The Bank for International Settlements, often called the “central bankers’ central bank,” has issued its most forceful warning to date regarding the expanding role of stablecoins in global finance. In an early-released chapter of its annual report, the BIS cautioned that unregulated stablecoins could erode monetary sovereignty, undermine financial stability, and trigger sudden capital flight—especially in emerging markets. The institution urged swift action by national authorities to craft robust regulatory frameworks and to accelerate the tokenisation of official currencies on secure, central-bank–controlled platforms.

Threat to Monetary Sovereignty

Central banks derive their authority from the exclusive right to issue legal tender and to manage national money supplies. By offering privately issued tokens pegged to fiat currencies, stablecoin operators challenge that monopoly. Unlike central-bank money, which carries the weight of government guarantees and is accepted universally at face value, stablecoins depend on the integrity of private issuers and the quality of the assets they hold in reserve. BIS Economic Adviser Hyun Song Shin drew a parallel to the 19th-century Free Banking era in the United States, when numerous private banknotes circulated at varying exchange rates—creating confusion and occasional runs on weaker issuers. Today’s stablecoins, he warns, replicate those vulnerabilities: if market participants lose faith in a stablecoin’s backing, they could rush to redeem en masse, forcing the issuer into a fire sale of assets and sharply depleting liquidity.

In smaller or less-developed economies, the threat is magnified. A well-backed dollar-pegged token could become more trusted than the local currency, luring savers away and reducing central banks’ control over money supply and interest rates. This “digital dollarisation” could hamper domestic monetary policy and strip policymakers of critical tools to respond to downturns. The BIS flagged that more than 70 jurisdictions are now exploring stablecoin licenses, heightening the urgency for unified standards to prevent a patchwork of competing rules that could be exploited by cross-border issuers.

Beyond sovereignty, stablecoins raise deep concerns about financial stability. Most issuers claim to hold reserves in safe assets—Treasuries, commercial paper or cash equivalents—but the true composition and liquidity of these reserves often remain opaque. BIS Deputy General Manager Andrea Maechler emphasized that insufficient disclosure and irregular audits leave users and regulators in the dark about what would happen if a major stablecoin suddenly faced mass redemptions. Unlike bank deposits, which benefit from deposit-insurance schemes and strict reserve requirements, stablecoins typically operate without such protections, exposing holders and counterparties to potential losses.

The BIS also highlighted the systemic risk posed by interconnections between stablecoins and the broader crypto ecosystem. Many decentralized finance (DeFi) protocols rely heavily on stablecoins for lending, borrowing and trading. A collapse in a major token could ripple through these networks, triggering margin calls, forced liquidations and sudden asset price swings—recalling the contagion seen during the TerraUSD crash in 2022. Furthermore, with stablecoins now accounting for over 90 percent of the $300 billion crypto market, any major shock could quickly spill into traditional financial markets via banks, funds or payment platforms that integrate these tokens.

Push for Central Bank Digital Currency Tokenisation

Against these risks, the BIS offered a clear alternative: accelerate the development and deployment of central bank digital currencies (CBDCs) on unified ledger systems. A tokenised platform under central-bank governance would incorporate reserve balances, commercial bank deposits and even government bonds into a single programmable framework. Transactions could settle near-instantaneously, with built-in compliance checks and transparent audit trails—addressing the very shortcomings that plague private stablecoins.

Such a system promises multiple benefits: it preserves central banks’ seigniorage, enhances cross-border payment efficiency, and curbs illicit financial flows by embedding anti-money-laundering and know-your-customer protocols at the protocol level. Pilot programs in Asia and Europe have already demonstrated the technical feasibility of wholesale and retail CBDCs, with select central banks running successful trials that simulate interbank token settlements and consumer payments. The BIS report urged policymakers to scale these prototypes rapidly, collaborate on interoperability standards, and define governance arrangements that respect national prerogatives while enabling seamless integration across jurisdictions.

Key Regulatory Imperatives

• Embed Reserve Quality Standards – To shore up confidence, regulators must mandate granular, frequent disclosures of reserve compositions and require high-quality, liquid assets to back any retail-oriented stablecoin. Independent audits, akin to those for banks, should verify that issuers hold sufficient collateral to withstand stress scenarios without resorting to fire sales.
• Impose Capital and Liquidity Buffers – Stablecoin issuers should be subject to capital requirements calibrated to their scale and interconnectedness. In addition, holding minimum liquidity buffers—distinct from the reserves used for peg maintenance—would help manage redemption spikes without immediate asset liquidation.
• Limit Interoperability with Unregulated Entities – Central banks and regulators should carefully limit the ways in which regulated stablecoins can interact with DeFi platforms and other unregulated entities. By enforcing “travel rule” compliance and transaction monitoring, authorities can reduce the potential for systemic spillovers.
• Foster International Regulatory Coordination – Given the inherently cross-border nature of digital tokens, unilateral actions risk fragmentation and regulatory arbitrage. The BIS recommended that multilingual working groups swiftly develop baseline standards, leveraging forums like the Financial Stability Board and the G20, to ensure consistent oversight of stablecoin issuers and infrastructure providers.

Broader Implications for Financial Innovation

While the BIS warning underscores serious risks, it also acknowledges stablecoins as a catalyst for digital payment innovation. Many central banks have drawn lessons from private token experiments—particularly the efficiency gains in settlement times and programmable features that enable automated collateral management and smart-contract–enabled credit offerings. The challenge for regulators, therefore, is not to stifle innovation but to channel it within safe, transparent, and publicly accountable frameworks.

Looking ahead, the interplay between stablecoins and CBDCs will shape the next chapter of financial market evolution. If robust regulatory safeguards can mitigate systemic vulnerabilities, private tokens may function as complementary instruments—facilitating niche use cases in cross-border remittances or automated treasury operations. Yet without decisive policy action, the proliferation of unregulated stablecoins risks repeating the lessons of past monetary episodes, where unchecked private issuance led to fragmentation, runs, and costly disruptions.

As global markets brace for further growth in digital assets, the BIS’s stark warning serves as a crucial reminder: stablecoins, in their current unregulated form, pose threats that extend far beyond the crypto sphere. Central banks and policymakers now face a narrow window to erect the guardrails needed to harness the promise of digital money while safeguarding monetary sovereignty and financial stability.

(Adapted from BusinessPost.ie)

Categories: Economy & Finance, Regulations & Legal, Strategy