Morgan Stanley: Falling Stablecoin Issuance Is Negative Sign for Crypto Trading

Stablecoins play a vital role in crypto trading and their products potentially compete with the fiat banking system, Morgan Stanley (MS) said in a research report Monday.

The bank notes that U.S. regulators have begun limiting stablecoin products, adding that stablecoin issuance is important for crypto traders. Falling stablecoin market capitalization is an indication of falling cryptocurrency liquidity and leverage, the equivalent of quantitative tightening for the crypto market, the report said. A stablecoin is a type of cryptocurrency whose value is pegged to another asset, such as the U.S. dollar or gold.

Morgan Stanley notes that stablecoin market capitalization started falling at around the same time as the Federal Reserve balance sheet.

In the crypto bull market of 2021, bitcoin’s (BTC) price led the growth in stablecoin market capitalization, while during the bear market of 2022 the opposite occurred, the note said.

“Rising market prices enticed traders to take on more leverage, in the form of borrowing stablecoins, which was then used to buy more crypto,” analysts Sheena Shah and Kinji Steimetz wrote. “Falling market prices were catalyzed by a reduction in crypto liquidity caused by traders closing long crypto positions, followed by redemptions of the stablecoin received.”

The bank expects U.S. crypto regulatory efforts to focus on stablecoin regulation, and says issuers will probably have to register and prove they hold enough liquid assets to back the issued stablecoins.

“All stablecoins rely on market trust in the system’s ability to keep a stable value,” the note added.

Read more: Bernstein Says Regulatory Backlash Will Lead to More Defi and Offshore Crypto