The idea of a “stablecoin” — a cryptocurrency fully backed by a trusted asset such as gold or the US dollar — is often presented as a bridge between traditional finance and the crypto world. Proponents argue that asset backing, speed, and convertibility make stablecoins a credible alternative to sovereign currency. Yet, when examined through the lenses of monetary legitimacy, financial stability, and public policy, the concept raises serious concerns, especially for countries like India.
The intuitive appeal of asset-backed digital money
At first glance, the idea appears straightforward. Investors put money into an ETF-like structure based on a measurable asset — say 10 or 100 grams of gold — and a digital token is issued against this holding. Since gold and the US dollar are universally accepted stores of value, the resulting “stablecoin” appears safer than volatile cryptocurrencies. Central banks themselves hold gold and dollars as part of their reserves, lending the concept an air of credibility.
However, asset backing alone does not make something a legitimate currency.
Why central bank backing matters
A useful historical parallel comes from India itself. In the 1980s, during a shortage of small-denomination coins, Mumbai’s public transport operator issued tokens that could be used in place of coins. These tokens functioned temporarily as money but soon created a crisis: the transport utility accumulated large volumes of its own tokens, which had no value outside the system and no backing from the central bank. Revenues collapsed, and the experiment was abandoned.
The lesson is fundamental. For any medium of exchange to function as money at scale, it must have the backing and guarantee of a central bank. Without this, there is no assurance of acceptance, redemption, or stability.
The problem with private stablecoin issuers
In principle, anyone could issue a stablecoin backed by gold or dollars. This creates two systemic risks. First, there is no binding guarantee that the issuer will honour redemption claims during stress. Second, the assets backing stablecoins are rarely kept idle. They are typically invested to earn returns, exposing them to valuation risks.
If asset values fall, or liquidity dries up, redemption may become impossible — triggering contagion across markets. This risk exists even when the backing asset is the US dollar, and is higher with volatile assets like gold.
Dollar-backed stablecoins: convenience or concealment?
Stablecoins such as Tether, USDC, or DAI are generally backed by the US dollar. The obvious question then arises: if a safe dollar exists, why use a private digital substitute?
The usual answers are speed and anonymity. Traditional banking channels take time, especially across borders, while stablecoins settle quickly. They are also widely used in crypto trading precisely because they avoid banking oversight and audit trails. This makes them attractive not only for efficiency, but also for opacity.
In India’s context, where systems like UPI already allow near-instant domestic transfers, the functional advantage of stablecoins is limited. What remains is their ability to bypass regulatory scrutiny.
Regulatory opacity and consumer risk
Stablecoins operate largely outside national regulatory frameworks. Governments and regulators often have no reliable information on market size, participants, or use of funds. Transactions easily cross borders, complicating jurisdiction and enforcement.
In a country with low financial literacy and weak grievance redressal for unregulated products, this poses serious consumer protection risks. If a stablecoin collapses, users have little legal recourse.
The threat to monetary policy
Perhaps the most serious concern is macroeconomic. Monetary policy works because central banks control the supply, cost, and circulation of money. If private stablecoins become widespread alternatives to sovereign currency, large volumes of transactions could shift outside the regulated financial system.
In such a scenario, policy tools affecting banks and formal finance would lose effectiveness. Money could flow freely through private digital ecosystems, rendering monetary policy and currency management ineffective. No modern economy can afford this erosion of state control over money.
Why sovereign credibility cannot be replicated
Currencies issued by central banks carry credibility because they are legal tender, backed by the state, and accepted universally. Private issuers lack this sovereign guarantee. Their promises are only as strong as their balance sheets and governance — both of which are opaque in the stablecoin space.
The continued use of overseas crypto platforms using domestic funds further adds to systemic vulnerability. A sudden collapse could transmit shocks across borders, creating financial instability without any regulatory safety net.
What to note for Prelims?
- Meaning of stablecoins and how they differ from cryptocurrencies
- Importance of central bank backing for currency legitimacy
- Risks of asset-backed private digital currencies
- Link between stablecoins and monetary policy effectiveness
What to note for Mains?
- Critically examine whether asset backing is sufficient to legitimise private stablecoins
- Discuss the risks posed by stablecoins to monetary sovereignty and financial stability
- Analyse the regulatory challenges of cross-border digital currencies
- Evaluate the relevance of stablecoins in India given existing digital payment systems
