Stablecoins could threaten future internet finance without stronger regulation

The growing role of stablecoins in crypto markets, decentralized finance and Web3 payment systems could expose the future internet to deeper financial instability unless regulators strengthen oversight, reserve transparency and cross-border supervision, warns a new systematic review published in Frontiers in Blockchain.

The study, titled "Stablecoins: financial risks, vulnerabilities, and implications for the future internet: a systematic review," finds that fiat-backed stablecoins such as USDT and USDC dominate the literature, while market and liquidity risks, credit risks, reserve opacity, regulatory gaps and weak supervision remain the most persistent threats to stablecoin reliability and the resilience of internet-based financial infrastructure.

Stablecoins move from crypto trading tool to financial internet infrastructure

Stablecoins were created to solve one of the major problems of cryptocurrencies: extreme price volatility. Unlike Bitcoin or Ethereum, which can fluctuate sharply, stablecoins are designed to maintain a relatively stable value by pegging their price to a fiat currency, a commodity, a basket of assets or, in some cases, an algorithmic stabilization mechanism.

This promise has pushed stablecoins far beyond their early role as a bridge between fiat money and cryptoassets. They now operate as liquidity tools, payment instruments, units of account and collateral across crypto exchanges, decentralized finance protocols and emerging Web3 platforms. In real-world settings, stablecoins have become a form of digital fiat within crypto markets, even though most are privately issued and do not carry the protections attached to sovereign money.

Central bank money is backed by monetary authorities, legal tender rules, lender-of-last-resort arrangements and established supervisory systems. Stablecoins, on the other hand, depend on private issuers, reserve structures, smart contracts, governance rules or market confidence. Their ability to maintain stability is not automatic, it depends on the strength of backing assets, redemption rights, reserve audits, legal classification and user trust.

The study identifies three broad stablecoin families.

• Fiat-collateralized stablecoins, including USDT, USDC, BUSD, TUSD and USDP/PAX, are generally backed by cash or cash-equivalent assets and are intended to redeem one-to-one against a reference currency, usually the U.S. dollar.
• Crypto-collateralized stablecoins, such as DAI and LUSD, use digital assets deposited in smart contracts, often with overcollateralization to manage volatility.
• Algorithmic stablecoins, including TerraUSD and similar designs, attempt to maintain parity by adjusting supply through programmed rules rather than relying on conventional reserves.

A fourth group consists of commodity-backed stablecoins, especially gold-backed tokens such as XAUT and PAXG. These link digital tokens to physical assets, creating a different risk profile tied to commodity prices, custody arrangements, ownership rights and reserve verification.

The review finds that fiat-backed stablecoins are the most widely used and the most frequently studied, reflecting their market dominance. USDT and USDC stand out because of their size, liquidity and central role in crypto trading. The study notes that stablecoins have been used more frequently than the U.S. dollar itself to purchase Bitcoin in recent years and account for a large share of cryptoasset trading volume, making their stability a key condition for the functioning of digital asset markets.

Additionally, their growing role increases their systemic importance. As stablecoins become embedded in digital payments, DeFi lending, tokenized asset settlement and cross-border transfers, their failure could affect far more than individual token holders. A stablecoin depeg, reserve crisis or redemption freeze could disrupt liquidity across multiple platforms and transmit shocks into traditional finance through banks, custodians and reserve asset markets.

This shift is a future internet issue, not only a crypto issue, the study points out. Web3 depends on decentralized infrastructures, distributed ledgers, smart contracts and tokenized value. In that environment, stablecoins can act as the monetary layer for digital transactions. If they are weakly governed, poorly backed or unevenly regulated, they could become points of fragility in the architecture of online finance.

Reserve opacity, depegging and algorithmic failures expose deep vulnerabilities

The review identifies market and liquidity risk as the most recurrent threats. Fiat-backed stablecoins are vulnerable when users doubt whether reserves are safe, liquid and sufficient. If a large number of holders demand redemption at the same time, issuers may be forced to sell assets quickly, potentially at a loss. If reserves include commercial paper, corporate debt, uninsured deposits or concentrated bank exposures, pressure can spread beyond the stablecoin market.

The temporary depegging of USDC after the Silicon Valley Bank collapse illustrates that risk. The event showed that even stablecoins backed by traditional financial assets can become unstable when reserve banks come under stress. It also revealed contagion channels inside crypto markets, because other stablecoins and DeFi protocols relied on USDC as collateral.

USDT has drawn sustained attention in the literature because of its key role in trading and repeated questions about reserve transparency. The review presents reserve opacity as a core financial vulnerability because stablecoins depend on confidence. Without standardized, frequent and independent audits, users cannot fully assess whether a token can meet redemption demands under stress.

Credit and collateral risks also vary by design. Fiat-backed stablecoins face risks tied to the quality of reserve assets and the solvency of banks or custodians holding those assets. Crypto-collateralized stablecoins face risks from sharp declines in the value of digital collateral. When crypto prices fall quickly, automated liquidations can trigger deleveraging spirals, weakening the peg and spreading stress across decentralized finance.

DAI shows both the promise and the difficulty of decentralized collateral models. Its overcollateralized structure can provide a buffer, but it remains exposed to volatility in the assets backing it, oracle failures and smart contract vulnerabilities. If collateral values collapse or automated systems misfire, the stablecoin can face pressure even without a centralized issuer.

Algorithmic stablecoins are presented as the riskiest category. The collapse of TerraUSD in 2022 remains the clearest example of how algorithmic stabilization can fail when confidence breaks. TerraUSD depended on its relationship with the LUNA governance token. When users lost confidence and LUNA's value plunged, the stabilization mechanism could not stop the downward spiral. The review also points to failures such as IRON Finance, where DeFi dynamics produced bank-run-like outcomes.

These highlight the danger of endogenous backing, where the system's stability depends on assets or tokens whose value is tied to confidence in the same ecosystem. Once doubts emerge, redemptions, governance-token declines and speculative attacks can reinforce each other. The result can be rapid and irreversible loss of parity.

Governance and operational risks cut across all stablecoin models. Centralized issuers create agency risks because users depend on private entities to manage reserves honestly and efficiently. Decentralized models introduce risks through smart contracts, token-holder governance, oracle systems and unclear accountability. In both cases, users may not know who is responsible if redemption fails, a contract is exploited, or reserves prove insufficient.

Consumer protection remains inconsistent. The review finds that many stablecoin holders face uncertainty over their legal rights. In some jurisdictions, it is unclear whether holders have a direct claim on reserves, a contractual claim against the issuer, a property right, an e-money claim, or no protected right in insolvency. This uncertainty becomes more serious during market stress, when redemption rights and creditor hierarchy determine whether users recover funds.

Commodity-backed stablecoins face a separate set of vulnerabilities. Gold-backed tokens may appear safer because they link value to a physical asset, but they still depend on custody chains, audits, insurance, ownership structures and commodity market stability. If users cannot verify the physical backing or enforce their ownership rights, the token's promise of stability weakens.

Fragmented regulation could weaken trust in future digital finance

The study finds that regulation is advancing, but not evenly. International bodies including the Financial Stability Board, the G20, the International Monetary Fund, IOSCO, the Basel Committee and the FATF broadly support the principle that similar activities and risks should face similar regulation. That means stablecoins used for payments, liquidity and settlement should not escape oversight simply because they are built on blockchain infrastructure.

The European Union's Markets in Crypto-Assets Regulation, known as MiCA, is presented as one of the most comprehensive frameworks. MiCA distinguishes asset-referenced tokens and e-money tokens, requires authorization, white papers, capital safeguards, liquidity rules, reserve standards, governance requirements and enhanced supervision for significant stablecoins. It also narrows the space for purely algorithmic designs, reflecting concern over models that lack credible external backing.

The United States remains more fragmented. Existing oversight is spread across federal agencies, state money transmitter rules and sector-specific enforcement. Policy proposals have called for stablecoin issuers to be treated more like supervised depository institutions and to hold safe, liquid reserves such as U.S. Treasuries or central bank reserves. But the absence of a unified federal framework continues to create uncertainty for issuers, users and markets.

Other jurisdictions have adopted their own approaches. For instance, the United Kingdom treats some stablecoins as systemic payment instruments. Japan limits issuance to regulated entities with strict reserve and custody standards. Singapore uses a licensing and prudential model that tries to balance innovation and risk controls. Switzerland classifies stablecoins according to backing structure and holder rights. Similarly, China and Russia restrict stablecoin use in settlements to protect monetary sovereignty.

This regulatory diversity creates risks for the future internet. Stablecoins move across borders, but regulation remains national or regional. If issuers can locate in looser jurisdictions while serving global users, regulatory arbitrage can concentrate risk in weakly supervised parts of the system. The review warns that this could undermine interoperability, accountability and trust in internet-based financial platforms.

The risks are especially high in emerging economies, dollarized countries and jurisdictions with weaker financial systems. Stablecoins can support financial inclusion, remittances and faster payments, but they can also accelerate capital flight, weaken local banking systems and reduce the effectiveness of monetary policy. If private dollar-linked tokens become widely used in domestic transactions, central banks may lose influence over money supply and payment infrastructure.

The study also stresses that stablecoins should be integrated into macroprudential supervision. Since they are increasingly linked to DeFi protocols, banks, exchanges, payment systems and tokenized assets, stablecoin risks cannot be monitored in isolation. Regulators need early-warning tools for peg instability, reserve stress, liquidity flows, DeFi exposures, market sentiment, cyber incidents and interconnections with traditional finance.