Don’t dismiss stablecoins as useless—they tell us something that fiat money cannot

That this wrapper is thin need not concern us for the moment. Demand for ‘stability’ allows us to picture an alternative world of finance. Fiat currencies, backed by nothing more than the word (‘IOU’) of a nation-state, have always embodied a power asymmetry. The history of nation-states and empires is littered with examples of sovereign defaults on obligations or currency debasement, often via hyperinflation. Fiat currencies, and even their gold-backed predecessors, have always been prone to bouts of instability.

The uncertainty stoked by such episodes tends to generate demand for alternatives that creates its own supply.

Take the global financial crisis of 2008-09. At its core, a risk-build-up was driven by demand for stable AAA-rated securities, which was met through financially engineered debt products. Mortgages issued to ‘Ninja’ borrowers (with no income, jobs or assets) in the US were repackaged into collateralized debt obligations and magically labelled as low-risk instruments.

Some of this demand arose from overseas investors looking to park huge sums in US assets that would secure them from the volatility of their own sovereign currencies. Ironically, their search for safety ultimately undermined safety itself.

The subsequent collapse gave rise to another financial ‘innovation’: cryptocurrencies. These promised freedom from sovereign control and a shift in power to asset holders. That promise, however, did not quite materialize. Private currencies backed only by algorithms exhibited wild volatility and were prone to online heists. Clearly, algo-run cryptos could be highly risky.

Again, demand was met through financial engineering. What if a cryptocurrency is backed by assets for its value to be pegged accordingly? Short-term US Treasury bills were thus bundled together to create a new asset class. It had a three-layer composite derivative structure, featuring the US dollar, Treasury bills and a cryptocurrency. Each component is volatile, yet the structure is perceived as less so than its parts, thanks to dollops of wishful thinking.

All that remained was a wrapper to package this construct, a name that would convey stability. Thus was born the moniker ‘stablecoin.’ There are assorted stablecoins in the US today, most of which are backed by assets to maintain a dollar peg.

So, where does our disagreement lie with Rabi Sankar’s assertion that fiat currencies meet all purposes? In the existence of a purpose for which stablecoins are particularly useful.

Fiat currencies don’t bear as much wishful thinking as stablecoins. And since the financial system rests on a degree of collective belief, a new asset class that attracts those ready to invest in an extra dose of fond hope serves a function. Policymakers can measure such demand and learn from it.

India’s crypto policy, despite its lack of clarity on crypto legality, offers an illustration. Crypto trading gains are taxed at slab rates, yet losses cannot be offset—neither across years nor even within the same year across multiple trades where some transactions make profits and others incur losses.

The fear of missing out plays a role in crypto demand. Indian investors often like to keep up with their American counterparts in making investment allocations. Yet, this ‘FOMO’ overlooks what already exists.

India has built a public digital money stack where trust rests on sovereign rails rather than private balance sheets: UPI has compressed settlement risk to near zero for retail payments, Aadhaar has solved the problem of identification at scale and the digital rupee aims to offer the benefits of programmable money under the aegis of sovereign credibility.

Stablecoins then perform a useful if unintended function. They reveal segments of demand willing to suspend disbelief in exchange for a private promise of stability. For regulators, this is not a threat, but a signal. They can acknowledge it only obliquely, through careful references to stakeholder views and evolving assessments. While the signalling value of stablecoins may be hard to talk about openly, it serves an informational purpose as a tracker of confidence in the fiat currency.

The author are, respectively, a corporate advisor and author of ‘Family and Dhanda’; and a strategic security and digital policy researcher.