Stablecoins and the illusion of stability

Stablecoins are, in essence, a simple and extremely profitable business. Investors exchange conventional currency for digital tokens issued by private firms. The issuer invests those funds in government securities and keeps the interest. The token holders receive nothing. Whether this arrangement serves any useful economic purpose ,beyond enriching the issuers, is a question their advocates prefer not to dwell on.

To understand the risks this model creates, it helps to be precise about what stablecoins are and how they differ from other crypto assets.

What stablecoins actually are

Stablecoins differ from cryptocurrencies such as Bitcoin in one crucial respect: they claim to be backed by reserves. In principle, a holder of a stablecoin should be able to redeem it at any time for conventional currency at a fixed rate. Bitcoin, by contrast, is backed by nothing — its value depends entirely on market demand and speculation.

There are two firms that dominate the market of stablecoins. Tether, the largest stablecoin issuer, has more than $175 billion worth of tokens in circulation and has redomiciled to El Salvador. Circle, which issues the USDC stablecoin, is the second largest and is based in the United States, where it publishes monthly reserve attestations from Deloitte.

The credibility of any stablecoin depends entirely on the quality and liquidity of the assets backing it. That credibility is the foundation on which the entire system rests, and it is more fragile than it appears.

A solution in search of a problem

Advocates argue that stablecoins represent an improvement in payments technology. Because they operate on blockchain networks, they can move funds quickly across borders without relying on traditional banking infrastructure.

In many advanced economies, however, this argument is less persuasive than it initially appears. Modern payment systems already allow funds to move rapidly between accounts and across borders. In Europe, cross-border transfers can be completed efficiently through established banking networks. For most ordinary transactions, stablecoins offer no clear advantage over existing systems.

Much of their current use remains concentrated within the cryptocurrency ecosystem itself, where they serve primarily as instruments for trading other digital assets.

Stablecoins also appeal to those who wish to operate outside the regulatory framework governing conventional financial transactions. Because blockchain-based transfers can be difficult to trace, they may be used to circumvent sanctions regimes, evade capital controls, or avoid the know-your-customer requirements that apply to standard bank transfers. Large sums have been transferred in cryptocurrency — and increasingly in stablecoins — to sanctioned jurisdictions, including countries such as Iran for example, in connection with sanctions evasion.

These uses help explain the rapid growth of stablecoins even in economies that already have efficient payments infrastructure. They do not constitute an argument in their favour.

The illusion of stability

The deeper problem with stablecoins is not their usefulness but their stability, or rather, the lack of it.

Stablecoins promise that holders can redeem their tokens for conventional currency at any time. That promise depends entirely on whether the reserves backing those tokens are both sufficient and immediately liquid.

If confidence in a stablecoin weakens, holders may attempt to redeem simultaneously. The result closely resembles a bank run. To meet redemption demands, the issuer must liquidate the assets backing the stablecoin. Even when those assets consist largely of government securities, selling large volumes rapidly can disrupt financial markets.

The problem becomes more acute when the reserves include less liquid assets. Recent US legislation — the GENIUS Act, passed in 2025 — permits stablecoin reserves to include shares in money market funds. Such assets cannot always be converted into cash immediately, particularly under stress. If a run develops, the issuer may be unable to meet redemption demands immediately. And if it cannot do so, the run accelerates.

The stability promised by stablecoins may therefore prove entirely illusory precisely when it matters most.

When one falls, others follow

Financial crises rarely remain confined to a single institution. The collapse of confidence in one firm can quickly spread to others, as investors attempt to withdraw before problems escalate.

Stablecoins are structurally vulnerable to exactly this dynamic. If one major issuer struggles to meet redemption requests, investors may rapidly begin to doubt the ability of others to do the same. What begins as a run on a single stablecoin can become a contagion across the sector.

This is not a hypothetical concern. Stablecoin runs have already occurred, and the pattern each time is familiar: once one issuer comes under pressure, confidence in others quickly follows.

What happens to the wider financial system if a major stablecoin issuer — a Tether or a Circle — were to fail? That question deserves a clear answer before the sector grows any larger.

Racing to catch up

Regulators are still grappling with how to respond.

In the United States, authorities have taken an increasingly supportive stance. Dollar-denominated stablecoins are seen as a way of reinforcing the global role of the US currency and generating additional demand for Treasury securities. The GENIUS Act translated that political enthusiasm into a regulatory framework highly favourable to the industry — the product, in no small part, of heavy lobbying by the crypto sector in the run-up to the 2024 elections.

European regulators have adopted a more cautious approach through the Markets in Crypto-Assets regulation (MiCAR). But important vulnerabilities remain, and one in particular deserves attention.

A new and particularly problematic structure has emerged: the multi-issuer stablecoin, in which the same token is issued across multiple jurisdictions but backed by separate reserve pools. Circle pioneered this model, issuing what is in effect two branches of the same stablecoin — one in the United States, one in Europe — each backed by its own reserves.

The problem arises in a crisis. MiCAR gives holders a right of redemption at any time and at par value, without a redemption fee. US holders of the same token, facing a run and knowing that European regulation offers faster access to funds, would have every incentive to seek redemption through the European branch — even though the European reserve pool was sized only to serve European holders. Those reserves could be rapidly overwhelmed.

Could the issuer simply transfer funds from its US reserves to cover the shortfall? Perhaps in normal times.

But financial history offers a cautionary lesson. During the 2008 crisis, German authorities blocked Unicredit from transferring liquidity from its German branch to Italy, despite the EU's formal prohibition on capital controls. In the spring of 2020, national authorities across Eastern Europe blocked similar transfers. In the current international environment, the assumption that US authorities would permit cross-border fund transfers in a crisis to bail out European stablecoin holders is optimistic at best.

The European Systemic Risk Board has recommended that multi-issuer stablecoins be banned outright. The President of the ECB, Christine Lagarde, has been unequivocal in her opposition. The French authorities, who initially authorised Circle's construct, are now facing challenges. The European Commission is under pressure to act.

A fragile foundation

Stablecoins are often described as a new and stable form of digital money. In reality, they reproduce a familiar pattern from financial history: privately issued instruments that promise stability but depend entirely on confidence in reserve assets and on institutional frameworks that may not hold under stress. The technology is new. The underlying vulnerabilities are not.

There is no compelling case for stablecoins in economies that already have efficient payments systems — unless one counts the facilitation of transactions that financial regulation is designed to prevent. Their foundations are fragile, their stability is contingent, and their growth raises serious questions that have not yet received adequate answers.

Stability is easy to promise in calm times. Delivering it when confidence disappears is another matter entirely.