Stablecoins are electronic currencies designed to have minimal fluctuations in their price against a reference currency or a basket of currencies, and thus allow redeemability at a fixed rate. This is obtained by backing stablecoin issuance with a portfolio of reserves in the form of currencies or other assets against which stablecoin holdings can be exchanged at a fixed rate.

Stablecoins issued by Big Tech platforms with the potential to be adopted worldwide, beyond regulatory borders and currency areas, are known as Global Stablecoins (GSCs). For example, Facebook’s project Libra/Diem was thought to be a unit of account and medium of exchange that would have seen the creation of an integrated platform comprising of a settlement asset, a payment platform, and an ecosystem of service and good providers along with social media – all transcending regulatory and currencies boundaries.

Stablecoins are widely anticipated to provide value to consumers due to their intrinsic properties: 

1.    low transaction costs
2.    ease of access
3.    crossover and bundling of services. 

However, they come with potential risks (see our article on The Risk Landscape of Cryptoassets).¹

This article investigates the monetary consequences of stablecoin adoption and the connected risks as perceived by policymakers.

Stonewalling Stablecoins

Maybe not surprisingly, Facebook’s plans irked government and regulators. The response was a stonewalling of Diem and all other similar projects. At present, regulators of the G7 countries have taken a strong stance against the implementation of any global stablecoin. In October 2020, they released a statement declaring that: 

The G7 continues to maintain that no global stablecoin project should begin operation until it adequately addresses relevant legal, regulatory, and oversight requirements through appropriate design and by adhering to applicable standards.

This situation is not thought to be sustainable given the pace of technological innovation and potential consumer benefits. Regulators are expected to provide a regulatory framework to allow the creation of global stablecoins. 

The Financial Stability Board (FSB) is the international body that has been tasked by the G20 with monitoring and making recommendations regarding the stability of the global financial system in relation to the adoption of global stablecoins. It offered ten recommendations for regulating stablecoins in October 2020 (FSB, 2020).

Figure 1 – FSB High-Level Recommendations

Source: Financial Stability Board (FSB), “Regulation, Supervision and Oversight of Global Stablecoin

Arrangements Final Report and High-Level Recommendations,” October 2020.

As of October 2021, the FSB noted that the implementation of its recommendations was still at an early stage (FSB, 2021).²

Monetary Implications of Global Stablecoins

Why are policymakers worried? Several risks have been presented in speeches and policy documents (see for example the speech of Fabio Panetta, Member of the Executive Board of the ECB, in 2020). Here, the focus is on implications for monetary policy and financial stability. These two areas are the traditional remit of central banks and sovereign financial authorities.

From the financial stability perspective, the convertibility of stablecoins is not afforded by the same framework in place for bank deposits (e-money). In the case of bank deposits, convertibility to the fiat currency is implemented by regulation that mandates a deposit insurance scheme along with prudential regulation and supervision. These safeguards are not currently in place for stablecoins, which are therefore vulnerable to runs as were banks before prudential regulation was put in place. A run could occur if issuers are perceived as incapable of absorbing losses and hence not able to fulfil their promise of redeeming their stablecoin issuance.

In the case of global stablecoins, a run could have systemic consequences. The effort to meet request of redemptions would force an issuer to liquidate a large pool of assets, generating pecuniary externalities and contagion effects throughout many markets and possibly the entire financial system.
The role of stablecoins as means of payment for transactions would also entail systemic disruption if liquidity, settlement, operational and cyber risks were not properly managed.

Spillovers from a run or an adverse event in a country could propagate across borders to other countries and globally due to the interconnectedness of platform ecosystems. In such a scenario, owing to the global nature of stablecoins, central banks would struggle to control domestic financial conditions and to provide emergency liquidity assistance, both key tasks of monetary authorities.

What are the potential implications of stablecoins for monetary policy? It is important to notice that large investments in safe assets – as for example treasury bills – by stablecoin issuers would affect the availability of safe assets and shape of the yield curve. This, in turn, limits the ability of a central bank to control financing conditions. The yield curve measures the cost of funding and the underlying price of risk in an economy. Distortions in financing conditions alter incentives for risk taking and may induce the build-up of vulnerabilities in the financial system.

The joint effect of currency substitution – the use of stablecoins in place of sovereign currencies – and the pressure on safe assets could also affect the monetary policy transmission and hence its efficacy, limiting further the policy space of a central bank. Currency substitution reduces the monetary authorities’ control over domestic liquidity by limiting the component over which the authorities have direct influence and hence limiting the effect of changes to policy rates.

At the extreme, if widely adopted, stablecoins could threaten monetary sovereignty. A wide adoption of a basket of stablecoins, or of one type only, could replace sovereign money with private monies and subject countries to the monetary stance of a private firm.

The issuer of a stablecoin – and especially a dominant one – would be driven by its own profit maximisation effort in setting rates, fees and conditions. It is unclear whether the profit maximization objective of the issuing firms could be compatible with consumer welfare across countries or with the aim of price and output stabilisation objectives of central banks.

Conclusions

The process of digitalisation is accelerating and transforming what we produce, as well as how we produce, transfer, and consume goods and services. This process is also reshaping means of payments and money itself. The emergence of global stablecoins is a natural development of the available digital and decentralised technologies. It raises important systemic risks but also offers large potential benefits for consumers. It calls for the design of an appropriate regulatory and supervisory frameworks.

Bibliography

Hong Kong Monetary Authority “Discussion Paper on Crypto-assets and Stablecoins,” January 2022
https://www.hkma.gov.hk/media/chi/doc/key-information/press-release/2022/20220112c3a1.pdf

BIS, (2019), “Investigating the impact of global stablecoins, A report by the G7 Working Group on Stablecoins,” 
www.bis.org/cpmi/publ/d187.pdf

Financial Stability Board (FSB), “Regulation, Supervision and Oversight of Global Stablecoin Arrangements Final Report and High-Level Recommendations,” October 2020
https://www.fsb.org/wp-content/uploads/P131020-3.pdf

Financial Stability Board (FSB), Regulation, Supervision and Oversight of “Global Stablecoin” Arrangements Progress Report on the implementation of the FSB High-Level Recommendations,” October 2021
https://www.fsb.org/wp-content/uploads/P071021.pdf

Arner, Douglas, Raphael Auer and Jon Frost, “Stablecoins: risks, potential and regulation,” BIS Working Papers No 9, November 2020
www.bis.org/cpmi/publ/d187.pdf

G7, “G7 Finance Ministers and Central Bank Governors’ Statement on Digital Payments”, 13 October 2020
https://home.treasury.gov/news/press-releases/sm1152

Dong He, “Monetary Effects of Global Stablecoins,” Spring/Summer 2021, Cato Journal
https://www.cato.org/cato-journal/spring/summer-2021/monetary-effects-global-stablecoins

Panetta The two sides of the (stable)coin Speech by Fabio Panetta, Member of the Executive Board of theECB, at Il Salone dei Pagamenti 2020 Frankfurt am Main, 4 November 2020
https://www.ecb.europa.eu/press/key/date/2020/html/ecb.sp201104~7908460f0d.en.html

Footnotes

¹ The Risk Landscape of Cryptoassets
https://en.aaro.capital/Article?id=980bbf38-0ca7-49df-92fb-fc307edc4eb5

² Coindesk, “FSB Says Adoption of Global Stablecoin Regulations Shows ‘Gaps’ and ‘Fragmentation’.” By Sebastian Sinclair Oct 7, 2021 at 8:00 a.m.
https://www.coindesk.com/policy/2021/10/07/fsb-says-adoption-of-global-stablecoin-regulations-shows-gaps-and-fragmentation/

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