In recent years, the belief that blockchain technology and asset tokenization will play a significant role in the future financial system has gained steady acceptance. Initiatives such as the U.S. "Genius Act," which establishes a regulatory framework for stablecoins, have further reinforced this trend.
However, the scenario where stablecoins—cryptocurrencies pegged to assets like the U.S. dollar—are used for large-scale settlement of financial transactions is unlikely to materialize. The reason is straightforward: current stablecoin arrangements are not secure enough to serve as large-scale settlement assets, at least in their present form.
Wholesale markets are characterized by large-value payments and securities transactions between regulated financial institutions, such as banks and broker-dealers. Settlement typically occurs within specialized entities known as financial market infrastructures (FMIs). Due to their importance to the global financial system, FMIs are considered "systemically important" and must adhere to regulatory standards far exceeding those governing today's stablecoins.
Following the 2007–2009 financial crisis, major central banks and securities regulators agreed on a comprehensive set of 24 principles that FMIs must follow. These principles have since been incorporated into domestic legislation worldwide. One particularly critical standard concerns the quality of the currency 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. If central bank money is not used, the settlement asset must have little to no credit or liquidity risk, and participants must be able to fund and withdraw from their settlement accounts on an intraday basis.
Some well-known FMIs do not settle directly in central bank money but still meet this standard. CLS Bank, based in New York and owned by the world's largest financial institutions, settles foreign exchange transactions in 18 currencies, with daily volumes averaging around $8 trillion. Euroclear Bank is a leading example of multi-currency settlement for securities transactions. Thanks to various risk-mitigation measures—such as direct backing by central bank reserves or full collateralization with the highest quality securities—the quality of their settlement balances can be considered equivalent to central bank money. Additionally, clients are not permitted to hold overnight deposits with them unless necessary for settlement purposes.
In contrast, the balance sheets and operational models of today's leading stablecoins are severely misaligned with those of regulated FMIs. They hold billions of dollars in uninsured bank deposits and often require one to three business days to process redemptions of stablecoins into fiat currency. The securities they hold may have relatively short maturities, but they would still need to be sold in the event of large-scale redemptions, potentially causing dislocations in securities markets. Therefore, current stablecoin arrangements cannot provide the credit quality or immediate liquidity required for 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 yet been achieved. However, central bank accounts would clearly enhance confidence in stablecoins and provide an ideal liquidity buffer for redemptions. Still, it is doubtful whether central bank accounts alone would suffice to meet the requirements of global FMIs.
The current business model of stablecoin issuers is based on maximizing the issuance of coins to generate income from interest-bearing assets. In contrast, private-sector FMIs like CLS Bank or Euroclear Bank generate revenue from settling transactions while keeping their balance sheets to a minimum.
Tokenized central bank money would clearly meet regulatory expectations, and some central banks are exploring "tokenized central bank money" or "wholesale central bank digital currencies." However, it is also conceivable to design a new type of private-sector stablecoin tailored for wholesale settlement. Such an arrangement would require a business model limited to settling wholesale financial transactions and restricted to use by regulated financial institutions.
Comments