The rise of stablecoins has been one of the most notable developments in the digital asset space. Designed to maintain a stable value by pegging to fiat currencies like the US dollar, they offer a haven of predictability in the volatile world of cryptocurrencies. These assets have rapidly evolved into key infrastructure for decentralized finance (DeFi) and global payments, with their market capitalization soaring from zero to hundreds of billions of dollars in just a few years.
However, this rapid growth has attracted scrutiny from regulators and international financial institutions. The Bank for International Settlements (BIS), often called the "central bank for central banks," issued a stark warning in its May 2025 annual economic report. The BIS emphasized that stablecoins are not genuine forms of money and highlighted the systemic risks they could pose to the global financial system.
This article delves into the BIS’s critique, exploring its "three gates" framework for evaluating money: singleness, elasticity, and integrity. We will examine why stablecoins struggle to meet these criteria and discuss additional practical challenges and future directions for digital currencies.
The Three Gates of Money: A Framework for Evaluation
The BIS report introduces a structured way to assess any monetary system. According to the BIS, reliable money must pass three critical tests: singleness, elasticity, and integrity. These principles ensure that money can serve as a dependable medium of exchange, store of value, and unit of account.
The First Gate: Singleness – Can Stablecoins Truly Be Stable?
Singleness means that one unit of currency must always be equal in value to another unit of the same denomination. For example, one US dollar should always be worth one US dollar, regardless of where or when it is used. This uniformity is essential for money to function effectively.
Stablecoins, however, struggle with singleness. Their value is not backed by sovereign credit but by the commercial credibility of private issuers and the quality of their reserve assets. This reliance introduces a risk of "depegging," where the stablecoin’s value diverges from its peg.
Historical precedents illustrate this danger. During the US Free Banking Era (1837–1863), private banks issued their own notes, which were supposed to be redeemable for gold or silver. In practice, the value of these notes varied based on the issuing bank’s reputation and solvency. A dollar note from a remote bank might only be worth 90 cents in New York, creating chaos and inefficiency.
Modern examples abound. The collapse of the algorithmic stablecoin TerraUSD (UST) in 2022 wiped out billions of dollars in value within days, demonstrating how quickly trust can evaporate. Even asset-backed stablecoins face ongoing scrutiny over the transparency and liquidity of their reserves.
The Second Gate: Elasticity – The Trap of 100% Reserves
Elasticity refers to the financial system’s ability to expand or contract credit in response to economic activity. This flexibility allows banks to support growth during booms and mitigate risks during downturns.
Stablecoins, particularly those backed by 100% reserves of safe assets like cash or short-term government bonds, operate like "narrow banks." While this model seems secure, it sacrifices elasticity. The reserves are locked away and cannot be used for lending, limiting the system’s ability to support economic growth.
Consider a comparison:
- Traditional Banking (Elastic):
When you deposit $1,000 in a bank, it holds a fraction as reserves and lends out the rest. This lending creates new money in the economy, supporting businesses and investment. - Stablecoin System (Inelastic):
When you buy $1,000 of a stablecoin, the issuer holds the full amount in reserve. No new credit is created, and the money remains idle.
If large sums migrate from traditional banks to stablecoins, the banking system’s lending capacity could shrink, potentially leading to higher borrowing costs and reduced credit availability for businesses and individuals.
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The Third Gate: Integrity – Anonymity vs. Regulation
Integrity encompasses the security and legality of a payment system. It requires robust mechanisms to prevent illicit activities like money laundering, terrorist financing, and tax evasion.
Stablecoins built on public blockchains challenge integrity due to their pseudonymous nature. While transactions are recorded on a public ledger, linking addresses to real-world identities is difficult. This makes it hard to enforce "know your customer" (KYC) and anti-money laundering (AML) regulations.
In contrast, traditional banking systems, though sometimes slow and costly, operate within a well-defined regulatory framework. Banks must verify identities and report suspicious transactions, providing a layer of security that stablecoins currently lack.
However, technological advancements are improving the situation. Tools for blockchain analysis and new regulations, such as the EU’s Markets in Crypto-Assets (MiCA) framework, are enhancing the ability to monitor and regulate stablecoin transactions.
Beyond the Three Gates: Additional Challenges
The BIS framework highlights critical issues, but other practical challenges also deserve attention.
Technical Vulnerabilities
Stablecoins depend heavily on internet connectivity and blockchain infrastructure. Widespread outages, cyberattacks, or natural disasters could disrupt entire networks. For instance, regional internet blackouts during conflicts demonstrate how reliant these systems are on external factors.
Long-term threats include quantum computing, which could break the cryptographic security protecting blockchain networks. While this risk is not immediate, it underscores the need for future-proof solutions.
Impact on the Financial System
Stablecoins compete with traditional banks for deposits, potentially reducing the funds available for lending. Moreover, the process of backing stablecoins with US Treasury bonds faces operational limits. When stablecoin issuers buy large volumes of bonds, they draw down reserves in the banking system, which could strain liquidity and attract regulatory scrutiny.
The Future of Stablecoins: Regulation and Innovation
The path forward for stablecoins lies between innovation and regulation. The BIS proposes a "unified ledger" model where central bank money, commercial bank deposits, and government bonds are tokenized under regulatory oversight. This approach aims to harness the benefits of blockchain technology while ensuring stability and compliance.
Market trends suggest a divergence:
- Regulatory Compliance: Some stablecoins will embrace transparency, audits, and KYC/AML integration, becoming part of the mainstream financial system.
- Niche Applications: Others may operate in less regulated spaces, serving specialized needs in DeFi or cross-border payments, but with limited scale.
Frequently Asked Questions
What are the main risks of stablecoins?
Stablecoins face risks of depegging, lack of credit elasticity, and regulatory challenges. Their dependence on private issuers and reserve assets makes them vulnerable to loss of trust and technical failures.
How do stablecoins affect traditional banking?
By attracting deposits away from banks, stablecoins could reduce the funds available for lending, potentially increasing borrowing costs and limiting economic growth.
Can stablecoins be made safe?
Yes, through stricter regulation, transparent auditing of reserves, and advanced compliance tools. However, achieving full safety requires balancing innovation with financial stability.
What is the BIS's alternative to stablecoins?
The BIS advocates for a "unified ledger" where central banks issue digital currencies and oversee tokenized assets, combining efficiency with regulatory control.
Are stablecoins legal?
Legality varies by jurisdiction. Some countries have embraced them with regulations, while others impose restrictions or bans. Compliance with local laws is essential for issuers and users.
How can I use stablecoins safely?
Choose stablecoins with transparent reserves and strong regulatory compliance. Diversify holdings and stay informed about technological and regulatory developments.
Conclusion
The BIS warning underscores the inherent tensions in stablecoin adoption. While these digital assets offer efficiency and innovation, they must overcome significant hurdles in stability, elasticity, and integrity. The future likely holds a blend of regulatory oversight and technological progress, aiming to integrate the best of both worlds for a safer and more inclusive financial system.