Stablecoin Flows Risk Pulling Liquidity from Banks

Stablecoins promise to speed up international value transfers by bypassing legacy infrastructure. However, they could also pull liquidity from banks if demand for dollar-denominated value grows rapidly.

The use of stablecoins can be seen in two time horizons: slow currency substitution over months or years and fast shocks that move capital at software speeds within hours.

According to Anthony Vassallo, director of crypto at Silicon Valley Bank before it failed in March 2023, the shift towards stablecoin competition will show up in these two time horizons. He argues that the slow clock builds over months or years through currency substitution and deposit erosion, while the fast clock creates a liquidity mismatch between stablecoins and banks.

Regulators are concerned about how stablecoin reserve requirements interact with traditional banking liquidity. The European Central Bank has warned that reserve structures may intensify stress if large stablecoin holdings are backed by assets sitting in bank deposits.