Systematic opening-up crucial to mitigate stablecoin risks

US President Donald Trump signed the Guiding and Establishing National Innovation for US Stablecoins Act on Friday.

What kind of potential impact the introduction of stablecoins will bring to the global financial system, especially China’s financial system, and how China should respond have become urgent questions to answer.

The GENIUS Act, the first federal regulation in this regard, was passed by the US Senate in June and by the House of Representatives on Thursday when the House also passed the Digital Asset Market Clarity Act and the Anti-Central Bank Digital Currency Surveillance State Act, both of which still need to be passed in the Senate.

The GENIUS Act lays out standards for stablecoins, a kind of digital currency pegged to the dollar or other fiat currencies. Unlike volatile cryptocurrencies such as Bitcoin, stablecoins are designed to hold a steady value by being pegged one-to-one to a stable asset.

For every stablecoin in circulation, the issuing parties are required to hold equivalent reserves, such as cash, short-term US Treasury bonds and other “approved assets”.

The act also creates requirements for issuers to regularly share information about their reserves.

At present, dollar-based stablecoins occupy 98 percent of the global stablecoin market.

So the use of stablecoins is expected to help increase the demand for US treasuries, lower interest rates and secure the dollar’s status as the world’s reserve currency.

With an estimated market capitalization of around $250 billion, the dollar stablecoins are primarily used as an intermediate asset for trading or a tool for accessing the dollar in countries with hyperinflation or other monetary issues, making them a global cross-border payment tool, and strengthening the anchoring position of the dollar in the digital economy.

That represents an extension of the dollar hegemony in the digital age. By incorporating dollar stablecoins into compliant financial instruments, the United States hopes to consolidate the dollar’s global reserve currency status and create a new demand pool for US treasuries.

If the dollar stablecoin penetrates on a large scale, it will have a significant impact on China’s financial system.

China’s monetary system has a unique “offshore-onshore” dual structure. The two have been separated by a “firewall” for a long time, and the flow of funds is only realized through limited channels. This institutional arrangement has played an important role in maintaining financial stability over the past 30 years, though it continues to evolve gradually.

With the dollar stablecoin consolidating the global closed loop of dollar credit, the risk of US debt and the vulnerability of the dollar are bound more deeply. Once the credit of US debt is damaged, the stablecoin system will be simultaneously exposed to systemic risks. China is reportedly reducing its holding of US debt by increasing its holdings of gold and other overseas assets. China reduced its holdings of US Treasury bonds by $900 million to $756.3 billion in May, marking the third consecutive month it has reduced its holdings, according to US Treasury Department. After May’s reduction, it became the third-largest holder of US treasuries, following Japan and the United Kingdom.

However, China faces constraints in identifying diversified global assets that match the scale and safety of US treasuries. In addition, the domestic market and international capital channels have not yet been fully opened, and international investors’ holdings of Chinese assets remain modest. The internationalization of the renminbi is also constrained by the same cause — the offshore market has already injected a large amount of liquidity, while the mortgageable assets (stocks, real estate, etc) are all located onshore. This presents an opportunity for China to further align the offshore and onshore markets through prudent institutional innovation.

Only by accelerating its financial institutional opening-up while managing and controlling relevant risks can China enhance its global financial competitiveness, promote the internationalization of the renminbi, and strengthen the currency’s pricing power to mitigate the potential impacts of dollar stablecoins.

By capitalizing on multilateral platforms and by deepening trade and energy cooperation with key regions, China is well-positioned to expand the global use of the renminbi. This will lay the groundwork for a more resilient and multipolar global financial system.