Crypto-related innovations could reshape key elements of the U.S. financial system and impact its overall stability. Why is crypto such a potentially disruptive force, and what should researchers, policymakers, and the public be on the lookout for as it evolves?

Those questions – and others – were explored at the Third Conference on Stablecoins and Tokenization, organized by the Federal Reserve Banks of Boston and New York on May 22.

Researchers also gave presentations during the virtual conference that looked at how stablecoins interact with bank deposits and the traditional foreign exchange markets.

Boston Fed Vice President Kenechukwu Anadu organized the conference series with Marco Cipriani, the deputy research director of the New York Fed. Anadu said during his opening remarks that financial innovation has accelerated rapidly since the conference debuted in 2024, and those innovations raise important questions for discussion.*

“For example, how might these digital cash-like products interact with the traditional financial system?”  said Anadu, who co-heads the Boston Fed’s Supervisory Research and Statistics function. “How do we foster innovation (while) continuing to promote consumer health and financial stability?”

Adrian: Public trust is critical to crypto’s long-term success

Tobias Adrian, the financial counsellor and director of the International Monetary Fund’s Monetary and Capital Markets Department, gave the first of two keynote addresses. He described tokenization and the rise of cryptocurrency as a significant shift in the “architecture” of finance and its governance.

When an asset is tokenized, a digital representation of it is created on a blockchain. So, financial institutions don’t each keep their own balance sheets. Instead, the blockchain acts as a public shared record and a “single, synchronized source of truth,” Adrian said.

Financial contracts on the blockchain can be executed automatically, and transactions can be settled 24/7, in real time. This could lead to new risks as human intervention may not be fast enough to correct mistakes or code errors, Adrian said.
“Long-term success, of course, depends on whether digital finance will gain the public trust,” he added.

Adrian also discussed stablecoins, a type of cryptocurrency that’s designed to maintain a stable price and is usually pegged to the U.S. dollar.

Adrian said stablecoins are spreading rapidly to emerging markets, where people use them to bypass local banks and move money across borders more easily. But Adrian noted these markets tend to have political instability, high inflation, and volatile currency, and he said the rapid adoption of U.S. stablecoins could destabilize the local currency. The IMF is working to understand those challenges, he said.

Gorton: Why didn’t the overall financial system feel the “crypto winter?”

During his keynote address, Gary Gorton, a professor emeritus of finance at the Yale School of Management, discussed the “crypto winter” from 2021 – 2022. This was when multiple crypto trading platforms, including FTX, collapsed, and the aggregate market value of cryptocurrencies fell from $2.9 trillion to about $1 trillion.

But, while this “cascade of failures” had huge impacts in the crypto space, Gorton said it had no real effect on the rest of the public or the overall economy because the lending activity on these failed crypto platforms was “circular.” That means they were mostly lending to each other.

Then in 2023, two banks that focused on converting cryptocurrencies into fiat currencies went bankrupt, Gorton said. New banks have sprung up to take their place, and Gorton raised concerns that they may face the same outcome. More must be done to truly address potential systemic risks, he said.

Researchers: Even “perfectly safe” digital money can be vulnerable to runs

Alexandros P. Vardoulakis, the chief of the Federal Reserve Board of Governors’ Financial Stability Policy section, presented a paper he coauthored with Board colleagues titled, “The Fragility of Perfectly Safe Digital Money.”*

Vardoulakis said that digital money, unlike traditional money, settles payments by relying on decentralized verification instead of a trustworthy financial institution. The cost of that verification is a separately priced transaction fee that can rise as demand increases.

The more people use a particular cryptocurrency, the more valuable and useful it becomes. But more users create more congestion on a network – which can drive up transaction fees.

The authors analyzed these competing forces using stablecoin transaction data from the Ethereum blockchain. They found that high transaction fees reduce incentives for people to use digital currencies for payments, so they’re more likely to redeem their money. And the more people who pull their money from a particular cryptocurrency, the less useful it becomes, Vardoulakis said. That can lead to even more users leaving.

So even if a cryptocurrency is fully backed by safe and liquid assets, it can still experience a “run,” and that’s a potential financial stability risk.

“Stablecoins, tokenized deposits, tokenized Treasuries, and central bank digital currencies issued on permissionless blockchains would all be exposed to the mechanism we document regardless of the safety of their backing,” the authors wrote.

Cipriani, the conference co-organizer, concluded the event by thanking the presenters and staff who made it possible.*

“We plan to do (this conference) again next year, and we look forward to seeing all of you back here,” he said.

Papers shared during the conference

Each of the papers shared during the conference are available on bostonfed.org. They are listed below:

• “Stablecoin Flows and Spillovers to FX Markets,” presented by Federico Grinberg (International Monetary Fund)
• “Flight to Safety: Evaluating Stablecoin’s Role as a Safe‑Haven Asset in DeFi Markets,” presented by Julapa Jagtiani (Federal Reserve Bank of Philadelphia)*
• “Demand for Safety in the Crypto Ecosystem,” presented by Lira Mota (Massachusetts Institute of Technology)
• “Stablecoins vs. Tokenized Deposits: The Narrow Banking Debate Revisited,” presented by Todd Keister (Federal Reserve Bank of New York)*
• “The Fragility of Perfectly Safe Digital Money,” presented by Alexandros P. Vardoulakis (Federal Reserve Board)*
• “Are Stablecoins and Bank Deposits Substitutes?” presented by Rashad Ahmed (Andersen Institute)

*The presenters each noted that the views they expressed at the conference were their own and did not necessarily reflect those of their employers.