Stablecoins and national security: Learning the lessons of Eurodollars

As Congress struggles to resolve big issues like funding for Ukraine and Israel, the debate over legislation to regulate stablecoins seems like small potatoes. But there is a connection, which is that stablecoins could have national security implications: Unless we strengthen their regulation, they could undermine our ability to use sanctions to advance our national interests. This was illustrated recently by news that Russian smugglers have used Tether, the largest stablecoin, to avoid Western sanctions and purchase billions of dollars worth of weapons.

Stablecoins are a type of cryptocurrency that is far more useful as a means of payment than Bitcoin.¹ That is because stablecoins are designed to maintain a constant price in terms of another asset.² Stablecoins pegged to the U.S. dollar are more “money-like” than other cryptocurrencies. They can be used to move value across borders without going through banks, and it is the banking system—and in particular the role of U.S. banks—that is key to the implementation and efficacy of sanctions.

Stablecoins are in some respects similar to Eurodollars, a financial innovation that helped to create the financial plumbing used to implement sanctions. Both stablecoins and Eurodollars are U.S. dollar-based liabilities that had their origins outside the regulated banking system. U.S. policymakers initially paid little attention to Eurodollars because the market was small. But it quickly grew, and—luckily for policymakers—Eurodollars ultimately helped cement the international role of the dollar. It is the global dominance of the dollar, coupled with the role of U.S. banks in facilitating dollar payments, that gives the U.S. its tremendous financial leverage.

Could stablecoins undermine that leverage? As with the early days of the Eurodollar market, stablecoin use is minimal today, and so their national security risk may also be minimal. But just as Eurodollar use grew quickly and unexpectedly, stablecoins could also grow. While they are used principally to trade other crypto assets today, they could become a more widespread means of payment. They have also become popular as a means for people in countries with weak currencies to acquire a dollar substitute. Moreover, that growth could come even if the U.S. does not take action. That is because many other jurisdictions are creating frameworks to license stablecoins, including Europe, the U.K., Japan, Singapore and the U.A.E. While those frameworks may lead to stablecoins in native currencies, they could also give rise to new dollar-based stablecoins.

This paper discusses how stablecoins could destabilize what Eurodollars helped to create—the global financial system plumbing that has been a means to implement sanctions³—and what to do about it. First, I provide a brief summary of the history of Eurodollars and their rapid growth. I discuss how Eurodollars strengthened the role of the U.S. dollar and U.S. banks. I then discuss the risks that stablecoins pose, in particular how they could be used to circumvent the existing financial system plumbing and sanctions. Finally, I suggest a path forward to promote responsible financial innovation while protecting our national security interests.