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The writer is former head of the secretariat of the Committee on Payments and Market Infrastructures of the Bank for International Settlements and former executive director at IMF
The belief that blockchain technology and tokenisation of assets will play a prominent role in the future financial system has gained steady traction in recent years. Initiatives such as the Genius Act in the US, which set a regulatory framework for stablecoins, have further reinforced this trend.
But the scenario in which stablecoins — cryptocurrencies that are pegged in value to an asset such as the dollar — are used for large-scale settlement of financial transactions is unlikely to materialise. The reason is simple: today’s stablecoin arrangements are not safe enough for them to function as large-scale settlement assets, at least in their current form.
Wholesale markets are characterised by large-value payments and securities transactions among regulated financial institutions such as banks and broker-dealers, with settlement typically taking place in specialised entities known as financial market infrastructures. Because of their importance for the functioning of the global financial system, FMIs are considered “systemically important” and are subject to regulatory standards that go far beyond today’s stablecoin rules.
In the wake of the 2007-09 financial crisis, leading central banks and securities regulators agreed on a comprehensive set of 24 principles that FMIs must observe, which have since been embedded in national legislation around the world. Particularly important is the standard on the quality of the money used to settle financial transactions. It requires FMIs to settle in the highest-quality form of money available — ideally central bank money or reserves, which carry neither credit nor liquidity risk. Where central bank money is not used, the settlement asset must have little or no credit or liquidity risk, and participants must be able to fund and defund their settlement accounts at very short notice, including intraday.
There are prominent examples of FMIs that do not settle directly in central bank money yet still meet this standard. The New York-based CLS Bank, owned by the world’s biggest financial institutions, settles foreign exchange transactions in 18 currencies with an average daily value of about $8tn. Euroclear Bank is a leading example in the multicurrency settlement of trades in securities. The quality of their monetary settlement balances can be considered equivalent to central bank money thanks to various risk‑mitigating measures, such as direct backing with central bank reserves or full collateralisation with the highest-quality securities. Moreover, clients are not allowed to hold overnight deposits with them, except where these are needed for settlement purposes.
By contrast, the balance sheets and operating models of today’s leading stablecoins are grossly misaligned with those of regulated FMIs. They hold hundreds of millions in uninsured bank deposits and typically take one to three business days to honour fiat redemptions of stablecoins. The securities they hold may have relatively short maturities, but would still need to be sold in the event of large-scale redemptions, with the potential to trigger dislocations in securities markets. As a result, current stablecoin arrangements offer neither the credit quality nor the immediacy of liquidity required of wholesale settlement assets.
An obvious question is whether access to central bank reserve accounts would make these arrangements safe enough for wholesale financial markets. For legal or policy reasons, this has not happened yet. But central bank accounts would clearly help foster confidence in stablecoins and provide a desirable liquidity buffer against redemptions. It is doubtful, however, that central bank accounts alone would be sufficient to meet global FMI requirements.
The business model of current stablecoin issuers is based on maximising coin issuance in order to generate revenue from interest-bearing assets. By contrast, private sector FMIs such as CLS or Euroclear generate revenue from settling transactions while keeping their balance sheets to a minimum.
Tokenised central bank money would clearly satisfy regulatory expectations, and several central banks are exploring “tokenised central bank money” or “wholesale central bank digital currency”. But it is also conceivable to design a new private sector stablecoin that is suitable for wholesale settlement. Such an arrangement would need to be based on a business model confined to the settlement of wholesale financial transactions and restricted to use by regulated financial institutions.
