The Fed Does Not Fully Control Digital Money

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.

The ECB study examines stablecoins deposited in Aave, one of the largest DeFi lending protocols. Its conclusions challenge the idea that decentralised markets are merely a digital extension of conventional finance.

Between January 2021 and January 2026, DeFi deposit rates on USDT, USDC and DAI averaged approximately 100 basis points above the Federal Funds target rate. At times, the difference exceeded 1,000 basis points.

More surprisingly, the relationship was not stable.

From mid-2022 until the end of 2023, DeFi rates were on average around 160 basis points below the Fed’s policy rate. During the tightening cycle that began in 2022, the Federal Reserve raised rates by a cumulative 525 basis points, while DeFi yields initially fell.

Then the opposite occurred. Between September and December 2024, the Fed cut its policy rate by 100 basis points, while DeFi rates rose by approximately 600 basis points—from around 3% to 9%.

The same dollar appeared to be carrying two radically different prices.

Bitcoin can overpower the Federal Reserve

Why can stablecoin rates move against monetary policy?

Because demand for stablecoin borrowing is often connected to leveraged investment in cryptoassets, particularly Bitcoin and Ether.

When monetary tightening depresses expectations for risky assets, crypto investors may reduce leverage and borrow fewer stablecoins. Lower borrowing demand can push DeFi deposit rates down—even though conventional interest rates are rising.

Conversely, a renewed speculative cycle can increase demand for leverage and drive DeFi rates higher while the Fed is cutting.

The monetary-policy transmission mechanism is therefore competing with a crypto-leverage mechanism.

In conventional finance, arbitrage should eventually close the gap between comparable rates. But moving capital between traditional markets and DeFi is neither frictionless nor universally accessible. Investors face regulatory barriers, transaction costs, gas fees, technological complexity and counterparty or smart-contract risks.

The ECB paper finds that USDC reacts more closely to traditional monetary conditions than USDT. The authors associate this with the greater integration of USDC and its users with regulated finance in the United States and Europe.

This distinction matters. Stablecoins are often discussed as if they formed a single asset class. In reality, their behaviour depends on the issuer, reserve structure, user base, regulatory status and connection to the banking system.

The dollar is expanding—but US monetary control may be fragmenting

Stablecoins undoubtedly extend the international reach of the dollar. They provide dollar exposure to individuals and businesses that may not have easy access to US bank accounts. They facilitate cross-border transfers, digital trading and settlement outside conventional banking hours.

Washington may therefore see dollar stablecoins as instruments of monetary influence.

That interpretation is only half correct.

Stablecoins can strengthen the dollar as a unit of account while weakening the uniform transmission of American monetary policy. Dollarisation and monetary control are not the same thing.

A private digital dollar may reproduce the name and nominal value of the sovereign currency without reproducing its interest-rate dynamics.

The result is a paradox: the dollar’s global footprint may grow while the Federal Reserve’s influence over certain dollar-denominated financial markets becomes less direct.

This becomes more significant as stablecoins expand beyond crypto trading into payments, remittances, tokenised securities and corporate treasury operations.

A parallel shadow-banking system is emerging

DeFi platforms perform functions that resemble banking: they collect liquidity, provide credit, determine interest rates and accept collateral.

Yet they normally lack many of the protections and constraints associated with regulated banks. There is no conventional deposit guarantee. Liquidity can disappear rapidly. Smart contracts can fail. Collateral values can collapse. Governance may be concentrated despite the language of decentralisation.

Aave’s deposits have already reached a scale comparable with smaller American banks. The relevant issue is therefore no longer whether DeFi looks like banking. It is how large it can become before regulators must treat it as part of the monetary and financial-stability architecture.

Traditional banks are subject to liquidity rules, capital requirements, supervision and central-bank facilities. DeFi protocols replace part of this institutional framework with automatic collateralisation, liquidation mechanisms and code.

Code, however, does not abolish risk. It changes where the risk appears and who absorbs the losses.

Regulation will make DeFi more connected—and less decentralised

The usual debate presents two alternatives: regulation will either destroy decentralised finance or make it safe.

The likely outcome is more complex.

Regulation may improve transparency, reserve quality and access for institutional investors. It may also strengthen the arbitrage channels connecting DeFi yields to conventional money-market rates.

But deeper integration will create new transmission channels in both directions. A shock originating in crypto markets could more easily affect regulated institutions, while a banking crisis could cause rapid movements between deposits and stablecoins.

The bridge between the two systems may reduce price differences during normal periods while increasing contagion during periods of stress.

The most successful stablecoins will probably become more regulated, more institutional and more connected to government debt markets. They may survive precisely by becoming less revolutionary than their original supporters imagined.

The real monetary question

The central issue is not whether stablecoins will replace sovereign currencies. Most stablecoins depend on sovereign currencies for their value, collateral and credibility.

The more serious issue is whether they will divide those currencies into several financial circuits, each with different yields, risks and responses to monetary policy.

The Federal Reserve can set the price of reserves and strongly influence regulated dollar markets. It cannot directly set the demand for crypto leverage, eliminate blockchain transaction costs or force arbitrage between every digital and conventional platform.

Stablecoins are therefore not outside monetary policy, but neither are they fully governed by it.

Central banks are discovering that issuing the world’s dominant currency does not automatically mean controlling every market that uses its name.

The dollar may remain dominant. But the monetary system built around it is becoming increasingly fragmented—and fragmentation is where the next generation of financial risk will develop.

Sources

• ECB Working Paper No. 3280 — ⁠DeFi-ying the Fed? Monetary policy transmission to stablecoin deposit rates⁠

• Bank for International Settlements — Stablecoins and the future monetary system⁠

• Federal Reserve — Financial Stability Reports⁠

• Financial Stability Board — Global regulatory framework for cryptoasset activities⁠

Roberto Balbino — CEO, Fintech SCB
International Finance & Banking Executive | Independent Analyst of Finance, Economics, Geopolitics & Global Markets