With U.S. regulators moving to limit stablecoin products, strategists at Morgan Stanley think the broader crypto economy should be paying attention.

"Falling stablecoin market capitalization means falling crypto liquidity and leverage," Sheena Shah and Kinji  Steimetz wrote in a note dated Feb. 13. "Stablecoins play a vital role in crypto trading and their products potentially compete with the fiat banking system."

The New York Department of Financial Services earlier this week ordered Paxos to stop issuing the Binance USD stablecoin, and the Morgan Stanley strategists expect upcoming regulatory efforts in the U.S. Congress to focus on stablecoins.

 "We think stablecoin issuers will likely have to register and show they hold sufficient liquid assets to back the issued stablecoins," they wrote, citing an analysis by DataFinnovation which showed that "BUSD wasn't always fully backed in the past."

The availability of stablecoins can serve as a "simple indicator of institutional demand for leverage, which influences prices," the report stated. 

Without new BUSD being created by Paxos, its still unclear whether current holders of BUSD will transfer their funds to other stablecoins, with a neutral impact to liquidity, or whether the risk of further regulatory actions will reduce the overall market demand for stablecoins, according to the report.