Today the European Central Bank (ECB) published a paper reviewing the current status of stablecoins and their potential impact on monetary policy, stability, payments and other areas. Some of the risks are similar to concerns about a central bank digital currency, especially concerning displacing banks. But the risks of “runs” on stablecoins are significant and potentially more contagious than typical bank runs.
The ECB outlined three scenarios for the use of stablecoins. The first is as a crypto-asset accessory where it’s referring to the current role of stablecoins, which is more-or-less limited to the (small) cryptocurrency community. It’s less worried about that and more concerned about the other two scenarios where stablecoins could potentially be used for mainstream payments or as a store of value.
In passing, it also mentioned a fourth scenario of central bank digital currency (CBDC), which it said would make the stablecoin “value proposition redundant (at least for domestic payments) “.
In terms of likelihood, the ECB thinks the widespread use of a stablecoin as a store of value is significantly less probable than the payment scenario.
Its biggest concern with mainstream payment stablecoins is the risk of a “run” on a stablecoin, which could destabilize the entire financial system.
It’s also concerned about the trend of relying on payment systems that are not based within the euro area.
The ECB urged international coordination and the ‘same risks, same rules’ treatment. It’s notable that yesterday the U.S. significantly eased the path to adoption of stablecoins.
Stablecoin risks for monetary policy
The first concern raised is that stablecoins could make it hard to implement negative interest rates. The ECB says it would be difficult for a stablecoin to sustain zero interest rates without charging fees or subsidizing it in some other way.
Is it possible the ECB is underestimating the potential impact on monetary policy? Because in a decentralized finance (DeFi) world, it isn’t just the stablecoin issuer that can pay interest. A stablecoin holder could earn interest from a separate DeFi protocol. We suspect the assumption here is that DeFi is part of the pure crypto-asset community, which is mainly geeks, so it’s not a threat. But some of these solutions are increasingly user friendly, so that assumption may not be valid. However, there’s also the potential to regulate DeFi.
The next risk is that stablecoins could reduce bank fees and commission income. If stablecoins became a store of value, banks would need to switch to more expensive deposits. And the collateral management might impact the functioning of money markets.
A run on a stablecoin would cause issues for the bank where the reserves are deposited. However, it has access to central bank funds. But where some of the collateral is invested elsewhere, those other entities that issue the collateral don’t have the same access.
The pricing of the assets used as collateral for the reserves of a stablecoin could be impacted. That’s especially the case for a store of value stablecoin because it would be larger in scale.
In the case of a multi-currency stablecoin, a shock impacting the coin could affect stablecoin holders because a devaluation would mean they had less money to spend with the Eurozone. So there would be increased risks of issues spreading from other currency areas and local central banks could have less control.
If a stablecoin is used as a store of value, there may be reduced demand for cash and central bank reserves reducing seigniorage income and increasing demand for other collateral.
Risk of stablecoin “runs”
Depending o the design of the stablecoin, the end user may be the bear the risk. That’s the case if the stablecoin’s value is linked to the value of collateral rather than a fixed fiat amount.
In that situation, if the collateral’s value starts to decline or there’s a cyberattack, there could be a “run” on the stablecoin. Even if the stablecoin has a fixed value, holders may lose confidence in the issuer’s ability to shoulder losses if the collateral devalues.
In a bank run, central banks can have significant influence. But the risk fo contagion in a stablecoin run is less controllable. A run in an emerging market could have a knock-on effect in developed markets where the assets are based. It could impact both short term government debt markets and banks if there is a sudden mass withdrawal.
The disruption of any mainstream payment system is a problem and potentially a systemic risk.
Complex governance structures for stablecoin protocols could result in disruption and the technical complexity of distributed ledgers comes with cybersecurity risks. Likewise, reliance on intermediaries or third parties is an additional risk.
The global nature of stablecoins could result in a regulatory minefield. Those only become an issue where there’s a conflict or a failure.
Next, the ECB explored the stablecoin impact on current retail payments markets. It has concerns about increasing dependence on global players for payment infrastructure. On the flip side, if there are numerous stablecoins, it has concerns over fragmentation within the Euro area compared to the current pan European support for SEPA payments.
However, no matter how popular stablecoins are, the ECB envisages cash coexisting with stablecoins.
Despite identifying rather a large number of risks which it will take action to address, the ECB expressed a desire to enable “private sector initiatives to safely extract the most value from technological innovations, to the benefit of a wide range of users.”