 Stablecoins, they are the bridge connecting crypto and fiat, the grease providing liquidity to the crypto markets. Stablecoins combined market capitalization has grown fourfold since the start of 2021. Tether, the largest stablecoin, is the world's most traded digital asset. The astonishing growth of stablecoins has sparked concerns among regulators and financial analysts across the globe. They say that, if left unchecked, stablecoins could turn into a ticking time bomb ready to explode. The whole thing holds up. As long as everybody believes it's fine and they're all losing it for their own trading and nobody's ever trying to cash out. What would happen if the market suddenly lost confidence in a stablecoin? According to critics, a stablecoin meltdown could have a devastating impact not only on the crypto ecosystem but also on traditional financial markets. But how justified are these concerns? What would be the consequences of a stablecoin meltdown and what could be done to mitigate the risk? Let's find out. Stablecoins are digital tokens whose value is pegged to another asset, such as fiat currency, a commodity or a cryptocurrency. Currently, the largest and most popular stablecoins such as Tether, USD Coin and Binance USD are pegged to the United States Dollar. They aim to offer the best of both worlds. Price stability of fiat currency combined with instant, seamless transactions offered by crypto. Stablecoins function like chips in the global crypto trading casino. They provide an efficient method for traders to take profit or cut their losses without having to convert their crypto into fiat. Like casino chips, stablecoins are valuable as long as they can be redeemed for real money. Investors trust in these tokens depends on the assumption that for each stablecoin in circulation there is one dollar in the issuer's reserves. And here is where it gets problematic. Most stablecoin issuers haven't been transparent when it comes to disclosing the status of their reserves and have failed to provide reliable audits. People have long been wondering whether Tether, the most controversial stablecoin, is in fact fully backed. This year, major dollar backed stablecoin issuers have finally released breakdowns of their reserves. However, the disclosures have sparked even more concerns. It turned out that only a portion of their reserves is made of cash. About 50% of Tether's reserves are made up of commercial papers, a type of short-term corporate debt. Also, USDC, the second largest stablecoin, appeared to be holding corporate debt as a significant portion of its reserves. Why are they holding these assets instead of cash? It's simple to earn interest. But these revelations have left many wondering what happens in case the company is issuing those commercial papers default on their debt. What if those assets fall in value due to a market crash? Will investors be able to redeem their stablecoins for real USD? It's unclear. In such a scenario, the stablecoin may be unable to preserve its one-to-one peg to the USD. It would break the buck, as they say. In the worst case scenario, it could trigger a bank run, where stablecoin holders would try to cash out at the same time. At that point, the stablecoin is sure may be unable to meet the redemption request, which would precipitate the token's value even further. Caitlyn Long, CEO of Avanti, has been warning stablecoin users around a possible stablecoin insolvency crisis. She's worried that in this situation, getting back users' money may be very difficult, given the regulatory vacuum in which stablecoins operate. And in that case, there may not be recourse for the users of the stablecoins. The treatment in the bankruptcy of a stablecoin issuer is so unclear that the consumers probably would lose. Bankruns have fueled major financial downturn, such as the Great Depression in the 1930s and the 2008 financial crisis. According to analysts, the collapse of a stablecoin the size of tether could also have serious consequences on the broader crypto market. When the tether price crashes and goes down, this investor is gonna lose money. And what's the logical next step? He's gonna exit the crypto markets, because he would not be willing to add more risk. So he'd go to something safe, like a currency that he knows, like US dollars. Maybe some exchange would take two days to complete to withdraw, so we don't know. So there will be additional risk and the market will certainly crash for the next two weeks to two months. A stablecoin meltdown may not just impact the crypto ecosystem. Analysts at Fitch Rating said that such an event could compromise the stability of traditional financial markets too. For example, tether is currently one of the largest holders of US commercial papers. In case of a bankrun scenario, tether would be forced to liquidate a huge amount of those assets. That would put enormous selling pressure on credit markets, potentially leading to a crash. Finance commentators Francis Coppola has been vocal around the risks posed by stable coins on traditional markets. Commercial paper markets are so very key to financial markets. So key, in fact, that the Fed has actually supported them. So there is quite a risk that that were to happen, certainly in normal commercial paper markets, that the Fed might have to come in and support market. And thereby providing an indirect burnout to stablecoins. Other experts say the threat posed by a stablecoin meltdown is largely overestimated. Even if tether were to collapse, they say a competitor with more solid reserves and reputation would replace it. USDC, tether's main competitor, is already gaining market share, perhaps thanks to its better regulated status in the United States. Circle, the company behind USDC, announced the makeup of its reserves will be changed to a safer mix of cash and US Treasury bonds. Other analysts are even convinced that a hypothetical tether collapse would be a bullish case for Bitcoin. Let's tether fails tomorrow. What does that mean? Sure, the whole market collapse means there's only one safe store value left. Bitcoin, all that money that's left would probably go flow to Bitcoin. The probability of a black swan event leading to a stablecoin meltdown is relatively low. And crypto investors tend to have a quite high risk tolerance. That is probably why the value of these coins has remained stable despite the warring disclosures around the reserves. That's what's so fascinating about it. The market hasn't cared. The market right now says it doesn't matter because those stablecoins trade at par are just like the ones that are 100% backed by cash in a bank deposit. There has never been an audited reserve, a real audited reserve and people don't care for that. They promise that for five years and they never delivered and the AUM keeps going up, keeps going up. Still, while the markets may not care about the reserves behind stablecoins, regulators certainly do. US Treasury Secretary Janet Yellen has urged the creation of a clear regulatory framework around this market. While some welcome the announcement, others are worried that US authorities may have a strong incentive to crack down on stablecoins. The market grew too much and they're beginning to emerge some use cases for stablecoins outside of crypto trading. People are doing borrowing, lending and other stuff, financial transactions that US government cannot regulate, cannot tax. So they finally understood that it poses a risk not to the traditional markets, but it poses a risk to the dollar itself. Whenever there's a small chance of a competition to the US dollars, to US dollars, they're gonna have, they're gonna want to seize it, control it, limit or whatever. It is still unclear how regulation on stablecoins will look like. It may impose limitations on issuers operations as well as on the types of assets they can hold in the reserves. One thing is for sure, it will have a significant impact on big players like Tether or USTC. So holders of these stablecoins should definitely keep an eye on this. Go look at the history of when regulatory crackdowns have occurred. They sometimes can be very sudden. And we've seen consumers get their coins caught up in intermediaries that can no longer transact with them. They can seize, they can lock the traditional banking access to the traditional banking system. So effectively, they can halt operations of those stablecoins, whether or not they're located in the United States. And whether or not they intend to do it, they're gonna cause a lot of turbulence and crash on some of the markets. Stablecoins have become an essential element of the crypto ecosystem. And this technology could potentially disrupt the world of traditional finance. However, a stablecoin meltdown could have serious consequences and cannot be ruled out. A better regulatory framework is needed to ensure tokens are properly backed and investors funds are safe. At the same time, regulators should be careful. By cracking down on stablecoins, they may trigger the very crisis they are supposed to prevent. Thanks for watching this Cointelegraph report. As always, don't forget to like and subscribe and be sure to stay tuned for more updates on the evolution of global regulation around stablecoins.