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U.S. Regulators Warn of Liquidity Risks in Digital Asset Markets

A trio of U.S. regulators issued a formal warning to banks regarding liquidity risks associated with the digital asset industry. To that end, the Federal Deposit Insurance Corporation, the Board of Governors of the Federal Reserve System and the Office of the Comptroller of the Currency penned a joint statement highlighting the risks and enumerated some ways banking organizations can mitigate these concerns.

Notably, the regulators pointed to the unpredictable nature of deposit inflow and outflow, especially as it pertains to the timing and scale of those deposits, as reasons for vigilance on behalf of the banking sector. The statement also cautions institutions to beware of other outside market forces that could potentially wreak havoc in the broader digital asset space.

“The stability of such deposits may be driven by the behavior of the end customer or crypto-asset sector dynamics, and not solely by the crypto-asset-related entity itself, which is the banking organization’s direct counterparty,” according to the statement. “The stability of the deposits may be influenced by, for example, periods of stress, market volatility, and related vulnerabilities in the crypto-asset sector, which may or may not be specific to the crypto-asset-related entity.”

Market liquidity represents the ease by which one asset, in this case digital currency, can be converted into cash or another digital asset, according to the Corporate Finance Institute. “A liquid market is considered more steady and less volatile as a thriving market with considerable trading activity can bring buy and sell market forces into harmony,” notes the educational resource. “As a result, anytime you sell or purchase, there will always be market participants prepared to do the opposite. People can initiate and exit positions in highly liquid markets with little slippage or price fluctuation.”

From Twitter

Adrian V. “Avi” Barbour @avbarbour86 

"Crypto Traders Worried About Continued Liquidity Thinning in Bitcoin and Ether"

Additionally, notes the statement, problems arising from deposit and market volatility may be further exacerbated due to customer confusion, media reports and misleading or inaccurate representations with respect to the insurance held by digital asset-related entities. The statement calls on banks to channel some of the tried-and-true risk management principles applied to traditional markets as they wade into the crypto-asset game. It also explicitly notes it is not intended to prohibit nor discourage banking entities from providing services to any particular customer type or class.

From Twitter 

Girl Gone Crypto @girlgone_crypto

"There are a lot of factors to consider when investing in a project such as tokenomics, liquidity, development, the team, audit reports etc… but don’t underestimate the power of simply vibe checking the project and it’s community"

The regulators also touched on how these emerging risks might specifically impact stablecoin-related deposit reserves. Those coins, in particular, may be susceptible to “large and rapid outflows stemming from, for example, unanticipated stablecoin redemptions or dislocations in crypto-asset markets.”

Among some of the mitigation tactics recommended by the organizations include assessing potential interconnectedness across deposit holding entities, developing contingency funding plans and “robust due diligence” with respect to asset-holders and how they communicate their services to end users.

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