RPT-COLUMN-Stablecoins might reboot US 'exorbitant privilege': Mike Dolan

By Mike Dolan

LONDON, Sept 10 (Reuters) - An increasingly anxious debate about the rise of dollar-pegged "stablecoins" has started to dwell on the resurgence of global dollar dominance rather than a "de-dollarization" long talked about. But its private sector nature adds considerable angst.

Dollar stablecoins, which are pegged to the U.S. dollar and offer instant settlement, are used by crypto traders to move funds between tokens. They were given a shot in the arm by July's "Genius Act" framework legislation in U.S. Congress, which requires stablecoins to be fully backed by liquid assets such as cash and Treasury bills.

Stablecoins have enjoyed rapid growth, with their combined market capitalization more than doubling in the past 18 months to almost $280 billion- and some projections have this reaching $2 trillion within three years. The U.S. Treasury lauds the potential demand boom for its burgeoning debt.

However, they still represent only about 1% of global transactions and are still a rounding error in comparison with the $100 trillion global government bond market.

Even though dominated by two behemoths Tether and Circle, which together make up more than 80% of the total size, the number of stablecoins is expanding.

But 99% of this universe remains dollar-backed even though most transactions happen outside of the United States.

And it's this feature that many regulators and central banks are increasingly looking at in examining the potential for stablecoins to ever represent a significant portion of global money flows and cross-border transactions.

That's not unthinkable, given that stablecoins offer rapid settlement and the ability to avoid exchange controls, border taxes and international sanctions - attributes that could become ever more attractive in an increasingly shaky geopolitical environment.

China, for one, has zeroed in on the risk. Until recently, Beijing was only committed to the development of a sovereign digital yuan, but the government is now examining the rising use of yuan-backed stablecoins. Whether it's too late for it or other governments to catch up remains to be seen.

'INHERENTLY FRAGILE'

Many of the potential risks to the international financial system are detailed in a piece this week by economist Helene Rey in the International Monetary Fund's Finance and Development magazine, where she argues that regulators need to get a handle on this digital currency world's relatively opaque data sooner rather than later.

Rey acknowledged the potential efficiency advantages stablecoins could offer in cross-border transactions, particularly in unstable countries with weak governance, but she also outlined a withering list of risks.

"On the negative side are dollarization and its side effects, financial stability risks, potential hollowing out of the banking system, currency competition and instability, money laundering, fiscal base erosion, privatization of seigniorage, and intense lobbying," she wrote.

In particular, she highlighted the danger that could arise if stablecoins remain overwhelmingly dollar-backed, as this could reduce demand for non-U.S. government bonds to favor Treasuries. Indeed, IMF data shows that the U.S. bonds backing Tether and Circle already exceed the government debt of Saudi Arabia.

"These stablecoins could constitute a digital pillar strengthening the exorbitant privilege of the U.S. dollar," she wrote.

This could lead to seismic portfolio shifts and the push for a single unit of account, with the dollar the most obvious candidate given its huge head start.

And the development of stablecoins could also result in a new, much more fragile financial infrastructure. Governments may be able to lean on tech companies to retain some control over this universe, Rey said, but the co-existence of multiple and potentially competing private-sector networks could undermine the entire monetary system and lead to an "inherently fragile" world.

Given how relatively small the stablecoin industry still is, this may all seem overly apocalyptic.

But its trajectory is enough for contingency planning - not least how it might figure given the upheavals of U.S. policymaking toward the rest of the world and against a backdrop of worrisome government debt piles, long-term inflation concerns and a rocketing gold price.

Europe is also eyeing this universe warily, exploring how to maintain relatively tight control of crypto and stablecoin development even as it prepares legislation for a digital euro.

European Central Bank President Christine Lagarde said last week that legislators should demand "safeguards" and "robust equivalence regimes" from foreign issuers of stablecoins to prevent the risk of a run on reserves held in Europe.

The Federal Reserve also announced last week that it would host a conference on payments innovation next month, focusing in part on stablecoins and tokenization.

But it would certainly be ironic if crypto - a part of the financial sphere born out of skepticism about dollar stability - ends up being the thing that reinforces the greenback's dominance over time.

The opinions expressed here are those of the author, a columnist for Reuters

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