The Fed Does Not Fully Control Digital Money
Stablecoin yields can ignore, delay or even reverse monetary policy. DeFi is no longer merely a crypto experiment: it is becoming a parallel monetary system with its own transmission mechanism.
For decades, central banks have operated on a seemingly straightforward assumption: change the policy rate, and the effects will gradually spread through money markets, banks, loans, deposits, asset prices and the wider economy.
The process is never instantaneous or perfect. Yet the direction is supposed to be clear.
When the Federal Reserve raises rates, the cost of money should increase. When it cuts them, financing conditions should ease. Arbitrage, competition and financial intermediation are expected to transmit the signal throughout the system.
But what happens when an increasingly important form of dollar-denominated private money does not follow that signal?
A new European Central Bank working paper offers an uncomfortable answer. Interest rates earned by depositing dollar stablecoins in decentralised-finance protocols can remain disconnected from conventional short-term rates, respond weakly to Federal Reserve decisions and sometimes move in the opposite direction.
This is not a minor technical curiosity. It raises a much larger question: can a central bank still claim effective monetary control when dollar-based financial activity increasingly takes place outside the banking system?
Stablecoins are private dollars without a central-bank transmission belt
Stablecoins are generally presented as digital representations of conventional currency. USDT, USDC and DAI are denominated in dollars and seek to maintain a stable value relative to the US currency.
That apparent simplicity is deceptive.
A stablecoin may be pegged to the dollar, but it does not automatically reproduce the institutional structure surrounding a bank deposit. Its yield, liquidity, collateral arrangements, counterparty risks and market dynamics can be very different.