The European Central Bank's (ECB) Isabel Schnabel recently gave a speech titled "From Money Market Funds to Stablecoins: Lessons for Central Banks," which discussed the history and parallels of money market mutual funds with stablecoins. She says, "The nature of money has never been static. Over the centuries, financial innovation has reshaped how money is created, transferred and stored, often enhancing efficiency, broadening access and boosting economic welfare. When such innovations reach scale, they alter the structure of the financial system, with consequences for financial stability, monetary policy and the international monetary order. One recent innovation has been stablecoins. These are privately issued digital tokens pegged to fiat currencies and typically backed by portfolios of traditional assets. Their rapid rise has raised questions about their benefits and challenges. To understand the unfolding changes, it is worth looking at how earlier innovations transformed financial markets." (Note: Register soon for our upcoming Money Fund Symposium, which takes place in just 3 weeks in Jersey City, N.J., June 24-26. We look forward to seeing you later this month!)
Schnabel explains, "More recently, a private and closer analogue of stablecoins emerged: money market funds. These created a highly liquid investment instrument that offered a market-based yield while promising a stable value, reshaping financial intermediation. In my remarks today, I will examine the parallels and differences between the emergence of money market funds and that of stablecoins to provide a perspective on the challenges posed by stablecoins and other forms of tokenisation for today's financial system."
She continues, "I will argue that private monetary innovation can offer significant benefits. But I will also show that it can heighten financial stability risks, affect monetary policy transmission and alter the international monetary order. Central banks and regulators need to be ready to adapt regulation, monetary policy implementation and payment infrastructure in an agile manner to safeguard financial stability, preserve monetary control and anchor their currency's role in the digital age."
Discussing "The rise of money market funds," she comments, "The emergence of money market funds in the 1970s was initially a distinct US phenomenon, driven by regulation and the macroeconomic environment. The key backdrop was Regulation Q, introduced in the aftermath of the Great Depression, which imposed interest rate ceilings on bank deposits in order to contain 'excess competition' among banks. As higher inflation gave rise to higher market interest rates, investors sought liquid alternatives delivering higher yields."
Schnabel states, "Money market funds met this demand by investing in a diversified portfolio of high-quality, short-term market instruments, while aiming to maintain a stable net asset value and promising redemption at or near par. In doing so, they replicated some of the key attributes of bank deposits, most notably stability of value and liquidity."
She tells us, "Over time, money market funds became central actors in wholesale funding markets and major buyers of short-term financial instruments, such as commercial paper, repurchase agreements and Treasury bills. The rise of money market funds in the United States led to some bank disintermediation as savings migrated from bank deposits into money market funds.... As a result, banks increasingly shifted towards wholesale funding, such as repos and other market-based sources, making part of their funding more short-term, expensive and volatile."
The ECB Executive Board Member states, "At the same time, money market funds benefited the financial system and the economy more broadly. Governments enjoyed access to a wider and more diversified investor base for short-term sovereign debt, while financial intermediation shifted away from banks towards capital markets, contributing to the expansion of market-based finance."
She comments, "While the first money market funds in Europe were established in the early 1980s, it was not until the 1990s that they really took off. They have since become an integral part of the euro area financial system. By increasing competition for savings and offering households and firms attractive alternatives to bank deposits, money market funds made it harder for banks to extract excess rents in protected deposit markets. Evidence from Germany suggests that the authorisation of money market funds in 1994 led to more intense competition in deposit markets, as evident in a visible decline in bank deposit margins around that time. Thus, the advent of money market funds offered benefits to investors in the form of higher returns and greater choice, while financial markets became deeper and more diversified."
She then says, "Stablecoins share several features with money market funds. Both invest in a portfolio of short-term safe assets and aim to offer redemption at or near par into fiat currency. And both operate outside the traditional banking system, thereby potentially contributing to the disintermediation of banks. But there are also important differences, especially in terms of remuneration and use cases. The attractiveness of money market funds has traditionally rested on their ability to offer competitive market yields. Stablecoins, by contrast, do not generally pay interest, at least not directly. Stablecoins do not therefore constitute an attractive store of value, compared with money market funds or remunerated bank deposits."
Schnabel adds, "And yet, this has done little to curb demand. Global stablecoin market capitalisation has increased swiftly and is now close to USD 300 billion, although growth has moderated recently. The two largest US dollar-denominated stablecoins, Tether (USDT) and USD Coin (USDC), account for roughly 90% of the total market. Euro-denominated stablecoins have so far played only a marginal role, with a combined market capitalisation of approximately EUR 500 million."
She tells us, "So far, stablecoins have primarily been used to settle transactions in crypto markets, with crypto trading remaining the dominant use case by far. Other use cases account for only a small share of current activity, but they are expected to grow over time, although there remains a high degree of uncertainty about their future trajectory. Around 85% of the transaction volume on crypto trading platforms involves exchanges between stablecoins and other crypto-assets, even though other types of transactions are gaining ground."
Schnabel continues, "The second fragility relates to the risk that money market funds, or stablecoins for that matter, may face runs themselves. This risk became evident during the global financial crisis, which exposed the vulnerability of money market funds to runs and the lack of a safety net to mitigate systemic risks. After the failure of Lehman Brothers in September 2008, the Reserve Primary Fund 'broke the buck,' meaning that its net asset value fell below par, triggering widespread redemptions, fire sales and a freeze in short-term funding markets. We have seen money market funds come under stress on several further occasions in recent years, such as during the European sovereign debt crisis and, more recently, at the onset of the COVID-19 pandemic."
She says, "Finally, unremunerated stablecoins, if systemically relevant, could reinforce the zero lower bound constraint on the policy rate, as negative interest rates could render stablecoins' business model unprofitable, leading to a collapse of the market. In fact, the significance of the money market fund industry in the United States likely contributed to the Federal Reserve shying away from negative interest rates.... As with the rise of money market funds, the dollar's dominance would be reinforced, not necessarily owing to stronger economic fundamentals but due to network effects, scale and first-mover advantages."
Schnabel adds, "It remains to be seen whether, in such an environment, stablecoins can find their place in the financial system just as money market funds did 50 years ago, or whether other innovations, like tokenised deposits, will prove to be the more promising alternative. In any case, as shown by the example of money market funds, innovation alone is not sufficient to guarantee lasting success. We also need to provide guardrails to preserve financial stability, monetary policy transmission and the international role of the euro."
