By Simone Cortese, Chief Product Officer for Fnality International
Stablecoins are opening up more efficient ways to move money and transact on-chain. But large-value wholesale transactions have more complex requirements, raising questions about the respective roles of stablecoins, tokenised deposits and central bank money in the new digital money ecosystem.
Key Takeaways
- Stablecoins have become a powerful innovation for payments, but they may need to be supplemented by additional types of settlement in wholesale markets.
- Central bank money should remain part of the critical architecture for large-value wholesale transactions.
Digital money is entering a new phase as activity moves beyond experimentation into real-world financial activity. Stablecoins are proving fast, programmable and useful across markets and borders. Tokenised deposits are also gathering momentum as commercial bank liabilities move onto new rails.
The harder question is what role these instruments can play when large-value wholesale transactions have to be settled. Moving value faster is not the same as having a sufficiently high-quality settlement asset. For regulated institutions, international supervisory guidelines state that settlement must close out an obligation without simply replacing one risk with another, achieving true settlement finality.
Stablecoins clearly have a role to play in settling obligations within institutional markets, with total supply already exceeding $300 billion. But being a useful global payment instrument is different from providing the common asset in which large institutions ultimately settle their obligations at the core of the financial system, where exposures can run to trillions of dollars.
What wholesale markets require
Wholesale settlement is not simply retail or institutional payment at a larger scale. There are three things that must be supported for it to work: finality, settlement-asset quality and interoperability. In other words, the obligation must be formally, and finally, extinguished with complete certainty; the settlement asset should not add unnecessary private credit risk; and different forms of digital money must be able to work across banks, issuers, ledgers and jurisdictions.
Stablecoins have obvious strengths, such as the ability to store value between crypto trades and support cross-border and corporate payments. However, users are likely to manage stablecoin balances actively, moving funds into yield-bearing assets when they are not required for payments. This may limit their velocity and reinforces the importance of considering the specific use case.
Additionally, there are challenges in using stablecoins as a means of payment when their value is based on underlying assets whose prices may vary. If stablecoin reserves are not legally ring-fenced, for example, the holder ultimately has a claim on the issuer. If they are ring-fenced, the claim is on a pool of assets. That can provide stronger protection, but it is still not the same as holding central bank money, which does not introduce asset, credit or operational risk from the stablecoin issuer, collateral originator or custodian, respectively.
Stablecoin reserves may contain cash, Treasury bills or other high-quality liquid assets (HQLA). But securities must be marked to market and may have to be financed or sold to meet redemptions during market stress events. As wholesale-market veteran Olaf Ransome, the self-described Bankers’ Plumber, puts it: “Always start with who has a claim on what.”
History shows why this matters. A Bank for International Settlements (BIS) study of 68 stablecoins found that not one maintained its peg absolutely in all scenarios. A promise of par is not the same as settlement at par. As stablecoin volumes continue to grow, repeatedly accepting privately issued money might create exposure elsewhere in that chain that ultimately needs to be cleared. Global systemically important banks (GSIBs) cannot continue building those exposures indefinitely, and BIS guidelines suggest that the “clarity and certainty of settlement finality is critical for mitigating settlement risk, which if not properly managed, could lead to systemic risk.”
Another issue is who will accept stablecoins on what terms. A dealer receiving $200 of one stablecoin and $300 of another does not necessarily have $500 that its next counterparty will accept. Different issuers can also mean different claims, liquidity and risks, so the dealer may have to redeem, exchange or clear them first. Even if stablecoins are backed by HQLA, their full value may not always be immediately available in cash, particularly during periods of market stress. Where banks are involved, the movement of cash and assets between affiliates and entities can present additional challenges, especially when different risk limits apply to each. Frequently addressing those risk limits with proper settlement of the relevant exposures is how banks can avoid ramping up risk or creating bottlenecks. None of this diminishes what stablecoins can do. It explains why they can work extremely well in bilateral or closed payment flows without automatically becoming the universal answer for wholesale settlement. A corporation paying suppliers in the same stablecoin has a compelling use case. A bank closing out obligations across repurchase agreements, derivatives or securities exposures with multiple counterparties is solving a different problem.
Tokenised deposits also have an important role to play in the emerging digital money ecosystem. They are programmable commercial bank money in digital form, well suited to supporting client activity, including treasury activities, cross-border payments and tokenised securities transactions. They should therefore be viewed as complementary to, rather than a replacement for, settlement in central bank money.
When used for large-value wholesale settlement, the underlying credit exposure remains. If Bank A accepts Bank B’s tokenised deposit, Bank A has exposure to Bank B, so the risk is transferred rather than extinguished. Connecting tokenised deposits with regulated wholesale payment infrastructure can preserve programmability across the transaction lifecycle, while enabling the underlying interbank obligation to be settled in central bank money balances. Tokenised deposits can put commercial bank money onto programmable infrastructure. Tokenised funds can mobilise collateral. But wholesale markets also need a neutral point at which material private exposures between GSIBs can finally end. The emerging model is therefore not about choosing a single form of digital money. It is about enabling stablecoins, tokenised deposits and tokenised assets to interact with a trusted settlement layer in central bank money.
In a world moving towards 24/7 global flows, we need architecture that can support settlement not just in one jurisdiction, but across jurisdictions in a harmonised way, enabling regulated flows of money.
The settlement layer beneath
The case for retaining central bank money at the heart of wholesale settlement, rather than anything less safe, is not just a matter of wholesale convention; it is also supported by recent statements from market authorities. In a new research paper for the Federal Reserve’s Jackson Hole symposium, Stanford University finance professor Darrell Duffie argues that stablecoins and tokenised commercial bank deposits are not sufficiently safe for multi-trillion-dollar applications between GSIBs. “Systemic financial-market infrastructure should rely for settlement on the literal unit of account, which only central banks can provide,” Duffie writes.
European Central Bank Executive Board member Isabel Schnabel reached a similar conclusion in her response to Duffie’s paper. “Stablecoins cannot be a substitute for central bank money in settlement,” she wrote. Schnabel goes on to argue that a safe settlement asset must not only avoid credit, liquidity and redemption risk; its supply must also be able to expand when liquidity demand surges. Central banks can provide liquidity elastically in times of stress; stablecoin issuers cannot.
That does not diminish the role of stablecoins. Schnabel herself says they can complement central bank money and broaden the range of payment instruments. It points instead towards a division of labour: stablecoins can extend the reach and functionality of digital money, tokenised deposits can bring commercial bank money onto programmable rails, and central bank money can provide the trusted settlement foundation beneath large-value wholesale activity.
As the ecosystem develops, clearer supervisory expectations around which settlement assets are best suited to which use cases could help these forms of money scale alongside one another, while retaining central bank money for large-value wholesale transactions where settlement risk matters most.
Interoperability is key to this future state. Issuers cannot sensibly integrate separately with every ledger, domestic payment system and central bank initiative. Specialised networks and different forms of money need to interact, while preserving access to a common settlement foundation.
As more value moves across stablecoins, tokenised deposits and tokenised assets, the need for this sort of common settlement foundation becomes increasingly important. Private forms of money can move value quickly and programmably, but large obligations still need somewhere they can be extinguished without adding another layer of private credit risk.
The stablecoin era does not lessen the need for central bank money in wholesale markets. It makes the settlement layer beneath it more important.
