Stablecoins can drain from banks and nations at lightning speed

Stablecoins, highly liquid and available 24/7, can rapidly drain from banks and nations. Whether this presents a risk or an opportunity depends on one's perspective. Sending money overseas abroad used to be a slow and costly process, but stablecoins offer a faster, cheaper alternative. These digital currencies can move money across borders without the delays of traditional systems, settle transactions round the clock, and bypass layers of intermediaries. But what does this mean for the future of banks and the wider economy?

Anthony Vassallo, director of crypto at Silicon Valley Bank, explains that competition from stablecoins will affect banks in two distinct ways. The first involves slow-moving factors such as currency substitution, deposit erosion, and weakened policy transmission over months or years. The second involves fast-moving events, like depegging, issuer shocks, or banking crises that can move capital at lightning speed within hours.

The European Central Bank has raised concerns about the impacts of large stablecoin reserves held in bank deposits. Such reserves can trigger cascading withdrawals if there is a surge in redemptions, creating a liquidity mismatch between digital money and the banking system. In March 2023, this dynamic played out when USD Coin lost its dollar peg after Circle disclosed that $3.3 billion of its reserves were held at the failed Silicon Valley Bank.

This turned a banking failure into a stablecoin crisis almost overnight, forcing authorities to step in to guarantee deposits.

A September report by Sphere Labs and SVB highlights that stablecoin demand in certain countries, such as Argentina, Nigeria, and Turkey, is closely tied to the need for dollar exposure. In Argentina, for instance, 94% of crypto purchases with pesos were in stablecoins. Similarly, Turkey saw around $38 billion of lira swapped for stablecoins over a year.

Arnold Lee, CEO of Sphere Labs, believes that stablecoin adoption is fundamentally driven by demand for dollars from people facing barriers to accessing traditional banking systems.

A separate study by the Bank for International Settlements found that increased demand for dollar stablecoins can impact traditional currency markets. When stablecoin demand rises in countries where people want dollar exposure, it can put downward pressure on local currencies and make dollars more expensive to obtain through foreign exchange swaps. This effect is stronger when financial intermediaries are already under strain.

However, stablecoins are not poised to replace banks entirely. Often, they function as an intermediate currency in a two-way flow between users seeking digital dollars and traditional banking systems. While stablecoins offer speed and efficiency, banks remain essential for facilitating monetary transmission and managing economic stability.