The New Bretton Woods? Stablecoins, Dollar Dominance, and the Fight for Monetary Sovereignty

By Chinedu Okoye 

Summary:

- The US stablecoins being contemplated as a way to stabilize the dollar and the ECB is looking to join the party wary of a dollar dependency and financial instability. 

- USD-backed digital tokens are still beholden to U.S. monetary policy, so, a widespread adoption of such tokens could reinforce USD hegemony.

- As a result emerging and frontier market countries might find themselves further subordinated unless they create smarter, diversified backing mechanisms.

- The prospects for a wide adaptation is low given the impacts and implications for financial institutions, and the regulatory gaps and divergence within the crypto space.

- Unsitting USD-backed digital assets would be an arduos task given the greenback's position in world trade, international transactions global reserves and the role it plays in the global financial architecture.

The Quest for Fiat Redemption:

In order to redeem stability, and battle the emergence of non-state issued cryptocurrencies, the US is looking to reestablish the dollars prominence, by a widespread adaptation of dollar backed stablecoins.

As at 28th July , the European Central Bank expressed worried about the implications of a widespread adaptation of USD stablecoins, expressed desires for the development of a Euro backed stablecoin(s).

This is in order to  avoid a USD dominance should the offtake of stablecoins continue. However there is already a dominance in the young but growing digital assets financial asset segment.

 

What are Stablecoins?

Stablecoins are basically "a bridge between volatile digital assets and traditional monetary systems." With their appeal in its functioning as a blockchain-based money equivalent which is liquid."

"The global [stablecoin] market is increasingly dominated by US dollar-based stablecoins." This account for some 99% of total stablecoin market capitalisation.

However, not all stablecoins are USD-backed; some are backed by commodities (e.g., PAXG for gold) or use algorithmic methods (Bitcoin, Etheruem etc), but the focus of this paper is on Fiat [USD] backed stablecoins such as: Circle (USDC), Tether (USDT).

This far, US the reserve currency first to the Stablecoin race though EUROe exists, it's adaptation is a far cry from. USD-backed coins 

 

Not so Stable, Stablecoin:

Stablecoins by definition imply that the exchange-ratio to the USD would always be stable. However this does not guarantee that the exchange-value of the coin would be stable. If each USDC comprises of the US Dollar and Treasuries, then a large devaluation or selloff of Treasuries or USD could impair confidence in the stablecoin’s backing.

Thus, the only stability it offers the holder is one against the currency it's backed by, but not against other economic goods and currencies. The appeal of a sustained demand for “smoother” transactions is it can be offset by the competition of a staggering amount of digital assets with such function.

 

A Possible Slow and/minimal Adaptation:

The above makes a fiat backed stablecoin in essence, just a digital form of the very currency.  Because they stay exposed to the same risks as the first they represent and are I vested in, adaptation by the market would be an ardous task, this applies to lenders, real businesses, and speculators alike.

The prospects of Europe launching its own stablecoin to reduce the dependency on US backed coins shows that we would see many more countries digitalize their currency and this brings us back to the same point just in a different form.

Another reason why a complete transition would be an ardous task is the difficulty financial institutions would have switching to digitalized currency (say Circle (USDC), or Tether (USDT), and the negative effects it will have on financial institutions.

This because, stablecoins are increasingly used to settle transactions and to lend and borrow in. This presents some challenges for isnitutons that are not willing or able to diversify. As the ECB state, if "interest-bearing stablecoins became common and more businesses started using them, they could divert deposits from traditional banks, which could jeopardise financial intermediation and hamper credit availability."

US to Dominate the Stablecoin Market:

In an event of a countries making this move to stablecoins, the prominence and strength of the underlying currency would be reflected in the exchange-ratios of their digital forms.

Also monetary policy would affect the value of these coins, in the same way. And since debt, international transactions, and Global foreign reserve carry a higher USD component, some countries could add the Greenback and even Treasuries to their stablecoin asset portfolio, in a not to dissimilar the US Dollar is held in global foreign reserves (58% of global foreign exchange reserves are in the USD).

Since the USD already has a large global demands USD backed coins are likely to dominate in a similar fashion.  The IMF reports that: "Such dominance of the US dollar would provide the United States with strategic and economic advantages, allowing it to finance its debt more cheaply while exerting global influence."

This as the US is looking to expand and retain the dollar dominance by increase the demand for both the dollar and US Treasuries through the wide use of dollar-backed stable coins. Ur could achieve this in two ways; (i) by stimulating demand for the dollar-backed digital tokens and, (ii) if the US Dollar makes up the basket of assets behind other non-USD stablecoins.

Other countries monetary policy authority would be greatly impacted and challenged by an emergence of these (mostly) USD backed stablecoins. Especially those that would add USD assets to their portfolio. However, stable coin doesn't provide real exchange rate stability (i.e., in terms of goods and services), but does give  stability relative to the underlying assets.

The Arduos Task of Unsitting the USD and A Strategy for Frontier and Emerging Market Economies:

It would be difficult for a currency underperforming the US Dollar, whose stablecoin (or digital tokens) would outperform USD Treasury backed coins.

Furthermore, peer currencies such as the Euro and Sterling could take a hit if said tokens are to kick off and grow exponentially in use and acceptance. The European Central Bank is right to be concerned about this development, even though the actualization and prominence is decades out, it pays to get into the race, cautiously.

It's inconceivable that Emerging and Frontier Market stablecoin versions would not have the Dollar as part of the underlying assets backing the coin. For resource rich Sub Saharan African countries, a mixture of local, foreign and commodities as underlying assets, could give it more stability, and reduce [the Federal Reserve's] monetary policy dependency and vulnerability 

Regulatory Hurdles to Stablecoin Adaptation:

Beyond monetary risks and institutional inertia, a major barrier to the widespread adaptation of stablecoins is it's interoperability challenges and regulatory divergence between different economic territories.

This fragmentation limits seamless usage across borders or platforms. So without universal protocols or cross-chain bridges that are secure, scalable, and widely adopted, it will be difficult for traditional institutions, especially banks and payment providers, to integrate them into core financial services.

This divergence in approach between major economic territories, creates uncertainty for global stablecoin projects. It could deter adoption by risk averse financial market players, making cross-border acceptance difficult. Until standardization, cross-border alignment, and technological interoperability improve, the adoption would remain slow.