A stablecoin makes a simple promise: you can turn it back into a dollar when you need one. The harder question is what happens when everyone needs that dollar at once.
In the past ten days, three official bodies have treated stablecoins as a question for banks, monetary policy and financial stability.
On October 12, the Financial Stability Board sent the G20 a note on the cross-border vulnerabilities of global stablecoins. Its concern is the mismatch between international activity and national oversight. A global stablecoin’s users, operators and reserves can span several countries and several kinds of firm, so no single authority may be able to see or address the whole risk.
An October 9 paper by International Monetary Fund staff examines what wider use of foreign-currency stablecoins could mean for the countries receiving them. Most are denominated in dollars. They could make payments faster and cheaper, but they could also speed the shift away from local currencies and make capital flows harder to manage. IMF staff paper
On October 13, two economists at the Bank for International Settlements, Rashad Ahmed and Iñaki Aldasoro, published a working paper on competition between stablecoins and banks. They found that higher bank deposit rates predict slower stablecoin growth. They state the limit of that finding plainly: stablecoins and deposits appear to be partial substitutes, but the study does not establish that stablecoin growth reduces total bank deposits or lending.
A promise of dollar stability depends on the banks and markets that make dollars available. Perry Mehrling’s The New Lombard Street: How the Fed Became the Dealer of Last Resort is a book about that dependence.
Mehrling’s “money view” begins with payments and the commitments behind them. An institution may own valuable assets and still be unable to meet a payment due today. In a crisis, the immediate problem is often getting cash where it needs to go.
His account of the 2008 crisis follows the Federal Reserve beyond its familiar role as lender of last resort. As private markets seized up, the Fed increasingly supported the markets through which institutions financed and traded assets. Mehrling calls this the role of dealer of last resort.
For a stablecoin, that view makes the size of an issuer’s reserves only half the question. The other half is whether the issuer can turn those reserves into dollars under pressure.
Take a dollar stablecoin backed by cash and short-term Treasury bills. In ordinary conditions, it may meet redemptions easily. Under heavy withdrawals, the issuer may need to draw down bank balances or sell securities quickly. The FSB names runs and forced sales of reserve assets as ways that stress in a stablecoin could spread.
A reserve statement describes assets on one date. A redemption promise has to hold through time, including the hours when confidence is failing and requests for cash arrive faster than expected. So the questions that matter are who can redeem directly, how quickly they get paid, and what happens if a bank, custodian or trading venue in the chain stops working.
The effects reach banks too. The BIS paper suggests that what banks pay on deposits can affect demand for stablecoins. Money that moves into a token does not necessarily leave the banking system, because an issuer may hold its reserves as bank deposits. Even then, as the BIS general manager, Pablo Hernández de Cos, said in an April speech, deposits would probably shift between banks and leave some with less deposit funding, and an issuer’s deposits may prove flightier than ordinary customers’ savings.
For countries outside the United States, the stakes include control over their own money. IMF staff see greater risks where economic policy frameworks are weak, payments are expensive, or access to foreign currency is restricted. Those are also the places where digital dollars may most appeal to users. IMF staff paper
What makes financial life easier for a household can make the currency harder for a government to manage. The household gains another way to hold dollars. Its central bank faces another route by which people can leave the local currency.
Private payment platforms could extend the dollar’s reach through everyday convenience. Wider reach would also mean more demand for dollars in a crisis, and that demand could grow without any agreement about who must supply them.
The FSB’s existing recommendations already address redemption rights, risk management, recovery and resolution, and cooperation across borders. The hard part is making them work across every bank, custodian and trading venue a stablecoin depends on.
In Mehrling’s terms, the test is whether those arrangements can meet demands for cash under stress, and whether any emergency support comes with obligations and losses assigned in advance.
Stablecoins may well make payments faster and cheaper. The more people use them as money, the more their redemption promise matters.
Watch the next phase of regulation for what it says about that promise: who must honor it, how quickly, and with whose resources.
This week’s book: Perry Mehrling, The New Lombard Street: How the Fed Became the Dealer of Last Resort (Princeton University Press, 2011).