The specter of financial contagion has found a new vessel in the digital age, as central banking authorities sound increasingly urgent alarms about stablecoins—those ostensibly “stable” cryptocurrency tokens that promise dollar-for-dollar backing while operating in a regulatory twilight zone that would make traditional money market fund managers blanch.
The scale of concern becomes apparent when considering that major stablecoins now rival large money market funds in size, yet operate with reserve management practices that would charitable be described as creative.
Major stablecoins now match money market funds in scale while embracing reserve practices that would charitably be called experimental.
While traditional financial institutions face rigorous oversight regarding their collateral holdings, stablecoin issuers have embraced short-term money market instruments as backing—a choice that introduces precisely the vulnerabilities regulators spent decades trying to eliminate from the broader financial system.
The mechanics of potential contagion read like a textbook case study in systemic risk. When confidence wavers (as it did with TerraUSD’s spectacular collapse in May 2022 or USDC’s brief de-pegging during March 2023’s banking stress), redemption waves can trigger fire sales of reserve assets.
These forced liquidations don’t occur in isolation—they ripple through securities markets, payment processors, and the broader financial infrastructure that stablecoins have quietly integrated themselves into.
Perhaps most concerning is the regulatory vacuum surrounding these instruments. Unlike their traditional counterparts, stablecoins operate across borders with minimal oversight, creating what amounts to a parallel monetary system with global reach but localized accountability. The regulatory uncertainty persists despite attempts to impose traditional oversight frameworks on these decentralized digital assets.
Emerging market economies face particular challenges, where foreign currency-pegged stablecoins dominate while regulatory capacity remains limited. The capacity constraints in these jurisdictions create additional vulnerabilities as authorities struggle to implement effective oversight frameworks for increasingly complex digital asset operations.
The FTX exchange collapse in November 2022 illustrated how quickly crypto-related vulnerabilities can cascade through interconnected systems.
Banking authorities now recognize that stablecoins represent potential contagion channels through financial sector exposures, wealth effects, and payment system integration—vectors that could amplify rather than contain financial instability. The rapid expansion of stablecoins is reshaping financial stability risks and regulatory boundaries, with existing oversight frameworks struggling to keep pace and diverging regulatory approaches risk fragmenting global digital finance.
The irony isn’t lost on observers: instruments designed to provide stability in the notoriously volatile cryptocurrency markets may themselves become sources of instability for the traditional financial system they increasingly resemble.
As one central banker might privately observe, we’ve managed to recreate the risks of unregulated banking while calling it innovation.
