Domestic-currency stablecoins designed to reduce reliance on dollar-backed tokens could have the opposite effect, according to a senior International Monetary Fund official.
IMF First Deputy Managing Director Dan Katz said on Friday that once local stablecoins and dollar stablecoins operate on shared blockchain infrastructure, users can move funds between them through decentralized exchanges, liquidity pools or peer-to-peer swaps. In a speech at the University of Cape Town, Katz said this frictionless movement may shift foreign exchange activity away from traditional financial intermediaries, reducing the visibility that authorities rely on to monitor and manage capital flows.
“In this way, local-currency stablecoins might even accelerate the adoption of FX stablecoins,” he said.
Stablecoin Interoperability and FX Flows
The IMF's comments highlight a growing concern among policymakers worldwide: stablecoins, once seen as a niche crypto product, are now deeply intertwined with the traditional financial system. Dollar-backed stablecoins such as USDT and USDC have become critical tools for trading, payments, and remittances. Their total market capitalization exceeds $150 billion, and they are widely used as a gateway between fiat currencies and digital assets.
Domestic stablecoins, often pegged to local currencies like the South African rand, the Indian rupee, or the Brazilian real, have emerged as a potential counterweight to dollar dominance. Governments and central banks have explored them as a way to preserve monetary sovereignty and reduce the appeal of dollar-denominated digital assets. However, Katz's remarks suggest that these intentions may backfire if stablecoins exist on the same blockchain networks.
When a local stablecoin and a dollar stablecoin are both issued on Ethereum, BNB Chain, or another major network, users can swap between them in seconds using automated market makers or decentralized liquidity pools. These swaps require no bank approval, no foreign exchange desk, and no reporting to regulators. A user holding a rand-pegged token can convert it into a dollar-pegged token instantly, often at a rate determined by global liquidity rather than official exchange controls.
This ease of conversion could make capital controls more difficult to enforce. In traditional finance, moving money from a local currency into dollars typically involves a bank, which is subject to anti-money laundering rules, know-your-customer requirements, and reporting obligations. Stablecoin swaps bypass these intermediaries, creating a parallel financial channel that is fast, global, and largely permissionless.
South Africa's Stablecoin Landscape
Katz pointed to South Africa as a case study. The country has seen relatively limited adoption of dollar-backed stablecoins, while rand-pegged tokens have attracted even less demand. This is not surprising, given the dominance of the dollar in global trade and finance. Even in countries with stable currencies, many users prefer dollar stablecoins because of their deep liquidity, widespread acceptance, and established network effects.
South Africa has a sophisticated financial system and a regulatory environment that has been actively engaging with crypto assets. The Financial Sector Conduct Authority has declared crypto assets to be financial products, bringing them under the umbrella of existing financial regulations. Yet despite this regulatory clarity, local stablecoins have not gained significant traction.
One reason is that the rand itself is relatively liquid and accessible. South African residents can open bank accounts, hold foreign currency within certain limits, and access international payment systems. The demand for dollar stablecoins may therefore be driven more by trading and investment purposes than by a need to circumvent capital restrictions.
Katz noted that it was still too early to draw firm conclusions from the South African experience. He said many users may favor dollar tokens because of their liquidity, network effects, and acceptance across platforms and borders. These features are self-reinforcing: more users mean deeper liquidity, which attracts more users, which increases acceptance. A new rand stablecoin would need to overcome this network effect, a steep challenge for any local currency project.
Risks Vary by Country
The IMF official emphasized that the risks associated with stablecoins are not uniform. In highly dollarized economies, where residents already use physical dollars for everyday transactions, stablecoins may largely replace existing holdings rather than create new demand. In such countries, the primary concern is not the expansion of dollar usage but the shift from physical cash to digital tokens, which may be harder to track and regulate.
In countries where access to dollars is restricted and economic frameworks are weak, stablecoins could increase foreign-currency demand in ways that amplify currency runs. If a local currency is depreciating rapidly, residents can use stablecoins to move their savings into dollars within minutes, without waiting in line at a bank or paying high fees for informal currency exchanges. This could accelerate capital flight and put additional pressure on the exchange rate.
For emerging markets, this creates a policy dilemma. On the one hand, stablecoins can improve financial inclusion and reduce transaction costs for cross-border trade and remittances. On the other hand, they may undermine monetary policy, reduce the effectiveness of capital controls, and expose households to the risks of a digital asset ecosystem that is notoriously volatile and prone to fraud.
Regulatory Response and Onchain Exchange Points
Katz urged authorities to bring onramps, offramps, and onchain exchange points within regulatory frameworks. This is not a simple task, as decentralized exchanges operate without a central authority and cannot be easily shut down. However, regulators can influence the ecosystem by focusing on the bridges between the crypto world and the traditional financial system.
Licensed crypto exchanges, bank partnerships, and payment processors serve as onramps and offramps. By applying anti-money laundering and know-your-customer requirements to these gateways, regulators can maintain a degree of oversight even if onchain swaps are permissionless. Some jurisdictions have already adopted this approach, including the European Union's Markets in Crypto-Assets Regulation and the United States' ongoing regulatory efforts.
Another approach is to require stablecoin issuers to hold reserves in regulated financial institutions and to provide regular audits. This ensures that token holders can redeem their stablecoins for fiat currency at any time, reducing the risk of a run on a stablecoin that is not fully backed. The IMF has previously called for comprehensive global standards for stablecoins, arguing that the current patchwork of national regulations is insufficient to address cross-border risks.
Historical Context and Earlier IMF Warnings
This is not the first time the IMF has addressed the impact of stablecoins on the global financial system. In recent reports, the institution has warned that dollar-backed stablecoins could improve foreign exchange access but also amplify currency runs in fragile economies. The IMF has also noted that stablecoins could facilitate the internationalization of currencies without the consent of the issuing country, potentially complicating monetary policy.
The institution's research has explored the idea of a global stablecoin framework that would require issuers to hold high-quality liquid assets, provide full transparency, and comply with anti-money laundering standards. Such a framework would aim to capture the benefits of stablecoins while reducing their risks to financial stability.
Katz's speech adds a new dimension to this analysis by focusing on the interaction between domestic and dollar-backed stablecoins. The notion that local stablecoins could increase demand for digital dollars is counterintuitive and poses a significant challenge for policymakers who see stablecoin legislation as a tool to protect national currencies.
Network Effects and Liquidity
Network effects play a crucial role in the adoption of stablecoins. A stablecoin is only useful if it can be traded, accepted, and redeemed easily. Dollar stablecoins benefit from being integrated into nearly every major crypto exchange, lending platform, and payment service. They serve as the base currency for the vast majority of crypto trading pairs and are often the first asset that users buy when entering the market.
Liquidity is another key factor. The largest dollar stablecoins have billions of dollars in daily trading volume, meaning that users can execute large transactions without significantly moving the price. Local stablecoins, in contrast, often have thin markets and high slippage, making them less attractive to institutional users.
Cross-border acceptance also matters. A dollar stablecoin can be sent to any wallet in the world, and many merchants and service providers accept it as payment. A rand stablecoin, by contrast, is primarily useful if the counterparty also wants to hold or transact in rands. This limits its utility and reinforces the dominant position of the dollar.
Implications for Monetary Sovereignty
The IMF's analysis raises fundamental questions about monetary sovereignty in the digital age. If stablecoins enable users to switch between currencies with a few clicks, the ability of central banks to control the money supply, set interest rates, and manage exchange rates may be eroded. This is particularly concerning for small open economies that are vulnerable to capital flow volatility.
However, Katz also suggested that stablecoins could bring benefits. They can reduce the cost of cross-border payments, increase financial access for unbanked populations, and provide a hedge against inflation in countries with unstable currencies. The challenge for regulators is to maximize these benefits while minimizing the risks to financial stability and monetary policy.
The IMF has advocated for international cooperation to address these issues. Because stablecoins operate across borders and can be issued from anywhere in the world, no single regulator can effectively govern them. A coordinated approach that involves standard-setting bodies, central banks, and financial intelligence units is essential.
Looking Ahead
As the stablecoin ecosystem continues to evolve, the relationship between domestic and dollar-backed tokens will be an important area of study. The South African experience is just one data point, but it suggests that simply creating a local stablecoin does not ensure adoption. Users are likely to choose the token that offers the most liquidity, the greatest utility, and the fewest barriers.
Katz's warning should serve as a cautionary note for governments considering stablecoin legislation as a way to maintain currency sovereignty. Unless local stablecoins can match the network effects of dollar-backed tokens, they may end up facilitating the very dollarization that policymakers sought to avoid. Regulators must therefore think carefully about how to design the interaction between different stablecoins and the traditional financial system, ensuring that the infrastructure is transparent, supervised, and aligned with broader economic objectives.
Source: Cointelegraph News