Do stablecoins alter the monetary policy transmission mechanism?

The so-called “stablecoins” are a specific category of crypto-assets that aim to maintain a stable value relative to a specified asset or pool of assets denominated in either a single official currency, or a “basket” of currencies.1 Currently, stablecoins are primarily used to facilitate trading, lending, or borrowing of other crypto-assets on or through crypto-asset trading platforms. They are not yet commonly employed as a means of payment. Uses for payment purposes are limited to specific types of domestic and international payments. At the moment, high transaction fees and price volatility act as an impediment to their use as a widespread form of payment.2

This situation may change if transaction fees were to fall. As suggested by Brunnermeier and Landau (2022), in a digital world, currency competition may develop inside and across borders. A widely adopted stablecoin with potential reach across multiple jurisdictions (so-called “global stablecoins” or GSCs) could become an important means of payment in and across many jurisdictions: it could further drive innovation in payments and satisfy the need for more efficient and cheaper cross-border payments and remittances, compared to other existing means of payment. However, GSCs adoption entails policy challenges. In particular, it could raise pressures for currency substitution, limiting the component of domestic liquidity directly influenced by the local authorities and, hence, reduce the latter’s ability to conduct monetary policy. As argued by Jamet et al. (2022), a world that sees a diminished role of central bank money and a stronger one for stablecoins and crypto-assets, with risks for monetary sovereignty, cannot be excluded. Also for this reason, monetary authorities in several countries are exploring the issuance of a central bank digital currency (CBDC), that is, public money for digital payments. At the same time, they are closely examining the supervision and oversight implications of GSCs ecosystems given their potential impact on payment systems and financial and monetary stability.3

In a recent paper (Cova et al. 2022), we assess the impact of a large use of GSCs on monetary policy effectiveness in two hypothetical countries (which we label Home and Foreign).

We simulate a two-country New Keynesian model in which we expand the means of payment beyond traditional cash. In particular, we allow households in both countries to use a GSC issued by a profit-maximizing private fund owned by households in one of the countries (Foreign).

Furthermore, we allow households in the other country (Home) to use also a CBDC, unconstrained and unremunerated. These assets are imperfect substitutes for the liquidity services provided. The GSC is a claim on the private fund and is fully backed by Foreign cash and by Foreign and Home riskless short-term sovereign bonds. Thus, the value of the GSC is linked to the prices of the assets chosen by the Fund to back it.

As shown in the Figure, in a situation where the GSC is widely used, the macroeconomic effects of a standard monetary policy shock (e.g. an unexpected reduction in the monetary policy rate) can be smaller or larger than in a (benchmark) cash economy, depending on how the GSC supply, set to maximize the issuer’s profits, responds to the shock. The less responsive the GSC supply, the more limited the change in overall liquidity following the shock and the associated macroeconomic effects.

In the case of a monetary policy shock in the country where the Fund issuing the GSC resides the benchmark transmission of monetary policy can be restored if we impose the GSC to be fully backed only by cash. Under this assumption, the supply of GSC adjusts one-for-one to changes in the money supply, and the standard transmission mechanism of monetary policy applies. Tight regulation on the type of assets backing the GSC can therefore preserve the standard monetary policy transmission mechanism.

In the case of a monetary policy shock in the other country, if households make a large use of GSC, monetary policy will be less effective as the supply of GSC (which is issued abroad and backed mainly by Foreign assets) will adjust less than one-for-one to that of cash. In this context, if the CBDC can easily substitute for the other means of payment, the central bank can substantially restore the standard monetary policy transmission by changing the supply of CBDC and, thus, the overall liquidity available to domestic residents.4

Tight regulation and the introduction of a CBDC can therefore contribute to a great deal to restoring the monetary policy transmission mechanism, even if GSCs were extensively used. In our analysis, we focus on the case of a GSC issued in one country (Foreign) and the CBDC in the other (Home) to investigate the spillover effects between the two economies. Of course the results would be specular if the GSC is issued in the Home country and backed by domestic rather than foreign cash. Moreover, we have deliberately neglected some important issues associated with the diffusion of digital currencies. In particular, we do not consider the impact of these innovations on the banking sector and, more generally, on financial intermediation;5 this sector could play a significant role in, and could be largely affected by, the issuance of both GSC and CBDC. Finally, international spillovers could arise from the cross-border use of CBDCs, which we have also ruled out by assumption.6 Both issues call for additional investigation and cooperation at international level.