Dollar-backed stablecoins are becoming an increasing threat to financial stability in developing economies. The Financial Stability Board (FSB) outlined this in its latest global financial system assessment report.
The FSB stated that increased stablecoin use will lead to weaker domestic currencies. It could also lessen the central bank’s ability to implement appropriate monetary policy.
Many developing countries are experiencing inflation, currency devaluation, and restricted access to foreign exchange. This makes them more vulnerable to the effects of dollar-backed stablecoins.
Over $150 billion worth of this currency exists worldwide, showing the increasing impact of stablecoins on financial systems.
Stablecoin Risks Decrease Monetary Policy Effectiveness
According to the FSB, foreign currency stablecoins could reduce the effectiveness of monetary policy in emerging markets. People and companies switch from saving, using, and transacting in local currencies to dollar-based digital money.
This reduces dependence on local currencies and makes it more difficult for central banks to keep inflation under control. Central banks lose their influence in managing inflation when they adjust interest rates.
This is because most economic activity occurs outside of the domestic financial systems. The FSB also warned that large-scale switches between local currency and stablecoins could lead to an increase in market volatility.
Large-scale movement of capital out of an economy during times of financial stress could intensify this volatility.
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Payment Systems Are Under Structural Stress
The FSB pointed out that these coins can be used to circumvent domestic payment structures and regulatory controls. Therefore, they could diminish the effectiveness of the financial authorities’ tools to manage capital flows.
Domestic banks may also experience declines in deposits if users move their money into the stablecoin ecosystem. Declines in deposits may reduce the financial intermediation functions of domestic banking systems.
Additionally, cross-border transactions involving these coins are more difficult for regulators to track and control than traditional ones. These factors represent significant challenges to implementing compliance mechanisms and preventing illegal transactions.
The FSB notes that these coins are still largely being used in crypto markets but are not being used in broader financial services yet. However, their growing use in emerging markets could rapidly change this dynamic.
A Need for Coordination and Oversight
Regulatory action taken now to mitigate future risks is critical. The FSB urges greater international coordination to address risks associated with stablecoin adoption.
It also said regulators should work together to develop common regulatory frameworks across all jurisdictions and financial systems. Regulators must require stablecoin operators to meet certain minimum transparency requirements.
These include maintaining adequate reserves and meeting operational resilience requirements. The FSB also emphasized the importance of improving global data collection regarding the use of these coins.
Improved data collection would enable regulators to better understand and respond to emerging threats to financial stability.
If left unregulated, the potential for these dollar-pegged coins to continue to grow rapidly may accelerate dollarization trends in economically vulnerable countries. This may alter global financial flows and further limit the effectiveness of national economic policies.
Why It Is Important
Unchecked growth of these coins may weaken emerging market currencies and reduce central bank control over economic stability.
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