The International Monetary Fund's First Deputy Managing Director, Dan Katz, has suggested that domestic-currency stablecoins intended to reduce reliance on dollar-backed digital assets might instead accelerate their adoption. Speaking at the University of Cape Town on Friday, Katz explained that when local and dollar-denominated stablecoins operate on shared blockchain infrastructure, users gain the ability to convert between them seamlessly through decentralized exchanges, liquidity pools, or direct peer-to-peer swaps. This technical interoperability could reshape how foreign exchange activity takes place, moving it away from traditional banks and currency dealers and potentially reducing the ability of authorities to monitor and manage capital flows.
"In this way, local-currency stablecoins might even accelerate the adoption of FX stablecoins," Katz said in his speech. His remarks add to a growing debate among policymakers about whether stablecoins are a threat or an opportunity for monetary sovereignty and financial stability.
Understanding domestic stablecoins
Stablecoins are digital assets designed to maintain a steady value by pegging to a reserve asset, most commonly the U.S. dollar. Domestic stablecoins, by contrast, are pegged to a national currency such as the South African rand, the euro, or the Japanese yen. These instruments are often promoted by local regulators and fintech firms as a way to preserve the benefits of blockchain-based payments without exposing users to dollar-denominated systems.
In theory, if a country's residents can use a rand-backed stablecoin for everyday payments and savings, they have less reason to hold dollar-backed tokens. That, in turn, could help authorities maintain control over their currency and reduce the risk of dollarization. Katz, however, turned that logic on its head. By making it easier for users to move between domestic stablecoins and dollar stablecoins on the same rails, these local tokens could become a gateway rather than a barrier.
How blockchain interoperability changes the equation
One of the key insights from Katz's speech is that the technology underlying stablecoins matters as much as the currency they represent. If a domestic stablecoin is issued on a proprietary network that is not connected to global decentralized finance, then conversion into a dollar stablecoin is difficult and expensive. But if both tokens are issued on widely used networks such as Ethereum or Solana, users can swap them in seconds using a decentralized exchange or an automated market maker.
Liquidity pools, which are smart contracts that hold reserves of two or more tokens, allow users to trade one stablecoin for another with low slippage and without needing a trusted intermediary. Peer-to-peer swaps can also be conducted directly between users, sometimes through messaging platforms or specialized protocols. These mechanisms are generally available around the clock, in contrast to traditional bank transfers that are limited by business hours, correspondent banking relationships, and national payment systems.
Katz argued that this convenience could push foreign exchange activity out of the regulated banking system. When individuals and businesses can exchange domestic stablecoins for dollar stablecoins onchain, they no longer need to approach a bank or a licensed currency dealer. This reduces the visibility that authorities have into cross-border transactions and could weaken the effectiveness of capital controls and anti-money-laundering measures.
The South African case
Katz used South Africa as an example of the complicated dynamics at play. In the country, dollar-backed stablecoins have gained some traction, though adoption remains limited. Rand-linked stablecoins have attracted even less demand. This pattern suggests that users are not automatically drawn to stablecoins simply because they want a digital version of their local currency. Instead, they may be seeking the liquidity, stability, and global acceptance of the U.S. dollar.
South Africa has a relatively developed financial sector, but its currency is subject to volatility and the economy faces structural challenges. For many users, holding a dollar-backed stablecoin is a way to protect purchasing power without moving money into a foreign bank account. The fact that domestic stablecoins have not gained significant traction may indicate that the demand for stablecoins is primarily driven by dollar exposure rather than by a desire for blockchain-based local payments.
Katz cautioned that it was still too early to draw firm conclusions from the South African experience. The market is nascent, and user behavior could change as infrastructure improves and regulatory clarity increases. Nonetheless, the example highlights an important possibility: introducing a domestic stablecoin may not reduce dollarization; it could actually strengthen the appeal of the dollar by making it easier to move funds in and out of dollar-denominated tokens.
Different effects in different economies
The implications of stablecoins are not the same for every country, Katz noted. In economies that are already heavily dollarized, such as Ecuador, El Salvador, or Zimbabwe, stablecoins may simply replace existing physical or digital dollar holdings. In such cases, the impact on the overall level of dollarization might be relatively small, although the shift to onchain infrastructure could still affect banks and payment providers.
In countries where access to dollars is restricted and economic frameworks are weak, the effect could be more pronounced. If residents can obtain dollar-backed stablecoins through peer-to-peer markets or offshore exchanges, they may be able to bypass capital controls and local currency restrictions. This could increase foreign currency demand and put additional pressure on the exchange rate, making it harder for central banks to manage inflation and maintain financial stability.
Katz's remarks echo earlier analysis from the IMF, which has warned that dollar-backed stablecoins could improve foreign exchange access but also amplify the risk of currency runs. In a crisis, a stablecoin pegged to the dollar may offer a convenient escape route for residents seeking to abandon the local currency, accelerating capital flight. Domestic stablecoins, if poorly designed or insufficiently integrated with local payment systems, may not offer enough of a counterweight.
Regulatory challenges and the path forward
Given these risks, Katz urged authorities to bring the entire stablecoin ecosystem within their regulatory perimeter. That includes onramps, which are the channels through which fiat currency is converted into stablecoins; offramps, through which stablecoins are converted back into fiat; and onchain exchange points such as decentralized exchanges and liquidity pools. Leaving any of these unregulated could create gaps that undermine the effectiveness of broader financial oversight.
One challenge is that decentralized exchanges are often noncustodial and operate without a single entity that can be held accountable. Regulators may need to focus on the points where the digital and traditional financial systems intersect, such as payment service providers that offer onramp and offramp services or wallet providers that integrate with banking networks. Another challenge is the cross-border nature of stablecoin transactions, which may require international coordination among regulators.
Some jurisdictions have already begun to address these issues. The European Union's Markets in Crypto-Assets Regulation, or MiCA, imposes requirements on issuers of asset-referenced tokens and electronic money tokens. In Asia, Japan and Singapore have introduced licensing frameworks for stablecoin issuers and service providers. In the United States, federal and state regulators have been debating whether stablecoins should be subject to bank regulation or supervised under a new bespoke framework.
Katz did not prescribe a one-size-fits-all solution, but he made clear that inaction is not an option. As stablecoins become more integrated with the global financial system, authorities will need to develop tools to monitor onchain activity, enforce rules, and cooperate across borders. The private sector, meanwhile, will likely continue to innovate, creating new ways for users to move between currencies and assets without regard for national boundaries.
Background: the IMF and stablecoin research
The IMF has been studying stablecoins and digital assets for several years. In previous reports, it has highlighted both the potential benefits and the risks of these instruments. On the one hand, stablecoins can lower the cost of cross-border payments, improve financial inclusion, and provide a safe haven in unstable economies. On the other hand, they can facilitate tax evasion, money laundering, and capital flight, and they may pose a threat to monetary policy autonomy.
The IMF has also warned about the risks of so-called dollarization 2.0, a term used to describe the replacement of a national currency by a digital foreign currency such as a dollar-backed stablecoin. Even in countries without the same level of dollarization as Latin American economies, the widespread use of a foreign stablecoin could affect the transmission of monetary policy and reduce the effectiveness of lender-of-last-resort interventions.
The speech at the University of Cape Town is part of a broader effort by the IMF to engage with African policymakers on digital finance. Africa is seen as a potential hotspot for stablecoin adoption, particularly in countries with high inflation, weak banking infrastructure, or large remittance flows. Domestic stablecoins have been proposed in several African countries as a way to promote digital payments while preserving the national currency. Katz's remarks suggest that these initiatives may need to be carefully evaluated in light of their interaction with global dollar-backed stablecoins.
Industry reactions and open questions
The stablecoin industry has generally welcomed the IMF's engagement with the topic, though some participants argue that the risks of domestic stablecoins accelerating dollarization are overstated. They point out that stablecoins are simply a more efficient means of transferring value and that users will choose the asset that best meets their needs. If a domestic stablecoin is well-designed, has adequate liquidity, and is supported by a strong payment network, it could compete effectively with dollar-backed options.
Others, however, believe that the network effects of the U.S. dollar and the existing dominance of dollar stablecoins make it difficult for domestic alternatives to gain traction. This is especially true in international markets, where dollar stablecoins are accepted by a wide range of exchanges, merchants, and payment providers. A domestic stablecoin may be useful within a single country, but it is unlikely to be accepted elsewhere. As a result, users may keep their funds in dollar stablecoins for cross-border and longer-term purposes.
Another open question is how stablecoin issuers will respond to regulatory pressure. Some issuers have already pledged to comply with sanctions and stop serving users in prohibited jurisdictions. Others are operating in a gray area, claiming that they cannot control who uses their tokens because they are decentralized. The resolution of these questions will shape the extent to which stablecoins can strengthen or weaken monetary sovereignty.
The evolution of infrastructure is also important. As blockchain platforms add more stablecoin pairs and reduce transaction costs, the barrier to switching between currencies will continue to fall. This could make it even easier for users to move from a domestic stablecoin to a dollar stablecoin, potentially magnifying the effect that Katz described. Regulators will need to monitor these developments and adjust their approaches accordingly.
Source:Cointelegraph News