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Stablecoins and Their Risks to Financial Stability

Author

Listed:
  • Cameron MacDonald
  • Laura Zhao

Abstract

The market for fiat-referenced cryptoassets, commonly known as stablecoins, has expanded rapidly in recent years alongside the growth of the cryptoasset ecosystem. In fact, the market capitalization of stablecoins increased by more than 30 times since the beginning of 2020. What risks could stablecoins pose to the financial system? We examine price stabilization mechanisms of stablecoins as well as the current and potential use cases of stablecoins. We then analyze the risks stemming from both. We argue that the price stabilization mechanisms of current stablecoins could lead to the risk of confidence runs, which can propagate to broader cryptoasset markets and the traditional financial sector. We also argue that stablecoins can contribute to risks to financial stability by facilitating the buildup of leverage and liquidity mismatches in decentralized finance. Such risks cannot be addressed by regulating the safety and soundness of stablecoins alone without adequately regulating broader activities in the crypto ecosystem. Finally, we explore the potential implications of the substitution of cash and bank deposits for stablecoins in payments and the financial system more broadly, particularly the current system of bank-intermediated credit and for monetary policy.

Suggested Citation

  • Cameron MacDonald & Laura Zhao, 2022. "Stablecoins and Their Risks to Financial Stability," Discussion Papers 2022-20, Bank of Canada.
    • Handle: RePEc:bca:bocadp:22-20
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    References listed on IDEAS

    as
    1. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, vol. 24(Win), pages 14-23.
    2. Michael Darlin & Georgios Palaiokrassas & Leandros Tassiulas, 2022. "Debt-Financed Collateral and Stability Risks in the DeFi Ecosystem," Papers 2204.11107, arXiv.org, revised Jun 2022.
    Full references (including those not matched with items on IDEAS)

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    Cited by:

    1. Anneke Kosse & Marc Glowka & Ilaria Mattei & Tara Rice, 2023. "Will the real stablecoin please stand up?," BIS Papers, Bank for International Settlements, number 141, October –.

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    More about this item

    Keywords

    Digital currencies and fintech; Financial institutions; Financial markets; Financial stability; Financial system regulation and policies;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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