Digital dollar dominance and the rise of private money networks
The scale of stablecoin adoption has reached significant proportions. Tether and USDC collectively hold more US Treasuries than Saudi Arabia, demonstrating the substantial backing required for these instruments. This massive Treasury holding pattern creates important implications for global capital flows and US financial dominance. This article by Hélène Rey explores how digital financial technologies—especially stablecoins and tokenization—are transforming the international monetary system.
Main points
- Stablecoins and the dollar: Stablecoins, mostly pegged to the US dollar and backed by liquid assets such as US Treasuries, are increasingly used worldwide for payments and remittances, even outside the United States. This rise strengthens the dollar’s global dominance but also introduces risks like financial instability, banking sector disruption, increased dollarization, and potential circumvention of regulations.
- Privatized seigniorage: The widespread international use of dollar-pegged stablecoins may privatize seigniorage and help a few private companies accumulate significant power and profits, leading to more lobbying for deregulation and opacity in cross-border flows. This dynamic could destabilize the public-good aspect of the monetary system and impact fiscal health in countries outside the US.
- Tokenization and integration: Tokenization allows assets to be recorded and transferred digitally, possibly integrating payment, messaging, and asset exchange functions on a single platform. While this promises greater efficiency and global access, it also risks financial fragmentation and instability if uncoordinated or poorly regulated.
- Financial stability and data integrity: The new digital environment could fragment international finance, encourage currency competition, and create new vulnerabilities—especially to data breaches and quantum computing threats. The most secure currency networks might develop an “integrity privilege,” becoming safer and more attractive than others.
Stablecoins, Tokens, and Global Dominance
By: Hélène Rey – London Business School
Digital assets, dollar reserves, and the new exorbitant privilege
In this paper, by Marina Azzimonti, Vincenzo Quadrini examines whether the rise of Stablecoins – digital currencies pegged to the US dollar – will reinforce US financial dominance by increasing demand for dollar-denominated backing assets, or erode US financial privilege by providing substitutes that reduce global demand for traditional US Treasury securities. The authors model three distinct economies – the United States, Rest of the World, and a blockchain-based Digital Economy that transcends geographical boundaries. Their model tracks how agents gradually become familiar with and adopt digital financial services over time, starting from minimal adoption in 2023 and reaching 10% long-term penetration. The expansion operates through financial demand for Stablecoins as savings instruments and real substitution of traditional services with digital alternatives. Finally, the model uses 2023 data including US interest rates, foreign asset positions, and current Stablecoin market characteristics to ground the analysis in empirical reality.
Findings
- Strengthened US financial dominance: Contrary to expectations that digital currencies might erode dollar privilege, the expansion actually reinforces the US position by creating sustained demand for US-backed assets, leading to lower US interest rates and increased foreign borrowing capacity.
- Divergent consumption risk effects: The Digital Economy expansion creates winners and losers – US consumers face higher consumption volatility due to increased leverage, while Rest of World consumers benefit from better risk-sharing through improved financial instruments. Digital Economy residents experience the highest volatility as their wealth becomes more dependent on volatile current earnings.
- Complex transition dynamics: US interest rates follow a non-linear path, initially rising as Digital Economy agents increase Stablecoin supply, then declining as broader adoption increases demand for dollar-backed assets.
- Amplified global imbalances: The expansion deepens US external borrowing and enhances global financial integration, but distributes benefits asymmetrically across countries and populations.
- Market scale implications: With projected Stablecoin markets potentially reaching $2 trillion by 2028, the Digital Economy could grow from 0.2% to 1.1% of world output, creating instruments that rival some countries’ Treasury holdings.
Digital Economy, Stablecoins, and the Global Financial System
Authors: Marina Azzimonti, Vincenzo Quadrini
From: Federal Reserve Bank of Richmond, University of Southern California
