The Hidden Risk Behind Stablecoins: What Happens When Digital Money Gets Big

Large fiat-backed stablecoins are evolving into systemically important financial institutions, linking digital payments directly to sovereign bond markets and creating new risks of runs, fire sales, and market spillovers. Without strong capital and liquidity safeguards, these always-on global tokens could amplify financial stress, but with proper design they could operate safely within the financial system.

Stablecoins were created to address a fundamental issue in cryptocurrency markets: how to transfer money quickly without the extreme price fluctuations of Bitcoin or Ether. But new research from the International Monetary Fund, drawing on work by the Bank for International Settlements, the Financial Stability Board, and major central banks, shows that these digital tokens are quietly becoming something much bigger. As fiat-backed stablecoins grow, they are starting to resemble global financial institutions, with balance sheets large enough to influence government bond markets and payment systems.

Although stablecoins account for a relatively small share of the total crypto market value, they dominate crypto transactions and cross-border flows. Their high velocity shows they are used mostly for payments rather than speculation. To keep their promise of being redeemable at face value, issuers hold large reserves in short-term government bonds, reverse repos, money market funds, and bank deposits. By the mid-2020s, the biggest stablecoin issuers had become notable holders of U.S. Treasury bills, linking the stability of digital tokens directly to the world’s most important bond market.

Why Stablecoins Can Be Fragile

At first glance, fiat-backed stablecoins look safe. They are backed by high-quality assets and promise instant redemption at par. But the IMF paper explains that this structure hides a classic financial risk: liquidity transformation. Stablecoin issuers offer users money-like claims that can be redeemed at any time, while investing in assets that are liquid in normal conditions but harder to sell in stress.

Unlike banks or money market funds, stablecoins operate 24 hours a day, across borders, and without deposit insurance or central-bank backstops. Most users cannot redeem directly with the issuer and must rely on secondary markets, where prices can fall below par when confidence weakens. This means that even small shocks can lead to sudden price deviations and redemption pressure.

How a Run Can Turn Into a Market Shock

The most dangerous scenario described in the paper is a self-reinforcing feedback loop. If confidence in a large stablecoin drops, users rush to redeem. The issuer first uses cash reserves, but if those are exhausted, it must sell government bonds. Those sales push bond prices down and yields up, reducing the value of the remaining reserves. As solvency weakens, confidence falls further, triggering more redemptions.

Once a stablecoin issuer is large enough, this process does not stop at the issuer. Bond price drops affect banks, investment funds, and other holders of the same assets. What begins as a digital run can quickly spill into sovereign bond markets and broader financial conditions. The paper shows that these dynamics resemble past money market fund crises, but with one key difference: stablecoins move faster and across borders.

The Bigger Structural Risks

Beyond short-term crises, large stablecoins could slowly reshape the financial system. Issuers’ preference for short-term government bonds may shorten public debt maturities, increasing rollover risk for governments. Internationally, stablecoins make it easier for people in countries with weak currencies to use foreign money digitally, accelerating what economists call digital dollarization.

This can bring benefits, such as cheaper payments and more stable purchasing power. But it can also weaken domestic monetary policy, reduce seigniorage revenues, and make capital flight easier during times of stress. For smaller and emerging economies, these effects could be particularly destabilizing.

What the Research Says Should Be Done

Using a simulation model, the IMF researchers test how different design choices affect stablecoin stability. The results are clear. Capital buffers, where assets exceed liabilities, are the most powerful protection against runs and fire sales. Cash reserves help absorb redemptions and reduce bond sales. Shorter bond maturities limit valuation losses. Redemption gates can slow panic, but if poorly designed, they may push users to run earlier.

The main message is that stablecoins are no longer just a private tech product. If they become large, they must be treated like financial institutions. Strong capital and liquidity rules can turn stablecoins into relatively safe payment tools. Without them, stablecoins risk becoming a new source of financial instability, one that operates at digital speed and on a global scale.