India: 6 potential risks of stablecoins for developing economies, according to central bank

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Stablecoins have gained significant attention in the digital currency sector due to their relative stability. However, the Reserve Bank of India (RBI) has highlighted several risks associated with stablecoins that could adversely impact developing economies. In this article, we will look into the six key concerns raised by the RBI regarding the potential risks stablecoins pose to developing economies.

1. Threat of currency substitution

Stablecoins, if widely adopted, could pose a threat to developing economies through currency substitution. As stablecoins are often pegged to traditional fiat currencies, individuals may prefer to hold stablecoins rather than domestic currency, potentially undermining the local currency’s value and causing an outflow of funds from the country. This could lead to reduced monetary sovereignty and hamper the central bank’s ability to manage the domestic economy effectively.

2. Challenges to domestic interest rate and liquidity management

The presence of stablecoins in an emerging market and developing economy (EMDE) can pose challenges for the central bank in setting the domestic interest rate and managing liquidity conditions. Stablecoins, operating outside central banks’ control, may attract deposits and investments, reducing the effectiveness of monetary policy tools. This lack of control can complicate efforts to stimulate economic growth and maintain financial stability.

3. Currency mismatches and ‘Cryptoisation’ of the economy

The widespread adoption of stablecoins in an EMDE can result in the ‘cryptoisation’ of the economy. This refers to the increasing use of digital currencies as a medium of exchange, as a store of value, and unit of account. Such a scenario could lead to currency mismatches on the balance sheets of banks, firms, and households. The RBI is concerned that this shift could disrupt the financial system, potentially exposing these entities to exchange rate risks and impacting overall economic stability.

4. Circumvention of capital flow management measures

Developing economies often implement capital flow management measures to regulate the inflow and outflow of funds, ensuring financial stability. However, the decentralized, borderless, and pseudonymous characteristics of stablecoins make them attractive instruments for circumventing these measures. Individuals and entities may use stablecoins to bypass capital controls, potentially leading to unregulated capital flows, increased volatility, and challenges in maintaining stability within the financial system.

5. Interference with credit risk assessment and money mobilization

Stablecoins may hinder the capacity of banks to raise capital and extend loans, undermining credit risk evaluation. It might restrict the bank’s access to capital if people and businesses choose to store stablecoins rather than deposit money in conventional banks. This can limit their capacity to extend credit and make loans, thus limiting long-term economic growth.

6. Increased potential for illicit activities

Since using stablecoins permits anonymous peer-to-peer transactions, it raises the possibility that these transactions will be misused. The inability to efficiently trace these transactions and the lack of transparency could facilitate illegal acts, including money laundering, supporting terrorism, and other financial crimes. If stablecoins are extensively adopted without sufficient legal frameworks, developing countries, which are already dealing with these difficulties, may be exposed to greater hazards.

Although stablecoins have some benefits in terms of accessibility and stability, developing economies should be aware of six possible hazards, according to the RBI. These risks, which range from currency mismatches, circumvention of capital flow controls, interference with credit risk assessment, and the possibility of illegal activities to threats of currency substitution and challenges to domestic interest rates, emphasize the need to establish strong regulatory frameworks. In order to protect their economies and financial systems from potential disruptions caused by stablecoins, developing economies must find a balance between encouraging financial innovation and taking the appropriate precautions.

Watch: Stablecoins with Daniel Lipshitz