Evolution of the Eurodollar System: Stablecoins, the New Eurodollars
The Eurodollar system has been a cornerstone of the global monetary framework for decades, structured as a private financial architecture supported by global banking and shadow banking networks. This system operates with the backing of mechanisms such as central bank swap lines, FIMA repos, and IMF tools like Special Drawing Rights (SDRs). Unlike domestic systems like the U.S., where the Federal Reserve creates bank reserves for interbank transactions, the Eurodollar system relies on payment promises secured by high-quality collateral rather than cash.
Offshore dollar deposits lack the backing of institutions like the FDIC or the Federal Reserve, necessitating robust collateral management, as the system depends on intermediary balance sheets to remain functional. This reliance amplifies the effects of the “collateral trap” during times of financial stress. Additionally, the Eurodollar system possesses unique characteristics that make it the global monetary network with the greatest network effects: credit creation and international liquidity, an efficient payment system, and a framework for risk transfer.
A distinguishing feature of the Eurodollar system is its capacity to function as a form of “private seigniorage.” Global financial institutions issue dollar-denominated liabilities outside the direct control of the Federal Reserve, generating benefits similar to traditional state seigniorage. Inspired by the analysis in the paper Monetary Base and Seigniorage in a Digital Era by Manmohan Singh, Mahmoud Abouelmakarem, and Apoorv Bhargava, I have further developed this idea. In a recent conversation with Manmohan Singh, we discussed how stablecoins are emerging as the "new Eurodollars."
Like Eurodollars, stablecoins represent a form of private money but with a digital infrastructure enabling programmability, faster settlement, and global accessibility. These currencies, such as Tether, are often backed by high-quality collateral, including U.S. Treasury bonds. Stablecoin issuers operate similarly to money market funds, with a profile closer to prime funds than government-only funds, focusing almost exclusively on purchasing U.S. debt.
Key Similarities and Differences
Collateralization
Eurodollars: Payment promises are backed by collateral, such as U.S. Treasury bonds or other high-quality liquid assets (HQLA). The system's strength depends on the quality of the collateral and trust in issuing institutions. This point was highlighted by the G30 during the regional banking crisis, suggesting that the Federal Reserve prioritize the availability of eligible collateral. Manmohan Singh has noted that the limited variety of collateral within the system introduces additional risks, increasing its fragility. Additionally, the practice of rehypothecation amplifies risk accumulation, further exposing the system.
Stablecoins: Generally backed by fiat reserves, HQLA, or a combination of assets like gold, Bitcoin, or even corporate debt. Their reliability hinges on transparency and strong collateral management. Stablecoins like Tether act as a bridge between the Bitcoin ecosystem and the Eurodollar system, as much of their assets are anchored to base collateral (U.S. Treasury bonds). However, the limited diversity of collateral in circulation presents challenges similar to those of the Eurodollar system. According to Singh, stablecoins backed by HQLA could strengthen the Eurodollar system by serving as a substitute for offshore bank reserves and enhancing liquidity even during intermediary stress.
Seigniorage
In its classical definition, seigniorage is the profit central banks earn from issuing money, comparing the cost of reserves to bond yields. The Eurodollar system, although private, fulfills a similar function. Offshore financial institutions arbitrage onshore and offshore rates, benefiting from the spread. This system relies on the value of pristine collateral like U.S. Treasury bonds, generating decentralized and private profit akin to seigniorage.
Stablecoins have the potential to enhance and reinforce this dynamic by introducing new blockchain-based technologies. These innovations could be essential for making the system more resilient to rising leverage and risk levels.
Decentralization
Eurodollars: Although a private system, it is rooted in traditional banking structures. It depends on trust among banks and shadow banking institutions, which require stable assets to prevent systemic collapse caused by volatility. In times of crisis, central banks act as a backstop to ensure payment, clearing, and settlement systems do not fail.
Stablecoins: These leverage decentralized technology to reduce dependence on intermediaries. The ease of acquiring stablecoins (with just a click) eliminates liquidity frictions, potentially stabilizing financial systems.
Stablecoins as Reinforcement for the Current Monetary System
In my book, I argue that stablecoins have the potential to complement the existing monetary system by:
Enhancing resilience: Blockchain technology reduces counterparty risk and enables near-instant settlements, making financial systems more robust.
Bridging gaps: Stablecoins can integrate with traditional systems while fostering financial inclusion in regions with limited banking infrastructure.
Strengthening liquidity: Like Eurodollars, stablecoins offer an alternative liquidity mechanism but with greater flexibility due to their digital nature.
Establishing Stablecoins Within the Eurodollar System
Stablecoins could play a key role as settlement and clearing assets within the Eurodollar system. During dollar funding stresses, they could act as a "buffer" to mitigate pressure. Their purpose would not be to serve as a store of value but to ensure the system continues operating without disruptions, avoiding disorderly asset sales during liquidity crises. This strategic use would bolster the system's ability to absorb financial tensions without compromising its stability.
Looking Ahead
As the financial landscape evolves, the convergence of legacy systems like the Eurodollar market and technological innovations like stablecoins has the potential to redefine global finance. Stablecoins, with their digital infrastructure and ability to provide liquidity quickly and efficiently, could inherit the role the Eurodollar system has played for decades, acting as a key enabler for cross-border transactions and contributing to global financial stability. This, of course, depends on appropriate regulation and transparent backing to gain and maintain market trust.
My recent conversation with Manmohan Singh not only validated these ideas but also offered new perspectives on the role of stablecoins in this transformation. As I explore in my book, we are witnessing a fascinating moment in monetary knowledge, where global finance is entering a new evolutionary phase. This shift promises to reshape the global monetary and financial system, marking the beginning of an era that combines the best of traditional systems with the limitless possibilities of modern technology.