioned reserves, including the real dollars and government bonds.

Crypto spillover risks

But that is where the trouble begins, according to a warning issued by rating agency Fitch last year. The agency feared that Tether's rapid growth could have implications for the short-term credit market, where it holds a lot of funds, according to the company's reserves breakdown disclosed here.

If traders decide to dump their Tether, the most-popular dollar-pegged stablecoin in the crypto sector, for cash, it would risk destabilizing the short-term credit market, Fitch noted.

Crypto losses now equal $1.7 trillion. The 2007 subprime mortgage market was $1.3 trillion.

It's highly likely that Crypto will be the catalyst for accelerated global collapse.

Weekend risk is HIGH. pic.twitter.com/4Ewo73uTeg

— Mac10 (@SuburbanDrone) May 12, 2022

The credit market is already struggling under the weight of higher interest rates. Tether could further pressure it lower as it holds $24 billion worth of commercial paper, $35 billion worth of Treasury notes, and $4 billion worth of corporate bonds. 

The signs are already visible. For example, Tether has been reducing its commercial paper reserves during the crypto correction in the last six months, its chief technology officer, Paolo Ardoino, confirmed on May 12.

So, based on Fitch's warning last year, many analysts fear that the "financial run" might soon spill over to the traditional market.

That includes Joseph Abate, managing director of fixed income research at Barclays, who believes Tether's decision to sell its commercial papers and certificate deposit holdings before maturity could mean paying several months of interest in penalty.

As a result, they could be forced to sell their liquid Treasury bills, which make up 44% of their net holdings.

Related: What happened? Terra debacle exposes flaws plaguing the crypto industry

"We do not know what is going to happen, but the danger cannot be dismissed out of hand," opines Robert Armstrong, the author of Financial Times' Unhedged newsletter, adding:

"Stablecoins have a total market capitalization of more than $150 billion. If the pegs all break — and they could — there will be ripples well beyond crypto."

The views and opinions expressed here are solely those of the author and do not necessarily reflect the views of Cointelegraph.com. Every investment and trading move involves risk, you should conduct your own research when making a decision.