The increasing popularity of stablecoins could lead to a decline in retail deposits for banks in the eurozone and weaken the effectiveness of monetary policy, according to a European Central Bank study.

The growing use of stablecoins can lead people and firms to move money out of traditional bank deposits and into digital assets, says the working paper quoted by Finextra.

Banks rely heavily on deposits as a stable and low-cost source of funding to support lending to households and businesses. When deposits decline, banks may be forced to rely more on wholesale or market-based funding, which is typically more expensive and less stable.

The ECB analysis shows that increasing interest in and attention toward stablecoins are associated with a measurable decline in retail bank deposits and a reduction in bank lending to firms.

"In other words, stablecoins can reduce the amount of credit banks provide to the real economy."

The paper also warns that when stablecoins are linked to non-euro currencies, such as the US dollar, the risks to monetary policy increase.

"In simple terms, foreign monetary conditions could be “imported” into the euro area through stablecoins. This would weaken the central bank’s control over financial conditions, reduce the effectiveness of traditional monetary policy instruments, and make it harder to stabilize inflation and economic activity, especially during periods of financial stress", write the authors.

To mitigate the risks, the paper suggests stronger transparency requirements for stablecoin reserves, robust redemption guarantees, adequate capital buffer to absorb losses and effective oversight. It also claims that the planed digital euro can offer a stablecoin alternative that preserves monetary sovereignty.

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