Stablecoins latest reason to worry about the dollar

On any list of oxymoronic investments, stablecoins might deserve a spot right near the top.

A stablecoin is, by definition, a variety of cryptocurrency meant to remain stable, being pegged to another very reliable asset. For most, we’re talking about US Treasury securities. Sure, stablecoins can use commodities, reserves of traditional assets and employ algorithms to control supply and maintain their peg.

But since virtually all financial roads eventually lead to US government debt, crypto enthusiasts know that the foundations underneath digital assets of all stripes are dollars. And that’s its own existential challenge for the crypto world.

Between the US national debt topping US$38 trillion, President Donald Trump’s chaotic trade war, efforts to replace the dollar as the world’s reserve currency and gold surging to all-time highs, the stability sales pitch from the crypto crowd has more than a few cracks.

Yet the risk that this dynamic goes the other way, too, is getting increased attention.

TheInternational Monetary Fund is warning that the $305 billion stablecoin market could threaten traditional lending, undermine the effectiveness of monetary policy and trigger runs on some of the globe’s safest assets.

The fact that stablecoins are backed by old economy fiat currencies makes them, in theory, far less volatile than, say, bitcoin. Yet the medium’s rapid growth and its increasing connections to mainstream finance — including US Treasuries — have regulators and watchdogs worried.

“Because stablecoins may be subject to run risk,” the IMF says, “fire sales of their reserve assets — such as bank cash deposits and government securities — could spill over into bank deposits and government bond and repo markets. This could increase volatility and require central bank intervention.”

How just interventions might work is anyone’s guess but there is a growing concern given the market’s rapid growth. The passage of the US GENIUS Act, which established a new regulatory framework for digital tokens in July, is expected to turbocharge the market.

Last week, a who’s-who of global finance’s biggest names from Deutsche Bank to Goldman Sachs to Banco Santander were devising a framework to issuea 1:1 reserve-backed form of digital money to operate on public blockchains. Citigroup has joined hands with nine European banks to create a regulated euro-based stablecoin.

IMF economists also worry about the stablecoin effect on central banks’ ability to influence economies. The more crypto assets displace the dollar and other fiat currencies, the less the Federal Reserve and peers can generate the “multiplier effect” that gives monetary policy its potency. Stablecoins could also warp the functioning of bond markets if more investors flock to crypto assets than traditional ones.

If the market really takes off, “any loss of parity with the reference currency would also impose direct losses and heightened uncertainty on a large user base,” the IMF says. Or if wild swings in value see assets losing their peg to the dollar; it happened to Ethena, the third-largest stablecoin, last weekend.

“If redemptions spike during a period of market stress, stablecoin issuers may be forced to sell Treasuries into a market where intermediaries – broker-dealers, for example – may not be available to absorb the flow,” says Ashwanth Samuel, a stablecoin researcher at theMassachusetts Institute of Technology.

Caution abounds. In London, the Bank of England only plans to lift limits on stablecoins after it can determine that they won’t threaten “the provision of finance to the real economy,” says Deputy BOE Governor Sarah Breeden.

Over at Federal Reserve headquarters in Washington, Governor Michael Barr warns that central banks have their hands full to ensure stability. Stablecoin issuers, Barr says, keep the profits from investing their reserve assets and “have a high incentive to maximize the return on their reserve assets by extending the risk spectrum as far out as possible.”

The worry, Barr says, is that “stretching the boundaries of permissible reserve assets can increase profits in good times, but risks a crack in confidence during inevitable bouts of market stress. Stablecoins will only be stable if they can be reliably and promptly redeemed at par in a range of conditions, including during stress in the market that can put pressure on the value of even otherwise liquid government debt, and during episodes of strain on the individual issuer or its related entities.”

As Barr stresses, private money is “vulnerable to run risk” even if backed by high-quality assets should creditors question the vulnerability of those assets. In September 2008, for example, the Reserve Primary Fund “broke the buck” after it dropped below $1 one day after Lehman Brothers went bust. That happened when investors began to doubt the value of the assets underlying the money market fund.

Barr cites overnight repos in the commercial debt market that often use US Treasuries for collateral. Under Washington’s GENIUS Act, stablecoin issuers can use as an underlying reserve asset any medium of exchange “authorized or adopted by a foreign government.” In other words, bitcoin and other cryptocurrencies could be used as a reserve asset in the overnight repo market.

“In a case of stress experienced by the issuer or counterparty, or if bitcoin were to drop sharply in value, a stablecoin issuer could be stuck holding the bitcoin that had declined in value, potentially compromising the one-to-one backing of the stablecoin liabilities,” Barr explains. To become viable, stablecoins need “tight control over reserve assets, coupled with supervision, capital and liquidity requirements, and other measures.”

If things go awry, Barr concludes, it’s not clear “robust guardrails” exist to “protect users of stablecoins and mitigate broader risks to the financial system.”

MIT’s Samuel adds that as policymakers continue shaping the regulatory perimeter for stablecoins, which are growing at a rapid pace, a key question will emerge: will stablecoin issuers have access to the Fed discount window, and if not, what, if any, structural safeguards are needed to protect the US Treasury markets?

In a joint letter, the Bank Policy Institute, Consumer Bankers Association, Independent Community Bankers of America and Financial Services Forum opined that yield-bearing stablecoins could drain as much as $6.6 trillion from traditional banks, estimates consistent with those from the US Treasury.

Question is, would such large outflows boost interest rates, raise borrowing costs and reduce loan availability? “Payment stablecoins should not pay interest the way highly regulated and supervised banks do,” the letter stated.

MIT’s Christian Catalini notes that “even when a technology has a decentralizing force, economies of scale in complementary resources, brand or distribution inevitably drive concentration.”

It follows, says Katie-Ann Wilson at the Official Monetary and Financial Institutions Forum, that “stablecoin issuers are not guaranteed to remain neutral. They could evolve into closed-loop platform operators, using their branded networks to capture transactional revenue, ultimately undermining the interoperability that digital assets promised to deliver.”

Not to worry, say some US government officials. That includes Jonathan Gould, head of the US Office of the Comptroller of the Currency. “If there were to be a material flight from the banking system, I would be taking action,” Gould says.

He adds that “payment stablecoin connectivity might be a possibility for community banks to break some of the dominance that exists right now among the very largest banks in the payment system in America.” Yet, OCC will ensure banks will be “safe and sound,” Gould says.

However, former Consumer Financial Protection Bureau economist Andrew Nigrinis dismisses the argument that there’s no material impact on community bank deposits.

“A thousand households each holding $1,000 in insured checking accounts pose far less run risk than one stablecoin issuer holding a single $1 million uninsured account,” Nigrinis says.

“Even if deposits return to the banking system through stablecoin custodians, they must be held as high-quality liquid assets — as the GENIUS Act recognizes — because they can vanish instantly,” he adds

The collapse of Silicon Valley Bank illustrated how concentrated, confidence-sensitive deposits can flee faster than regulators can react. “Stablecoin-linked deposits may net to zero in accounting terms,” Nigrinis notes, “but their volatility and limited capacity to support lending make them fundamentally different from the stable, credit-supporting deposits that finance Main Street.”

Follow William Pesek on X at @WilliamPesek.