Stablecoins that approach a systemically important scale could come to play an important role in short-term securities markets such as commercial paper, while bringing new risks to these markets, according to a report by Fitch Ratings released on Monday.

“The [U.S.-dollar denominated] reserves that coin operators hold to at least partially back their currency can affect short-term markets, particularly as they increase in scale,” Fitch warned.

Stablecoins are cryptocurrencies that, in the attempt to offer price stability, peg their market value to a commodity’s price or a fiat currency like the U.S. dollar. The digital tokens are usually backed by reserves of dollars or securities and other assets, such as certificates of deposit or commercial paper (CP).

According to Fitch, the 10 largest stablecoins had an aggregated market capitalization of $126 billion as of September 30. Fitch estimated the ninth-month growth rate of stablecoins’ market cap at 420%.

Because of the increasing market size, stablecoin operators could become significant investors in the U.S. CP market, exceeding the holdings of money market funds within two or three years, said Fitch.

That’s a problem because stablecoins could be subject to run risk in a market panic. If stablecoin holders en masse seek to redeem their stablecoins for U.S. dollars, stablecoin operators could be forced to sell their less-liquid holdings. CP maturities generally run from 1 day to 90 days.

“Stablecoin-related turbulence could both affect the CP market itself and transmit shocks to other market participants,” Fitch said. “Risks could be aggravated if the infrastructure and partners used by stablecoin operators to engage with traditional markets lack a record in the smooth handling of transactions during periods of market stress or volatility.”

The stablecoin Tether is the largest by market cap, reaching $68.4 billion as of September 30. As of June 30, the company said that it held half of that amount in CP and certificates of deposit. Other operators hold only as much as 10% of reserves in CP. The size of the U.S. commercial paper market is about $1.1 trillion.

It usually doesn’t take much to stress the CP market. The market “froze” in the early days of the COVID-19 pandemic, as it did during the 2008 financial crisis.

One barrier to monitoring this systemic risk is that U.S. regulators don’t have a lot of visibility into stablecoin operators’ securities holdings. “Actual holdings remain opaque, even in the most transparent cases, and granular asset breakdowns are not readily available,” Fitch said. Indeed, it is sometimes unclear if some stablecoins are backed by the U.S. dollar on a one-to-one basis.

EU and U.S. regulators are developing rules for stablecoin operators and their reserve holdings, but the timeline is unclear, pointed out Fitch.

The EU, for example, is negotiating new regulations on crypto assets that would require stablecoins intended to be used as a means of payment to invest their reserves in cash and very low-risk government securities.

However, Fitch said, “a requirement for stablecoin operators to hold more reserves in safe and highly liquid assets could reduce allocations to CP, but raise the influence of stablecoins on the short-dated government market.”

Fed Chair Jerome Powell recently said he has no interest in banning stablecoins or cryptocurrencies.

But in July, he told the Senate banking committee that stablecoins “are like money funds, they’re like bank deposits, and they’re growing incredibly fast but without appropriate regulation. … If we’re going to have something that looks just like a money market fund or a bank deposit or a narrow bank and it’s growing fast, we really ought to have appropriate regulation.”

At their July meeting, Federal Reserve officials discussed whether stablecoins are a threat to financial market stability. According to the minutes, officials noted that stablecoins appear to have “the same structural maturity and liquidity transformation vulnerabilities” as money market funds but with less transparency.

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