Central banks warn stablecoins perform poorly as money

Stablecoins were initially designed to bridge the gap between volatile cryptocurrencies like Bitcoin and traditional monetary systems, typically by aiming to maintain a one-for-one peg with fiat currencies such as the US dollar, often backed by reserves in government bonds and money market funds. While proponents laud their efficiency in transferring money online, the BIS report points to critical failures when stablecoins are measured against the three essential tests of money: singleness, elasticity, and integrity.

Singleness: The Erosion of “No Questions Asked” Money

A core characteristic of sound money is its “singleness” – the principle that it can be accepted universally “without due diligence” or “no questions asked”. The BIS argues that stablecoins often trade at varying exchange rates, undermining this crucial uniformity. Unlike bank-issued money, which is ultimately settled against central bank reserves ensuring par value, stablecoins represent the liability of a specific issuer. This means that different stablecoins, even if pegged to the same fiat currency, can deviate in value based on the perceived creditworthiness of their issuers. This fragmentation makes them akin to private banknotes of a bygone era, failing to provide the consistent, unchallenged value necessary for a widely adopted currency.

Elasticity: The Inability to Respond to Economic Needs

The monetary system requires elasticity – the flexible provision of money to meet the economy’s demands, particularly for large-value payments and during times of stress. Commercial banks, supported by central banks acting as lenders of last resort, can elastically expand and contract their balance sheets to create money through lending. Stablecoins, however, operate on a “cash-in-advance” model, meaning any new issuance requires full upfront payment by holders. This inherent constraint stifles their ability to create money through lending, a vital function for a dynamic economy, and restricts their capacity to provide liquidity during crises.

Integrity: A Conduit for Illicit Activities

The integrity of the monetary system against financial crime is paramount. Stablecoins, by their nature as digital bearer instruments on borderless public blockchains, are identified by the BIS as a “go-to choice for illicit use to bypass integrity safeguards”. Their pseudonymity allows users to hide identities behind wallet addresses, and the absence of “know-your-customer” (KYC) controls, common in traditional finance, facilitates activities such as drug trafficking and money laundering. While some efforts are made to track illicit flows, the sheer scale of everyday payments makes it unrealistic to apply the necessary AML/CFT (Anti-Money Laundering and Combating the Financing of Terrorism) checks without the inherent safeguards of a two-tier system.

The BIS report also raises several other critical concerns. The widespread use of primarily US dollar-denominated stablecoins could lead to “stealth dollarization” in other countries, threatening their monetary sovereignty and impeding their ability to implement monetary policy. Furthermore, the continued growth of stablecoins poses financial stability risks, including the potential for “fire sales” of safe assets if large redemptions occur, given their substantial investment in markets like US Treasuries.

Instead of relying on private digital currencies like stablecoins, the BIS advocates for a “next-generation monetary system” built on the “tried and tested foundations of trust”. This vision centers on “tokenization” – the process of recording claims on real or financial assets onto a programmable platform. The proposed solution involves a “unified ledger” bringing together tokenized central bank reserves, tokenized commercial bank money, and tokenized government bonds.

Initiatives like Project Agora, a collaborative effort with seven major central banks and 43 commercial institutions, are trialing such a system to speed up and reduce the cost of cross-border payments. This approach aims to leverage technological advancements while preserving the essential characteristics of sound money: singleness, elasticity, and integrity, by ensuring final settlement in central bank reserves.

While stablecoins offer certain technological promises, the BIS’s comprehensive assessment underscores their fundamental shortcomings as reliable money. The report serves as a crucial reminder that true monetary stability and integrity are best preserved through systems anchored by central banks, ensuring public trust and financial resilience in an evolving digital landscape.