This post was originally published on this site.
Stablecoins look like smooth plumbing. They are closer to accelerants poured on dry timber. The immediate convenience hides a simple fact of market physics: when you offer on-demand redemptions against assets that are not on-demand, you have built a run-prone machine. That is true whether the label reads bank, money-market fund, or dollar-pegged token.
Stablecoin liquidity is maturity mismatch by another name
Stablecoins promise instant convertibility into fiat. Their reserves, when they are responsible, sit in cash and short-term government paper. That sounds safe until stress hits. If redemptions spike, issuers must raise cash. Cash comes from selling Treasuries or pulling funds from banks. In quiet times, the system looks stable. Under pressure, the bonds are sold into the same narrow windows, and bank deposits shrink at speed. Central bankers in Europe have warned about this, not from ideology, but because the math lines up: a retail run that begins on a crypto exchange ends in the regulated money markets via fire sales. The U.S. Financial Stability Oversight Council has used the same word the industry avoids: run.
Shadow banking, with an API and a marketing budget
Strip the code and branding, and stablecoins function like money-market funds bolted to a retail front end. The economic activity is familiar: maturity transformation without deposit insurance, with partial access to banking rails, and with high-speed redemption. Policymakers in Washington tried to draw bright lines with a federal framework last year. Yet banks have already flagged the workaround: if issuers pay “rewards” to token holders, they can mimic interest and siphon deposits without being treated as banks. Europe’s MiCAR set ground rules for asset-referenced and e-money tokens, but left a glaring hole: the same coin can be issued from two jurisdictions, with one set of reserves and multiple legal claims. In a large redemption, who gets paid? The queue is global, the law is local. Game theory says everyone runs first.
Dollarization is not a bug, it is the business model
The benefits of dollar-denominated stablecoins to the United States are obvious. They export dollar access, deepen demand for Treasury bills, and extend U.S. soft power without a single branch built abroad. Asset managers in Europe have been blunt about the flip side: a retail wallet in Lagos or Ljubljana can hold dollars without a U.S. bank account. That is inclusion for the user and disintermediation for the local system. For the euro area and the UK, the math is different. Stablecoins tilt funding away from domestic banks toward a dollar liquidity stack they do not control. The short-term consumer upside competes with monetary sovereignty and bank resiliency. If one jurisdiction opens the door, rivals are pushed to follow. It is a prisoner’s dilemma with the dollar in the dominant strategy.
Liquidity illusions meet fat tails
The failure of algorithmic pegs like TerraUSD was not an exotic black swan. It was reflexivity on display: when confidence is the collateral, a small loss of peg triggers forced selling, which triggers more redemptions. Investors dismissed that as a design flaw unique to “algo” coins. They missed the broader lesson. In stress, correlations go to one. Even overcollateralized or reserve-backed stablecoins wobble when their banking partners wobble or when a large holder hits the exit on a weekend. The simplest assumption in peacetime — that bills can always be sold at par — is the first to break in a dash-for-cash. Liquidity that seems continuous becomes lumpy and rationed. That gap is where stablecoins can turn from harmless plumbing into a transmission belt for shocks into the Treasury market itself.
Banks lose deposits. The core gets brittle
Consumer behavior shifts with interface, not white papers. Once money lives in a 24/7 token, every negative headline becomes a potential instant bank run. Households that would wait in a branch queue can now redeem with a swipe. When that sits atop a non-bank issuer, the run does not stop at the issuer. Funds are pulled from commercial banks where reserves are held. Wholesale funding backfills the hole at a higher cost. It is not a theory; it is how bank balance sheets respond when retail deposits flee. European officials worry about this because their banks rely more on stable retail funding. A broad migration to dollar-pegged tokens can leave domestic banks thinner, more fragile, and more dependent on central bank liquidity. The stablecoin then, ironically, increases central bank footprint in crises.
A tightly coupled system fails fast
Engineers do not fear complexity; they fear tight coupling without buffers. Stablecoins connect consumer wallets, crypto exchanges, DeFi protocols, market makers, custodial banks, and the Treasury market. Each node is audited on paper, but the links are what break under stress. A delay at a custodian, a redemption flood from an exchange, a liquidity mismatch in a treasury ETF used as a reserve proxy — the system routes the problem through the narrowest pipe. Aviation learned to add redundant hydraulics and containment for engine failures. Payments should learn the same. If authorities permit large stablecoins, they need circuit breakers, redemption gates, and pre-funded liquidity backstops that do not rely on selling the same assets everyone else will sell. That adds friction, but friction is a feature in systems that must not fail all at once.
Regulation must choose between narrow banks and caps
There are only three coherent paths. Treat systemic stablecoins as narrow banks with 100 percent reserves at the central bank, explicit supervision, and no asset-liability mismatch. Cap their size and market share, forcing competition to remain subscale so runs cannot propagate. Or channel the same functionality into public money rails, whether a retail-facing central bank platform or a limited-purpose digital euro or Fed service that removes the need for private pegs. Anything short of that invites regulatory arbitrage. The current patchwork — a federal law with loopholes on interest-by-another-name, a European framework that tolerates dual issuance from offshore affiliates — incentivizes issuers to grow in the shadows until the next stress test arrives.
The dollar wins. The system still risks losing
It is tempting in Washington to accept the trade. More global dollars, more Treasury demand, more network effects. But first-order benefits can carry second-order costs. A large, runnable pool of dollar IOUs sitting outside the banking system will sell the same assets at the same time under pressure. That can turn a stablecoin wobble into a Treasury market air pocket. The soft power that comes from exporting dollars should not rest on brittle pipes. A modest inversion helps. Make run-risk expensive. Impose liquidity fees that rise with outflows, as some money-market reforms did. Demand same-day disclosure of reserve composition and custodians. Ringfence banking partners from concentrated issuer deposits. These measures are not glamorous, but they build buffers where the current system has none.
Stablecoins are a useful laboratory. They expose how much of modern finance leans on confidence and choreography rather than true redundancy. If policymakers want the benefits — faster payments, broader access to stable value — they can get them without importing the failure modes of shadow banking. Resist scale without safeguards. Else, the convenience of one-click dollars becomes the next conduit for the oldest risk in finance: a run that everyone saw coming, and no one slowed down.