Central Bankers Warn Stablecoins Fail Key Money Tests

Top central bankers have expressed concerns over the performance of stablecoins as a form of money, highlighting their lack of backing from central banks, insufficient guardrails against illegal use, and inflexibility in funding for loans. According to a special chapter from this year’s unreleased annual economic report by the Bank for International Settlements (BIS), stablecoins failed to meet the three main tests of any money: singleness, elasticity, and integrity. The report, expected to be released on June 28th, suggests that stablecoins may at best serve a subsidiary role in the financial system due to their poor performance on these tests.

The BIS report also pointed out that stablecoins are often used by criminals to bypass integrity safeguards, as they lack traditional finance’s “know-your-customer” controls. Other concerns raised by the BIS include the potential of stablecoins to undermine monetary sovereignty, transparency issues, and the risk of capital flight from emerging economies. Without proper regulation, stablecoins pose a risk to financial stability and monetary sovereignty.

Hyun Shin, the Economic Adviser at BIS, explained that stablecoins, as digital bearer instruments, lack the traditional settlement function provided by a central bank with fiat money. He compared them to private banknotes circulating in the 19th-century Free Banking era in the U.S., noting that they could only trade at varying exchange rates depending on the issuer. This undermines the no-questions-asked principle of central bank-issued money. Shin also warned of the risk of “fire sales” of the assets backing stablecoins if they collapsed, citing the example of TerraUSD (USDT-USD) and the LUNA token in 2022. Additionally, there is the issue with Tether quitting the EU market due to regulatory bumps despite dominating more than half of the stablecoin market.

Andrea Maechler, Deputy General Manager at BIS, also expressed concern about the control and disclosure of stablecoins. She questioned the quality of the asset backing and the transparency of where the money is held. The outgoing head of the BIS, Agustin Carstens, believes that the next-generation monetary and financial system must combine the time-tested principles of trust in money backed by central banks with the functionality unlocked by tokenization. He adds that the system is expected to deliver improvements to current practices and to enable new economic arrangements.

Carstens claims that realizing the full potential of the stablecoin system requires bold action. However, many issues would need to be overcome, including who sets the rules governing the “programmable ‘unified ledger’ platform” and that individual nations would likely want to retain control of how and who uses their currencies. The BIS hinted that it wanted central banks to “go down the route” of a tokenized “unified ledger” incorporating central bank reserves, commercial bank deposits, and government bonds. This would mean that central bank money would remain the primary means of global payment. Currencies and bonds worldwide could also be integrated into the same “programmable platform.”

Shin also said tokenized central bank reserves provided a stable and trusted settlement asset for wholesale transactions in a tokenized ecosystem, ensuring the singleness of money. Tokenized commercial bank money could build on the proven two-tier system, offering new functionalities while preserving trust and stability. Shin also pointed out that tokenized government bonds could enhance liquidity and support various financial transactions, from collateral management to monetary policy operations.