Stablecoinks
The rise of cryptocurrencies in general, and stablecoins in particular, is inextricably linked to the dollar: replacing the dollar, challenging the dollar, reinforcing the dollar. This appeals to constituencies who, for varying reasons, are keen to see the demise of dollar hegemony. Therefore, any understanding of how stablecoins may prosper as financial assets requires some consideration of the role of the dollar in international finance.
The dollar is customarily referred to as the global reserve currency, but this can mean different things to different people and different facets can sometimes become confused. The term itself encapsulates this, referring as it does to both reserves and currency, and suggesting the currency is the reserve, which it isn’t. US assets, primarily government bonds, are the foreign reserve asset of choice, particularly for countries with large trade surpluses with the US and the major oil exporters. These are reserves denominated in the dollar currency, so, more precisely, the dollar is the currency of the global reserve asset.
At the same time there is demand for dollars themselves as a medium of exchange in international payments. Famously, the international trade in oil is primarily invoiced and settled in dollars. As are many other products, in addition to trade directly with the United States. In foreign exchange the deep liquidity available when swapping a currency in or out of dollars means that it is often cheaper to exchange two non-dollar currencies by exchanging one into dollars, then exchanging those dollars for the desired currency, than to exchange the currencies directly.
The appetites for US assets and for US dollars are connected — you need dollars to buy the assets — but are not the same thing. This US dominance in both spheres is sometimes portrayed as coercion or conspiracy, but it is neither. In the 70s oil-rich states bought treasuries because the US was the only source of debt on a scale that matched their oil profits, which they couldn’t immediately spend without upending their economies. Similarly, transacting in dollars is attractive in terms of availability and cost, making geopolitical arm-twisting unnecessary. Any inclination to suspect corruption can be tempered by considering what you would do if you were in possession of the kind of sums involved and responsible for their safekeeping or safe transit.
But what does this pedantry have to do with stablecoins? Well, before considering some of the main use cases and customer profiles we need to draw another distinction, this time regarding stablecoins themselves. The initial batch of stablecoins, such as Tether’s USDT, which remains easily the largest stablecoin with roughly 60% of total market capitalization, are domiciled in lightly regulated jurisdictions — El Salvador in the case of USDT — where there is little scrutiny of their reserves; the promise is that they maintain par value with the dollar, however their asset holdings are opaque. Furthermore, these tokens were established in a period of negligible interest rates and paid no return to holders. Subsequent inflation and rising rates have handed them a substantial revenue stream for holding nothing more exotic than US government bonds, and they have continued their (highly profitable) policy of not paying a return, abetted by more stringent regulatory regimes.
Both the US, with the GENIUS Act, and the EU, with MiCAR, have implemented tighter regulations on stablecoins which want to operate within their territories. In both cases the permitted assets backing stablecoins are highly restricted, virtually guaranteeing they maintain par value with the fiat currency in which they are denominated. They also both prohibit stablecoins from paying a return to holders. This legal limitation inadvertently reduces commercial pressure on Tether to begin returning at least some of the yield from its assets to token holders.
These regulations have created another distinction, with issuers creating compliant domestic variants, with tightly controlled reserves, alongside their original international offerings which remain opaque. This lack of transparency makes the domestic coins the more likely to establish themselves as a significant component in international transactions.
The use cases for stablecoins reveal a similar duality as the dollar in international finance.
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1. Cross border transfer of fiat currency. In this case stablecoins are purchased with one fiat currency then sent to a recipient who reconverts the stablecoin to another fiat currency. Here the stablecoin acts as a means of exchange, but not as a retained asset. Great claims are made by advocates that this disrupts traditional financial rails both in terms of time and cost, however, the foreign exchange conversion which is the most costly component of traditional cross-border transactions is still required.
2. Cross border transfer retained in stablecoin. The same process can be truncated by the recipient deciding to keep the funds in stablecoin and using the tokens directly to make payments. In addition to being a means of exchange, the stablecoin is also being retained to store value in its currency of denomination. This avoids the expense of FX conversion into fiat but does so by relying on a network of vendors willing to accept stablecoin. This creates a problem for an incipient issuer; the token is only useful if it is already in general use.
3. Stablecoins as a store of value. Although they currently pay no yield to holders, stablecoins denominated in strong currencies are attractive to residents of countries with weaker currencies who wish to protect their savings. The tokens are used primarily as a store of value.
The purported benefits of stablecoins are only really delivered by cases 2 and 3, and are then dependent on a degree of dollarisation, which will be resisted by the governments concerned.
Although the euro is a stable currency, the prospect of uptake of dollar stablecoins in the eurozone has provoked concerns even within the European Union. An appetite for stablecoin holdings and a preference for USD denomination could weaken both the funding mix of European banks and the transmission of EU monetary policy, and inhibit private and sovereign financing. However, it is unclear how the proposed low holding limit central bank digital currency (CBDC) would avert these, given the appeal of stablecoins would be for holding wealth rather than retail payments, which are already relatively efficient both in cost and time in the eurozone.
Despite the recent opportunistic US Treasury bias towards short-term bill issuance — the very assets demanded both by regulation and the business case of stablecoin issuers- adoption of fully reserved stablecoins on a scale to realise the fears of the EU would require a volume of US government debt improbable given already stretched finances. Tokens denominated in other major currencies would then be an attractive source of yield for issuers, in preference to simply holding dollar bank deposits, thus stimulating the use of euro stablecoins and alleviating EU anxiety.
Assuming stablecoins did break through on a massive scale, then this unquenchable demand for assets is more likely to see the tokens join a long list of financial instruments — bills of exchange, goldsmith’s notes, account balances, Eurodollars — which started as fully-backed but, as the advantages of their utility came to outweigh concern over their redemption, became methods of credit creation. Stablecoin issuers would obtain banking licenses and become lenders, or more efficiently, and therefore perhaps more likely, traditional lenders would absorb the technical innovations into their operations.
However, to reach that stage, stablecoins must establish themselves as a means of exchange or store of value, or both. With little domestic incentive for the former in the US or the Eurozone, adoption would be driven by recipients in developing markets willing to retain the coins as a local means of payment in preference to paying for (still expensive) conversion to fiat. This requires a network of users, the evolution of which is not foregone given the limited incentive for early adopters.
It would also be supported by the conversion of savings in developing markets into stablecoins, however, initially at least, this is likely to be the preserve of a crypto-aware minority. In any case, it is clear that rather than replacing the dollar, stablecoin growth would instead increase demand for both US assets for security and the dollar for payments.
In conclusion, there may be an opportunity in the medium term for stablecoins to establish themselves as a fully backed proxy for dollars (or euros) but the cost-saving necessary to drive this is predicated on the dollarisation of developing countries, and, of course, those countries are not without agency in attempting to retain monetary sovereignty. However, if successful, in time demand would see the reserve become fractional, with wallets substituting for accounts. Stablecoins would not replace the dollar, they would become the dollar. Just as in Animal Farm we would find ourselves looking from dollar to stablecoin and conclude “it was impossible to say which was which.”
