By Yikai Wang
ABA DataBank
In September 2008, at the onset of the global financial crisis, investors redeemed their shares in prime money market funds en masse. History repeated itself during the COVID-19 pandemic with another round of sharp outflows. In both episodes, the strains cascaded to the broader funding markets, impacting businesses and other financial institutions that rely on them for funding. In 2008, the largest and oldest MMF “broke the buck” and liquidated. In both situations, the Federal Reserve and the Treasury intervened to provide liquidity to these funds and stem contagion fears.
Payment stablecoins issued by nonbanks are economically equivalent to MMFs. One could even characterize them as tokenized MMFs used for payments. They share the same vulnerabilities with MMFs, and may suffer similar runs under stress. As Congress and regulators debate the right level of stablecoin regulation, these run risks and the potential role of the Fed warrant careful consideration. Given financial market history, there is a strong possibility that additional stablecoin issuers will face runs at some point and that investors will lose money. If these new assets grow and become more interconnected, runs could transmit strains to the broader financial system.
Payment stablecoins face similar run risks
Payment stablecoins and MMFs share a crucial structural similarity in their susceptibility to run risk during financial stress. Both are designed to provide investors with a stable, cash equivalent asset, backed by underlying reserves — but neither is explicitly guaranteed by the government. MMFs are backed by short-term, high-quality debt instruments. The GENIUS Act and the STABLE Act both contemplate allowing payment stablecoins to be backed by similar instruments.
For example, the top two stablecoins by market capitalization, Tether and USDC, maintain reserves in traditional financial assets, just like MMFs (with less transparency of investments). Tether’s reserves reportedly include Treasury bills, overnight reverse repos and relatively risky assets such as precious metals and Bitcoin. In contrast, USDC is mainly backed by Treasury bills and cash deposited in U.S. banks.
Because stability of payment stablecoins hinges on investor confidence in the quality and liquidity of its reserve assets, any concerns with the value of stablecoin reserves can trigger redemptions, just as happens in MMF runs. During market turmoil, stablecoin investors may rush to redeem their tokens for cash purely because their risk appetite has declined. When many investors try to redeem at the same time, the stablecoin issuer has to sell a large amount of reserve assets within a very short timeframe. Depending on the liquidity of the market for the reserve assets, the price of the stablecoin could fall significantly below its par value.
Why do MMF investors run?
MMFs are defined and regulated by the SEC. Investors can put money into and take money out of MMFs on demand, assuming the MMF has the funds to repay investors. If investors fear that an MMF will not be able to repay everyone, they have a strong incentive to withdraw their funds first — that is, to run.
Early redeemers of MMF shares typically receive the promised full value, while remaining investors face a higher risk of loss. During the 2008 and 2020 episodes referenced above, large outflows from prime MMFs were triggered by fears of defaults on prime MMF investments. Those fears led to withdrawals, sales of MMF holdings at losses, and a withdrawal of funding to MMF’s usual borrowers. MMF sales led to lower prices, reinforcing the initial market fears. The lower prices made it difficult for some prime MMFs to maintain a $1 net asset value per share, which is known as “breaking the buck.”
Regulatory actions
In response to the 2008 MMF run, on September 19 of that year, the Department of the Treasury intervened, guaranteeing the value of MMFs. The Federal Reserve introduced the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF). The Federal Reserve Bank of Boston was authorized to make loans to eligible banks to facilitate the purchase of asset-backed commercial paper from domestic prime MMFs. In March 2020, the Fed established the Money Market Mutual Fund Liquidity Facility (MMLF) to assist MMFs to meet investor redemptions. The purpose of both facilities was to provide liquidity to domestic prime MMFs, but the MMLF loans covered a broader set of assets. Both AMLF and MMFL fulfilled their goals of helping MMFs meet heightened redemptions and stabilize U.S. short-term funding markets. The AMLF and MMLF extended $217 billion and $58 billion in credit, respectively.
Since the 2008 crisis, through three waves of MMF reforms (2010, 2014 and 2023), the SEC has increased liquidity requirements, mandated liquidity fees to address run risk and requested more robust stress testing and reporting. For example, after the 2023 reform, the required minimum levels of daily and weekly liquid assets have increased from their 2010 threshold of 10% and 30% to 25% and 50%, respectively.
Policy implications
As policymakers consider stablecoin regulations, it is essential to recognize the parallels between stablecoins and MMFs, particularly regarding run risks and potential threats to financial stability. Drawing on lessons from past MMF reforms, regulators have the opportunity to craft a regulatory framework for stablecoins that mirrors the credit and liquidity safeguards applied to MMFs.
To mitigate systemic vulnerabilities, stablecoin regulation could include the following provisions:
- Credit quality requirements for reserve assets backing payment stablecoins.
- Prescriptive reserve composition standards, limiting assets to cash and high-quality liquid securities.
- Liquidity requirements, such as a minimum percentage of reserves in daily and weekly liquid assets.
- Maturity limits on reserve assets to reduce duration risk.
- Liquidity fees triggered when liquid assets fall below predefined thresholds.
- Custodian requirements mandating securities and other noncash assets reserves be held at regulated custodians.
- Cash reserves mandated to be deposited at FDIC-insured banks.
- Daily disclosure of the reserve assets with monthly audits, published on the issuer’s website to enhance transparency.
- Prohibition on the payment stablecoin issuer lending reserve assets or using reserve assets as collateral.
- Requiring issuers to assess through stress tests their ability to maintain a $1 net asset value under adverse scenarios.
By drawing on the regulatory lessons learned from MMFs, policymakers have an opportunity to get ahead of the curve. Implementing sensible, risk-based safeguards for stablecoins will not only protect investors and preserve financial stability but also foster growth in the digital asset space. With proactive regulation, the promise of stablecoins can be realized without repeating past mistakes.
Yikai Wang is a VP for banking and economic research in ABA’s Office of the Chief Economist. For additional research and analysis from the Office of the Chief Economist, please see the OCE website.
