{ "title": "The Stablecoin Balancing Act", "sourceUrl": "https://www.imf.org/en/publications/fandd/issues/2025/09/the-stablecoin-balancing-act-darrell-duffie", "canonical": "https://www.imf.org/en/publications/fandd/issues/2025/09/the-stablecoin-balancing-act-darrell-duffie", "overlayPath": "/en/publications/fandd/issues/2025/09/the-stablecoin-balancing-act-darrell-duffie/index.md", "summary": "Fighting financial crime doesn’t have to come at the cost of privacy", "sections": [ { "heading": "Overview", "content": "- Title: The Stablecoin Balancing Act\n- Authors: DARRELL DUFFIE, ODUNAYO OLOWOOKERE, ANDREAS VENERIS\n- Publication: F&D Magazine\n- Date: September 2025\n- Core proposition: \"Smart-compliant\" payment systems—compliance-by-design embedded in stablecoin blockchains—can simultaneously fight financial crime, protect privacy, and enable efficient large-scale payments." }, { "heading": "Motivation and framing", "content": "- Problem statement:\n - Digital assets such as stablecoins can be \"washed\" through many accounts, complicating law enforcement efforts to stop money laundering and financing of terrorism.\n - Current approaches often force a trade-off between privacy for law-abiding users and effective compliance enforcement.\n- Key contextual references:\n - The approach aligns with the 2023 IMF–Financial Stability Board policy framework for crypto assets, which calls for compliance measures for stablecoin providers." }, { "heading": "Compliance-by-design model (concept)", "content": "- Core features:\n - Identity verification by licensed credential issuers places users within a KYC perimeter; verification is stored on the ledger as a \"hashed\" certificate.\n - Transactions must include zero-knowledge proofs (ZKPs) that demonstrate eligibility within the KYC perimeter without revealing personal data.\n - Ledger-embedded smart contracts monitor transactions for risk indicators and enforce responses in real time (on-chain), replacing much of today's off-chain reactive reviews.\n- Expected user segmentation:\n - Some institutions and individuals will select compliance-by-design networks if they value both compliance and confidentiality.\n - Others may continue using legacy pseudonymous stablecoin systems with looser compliance." }, { "heading": "Verification without exposure (technical mechanism)", "content": "- Zero-knowledge proofs (ZKPs):\n - ZKPs allow proving a statement without revealing the underlying data (analogy: proving which poker hand wins without revealing cards).\n - In payments, a ZKP proves KYC compliance without revealing identity or personal information.\n- zkKYC and selective disclosure:\n - The KYC perimeter could be implemented using zero-knowledge KYCs (zkKYCs) (Pauwels 2021), combining ZKPs with selective disclosure.\n - Verifiable credentials are issued by a government agency or authorized financial institution and stored off-chain in a private digital wallet.\n - During a payment, a zkKYC token is embedded on-chain proving KYC status, indicating whether the user is an individual or institution, transaction-amount thresholds, and wallet thresholds—without revealing identity.\n- Law enforcement access:\n - Privacy preserved unless risk indicators (unusual patterns, transfers exceeding designated thresholds, links to known high-risk wallets) trigger smart-contract-generated suspicious activity reports (SARs).\n - Authorities may unmask identities only with a legal process that depends on jurisdiction (e.g., warrant or administrative subpoena)." }, { "heading": "Implementation details and flow", "content": "- Typical transaction flow:\n - Both sender and recipient must be verified by a credential issuer before transacting.\n - Wallet generates a zkKYC token that cryptographically proves KYC certification and other relevant flags.\n - Smart contracts analyze encrypted zkKYC tokens for SAR criteria and can:\n - Allow white-listed routine transfers to proceed seamlessly.\n - Delay or flag suspicious transactions and automatically generate SARs.\n - Block high-risk transfers involving known offenders.\n- Interoperability and anchoring:\n - For natural persons, verifiable credentials may be anchored to standardized legal documents (passports, driver’s licenses) to mitigate identity spoofing.\n - The same approach could be applied to decentralized payment systems based on central bank digital currencies and other digital representations of money." }, { "heading": "Technological and systemic challenges", "content": "- Performance and computational constraints:\n - Significant computational burden for large-scale payment systems to interpret complex and evolving regulations at near-real-time throughput.\n - Privacy-preserving mechanisms impose computational costs, risking delays during peak-payment periods.\n - Overly simplistic rule implementations risk many false positives and false negatives, potentially overwhelming enforcement authorities.\n- Friction and interoperability costs:\n - Compliance-by-design systems may add frictional costs and delays when moving funds between different payment systems.\n- Potential mitigations:\n - License and manage smart contracts via regulated providers offering compliance-as-a-service, allowing limited access to payment data in exchange for compliance services.\n - Advances in applied cryptography and zero-knowledge-proof implementations could improve speed; multiparty computation techniques may help distribute computational burden." }, { "heading": "Governance, legal, and cross-border considerations", "content": "- Governance requirements:\n - Trusted ecosystem of credential issuers is critical; credential issuers and smart contract operators must be carefully licensed, transparent, and accountable.\n - Uniform standards for KYC verification are needed, with verification interoperable across multiple ledgers.\n - System-wide compliance quality depends on the least rigorous credential issuer.\n- Legal due process:\n - Laws may need adaptation to specify thresholds for triggering SARs and conditions for authorities to unmask identities.\n - Different jurisdictions likely to set distinct due-process thresholds (example: one country may require administrative subpoenas, another may demand judicial warrants).\n- Cross-border enforcement:\n - Effective cross-border enforcement relies on cross-jurisdictional cooperation similar to correspondent banking today.\n - Project Mandala (Bank for International Settlements 2024) is cited as an analogous proposal using zero-knowledge proofs for cross-border compliance coordination." }, { "heading": "Conclusions and implications", "content": "- Practical potential:\n - Compliance-by-design stablecoin systems can offer a balance between privacy and legal compliance and may make large-scale payment systems both private and compliant.\n - The approach is not mandated by the authors; adoption may vary across jurisdictions, and offshore alternative stablecoin systems could persist without this approach.\n- Policy implications:\n - Establish licensing, transparent operation, and interoperability standards for credential issuers and smart-contract operators.\n - Consider legal frameworks specifying when SARs are triggered and under what legal processes authorities may obtain identity data.\n - Encourage research and development in scalable zero-knowledge-proof implementations and complementary cryptographic techniques.\n- Broader benefits:\n - Stablecoins, if designed with compliance-by-design, could improve financial inclusion, increase payment efficiency, and impede illicit actors.\n\nSource: \"The Stablecoin Balancing Act,\" F&D Magazine, September 2025, DARRELL DUFFIE; ODUNAYO OLOWOOKERE; ANDREAS VENERIS.\n\n---\n\n Content in this bundle\n\n- The Stablecoin Balancing Act\n - The Stablecoin Balancing Act (Markdown version){rel=\"alternate\" type=\"text/markdown\"}\n - The Stablecoin Balancing Act (PDF){rel=\"external\" type=\"application/pdf\"}\n\n---\n\nSource: https://www.imf.org/en/publications/fandd/issues/2025/09/the-stablecoin-balancing-act-darrell-duffie" } ], "bullets": [ "[Markdown version](/en/publications/fandd/issues/2025/09/the-stablecoin-balancing-act-darrell-duffie/index.md)", "[Structured JSON version](/en/publications/fandd/issues/2025/09/the-stablecoin-balancing-act-darrell-duffie/index.json)", "[Bundle manifest](/en/publications/fandd/issues/2025/09/the-stablecoin-balancing-act-darrell-duffie/bundle-manifest.json)", "Authors: DARRELL DUFFIE, ODUNAYO OLOWOOKERE, ANDREAS VENERIS", "Published: September 3, 2025", "Title: The Stablecoin Balancing Act", "Authors: DARRELL DUFFIE, ODUNAYO OLOWOOKERE, ANDREAS VENERIS", "Publication: F&D Magazine", "Date: September 2025", "Core proposition: \"Smart-compliant\" payment systems—compliance-by-design embedded in stablecoin blockchains—can simultaneously fight financial crime, protect privacy, and enable efficient large-scale payments.", "Problem statement:", "Key contextual references:", "Core features:", "Expected user segmentation:", "Zero-knowledge proofs (ZKPs):", "zkKYC and selective disclosure:", "Law enforcement access:", "Typical transaction flow:", "Interoperability and anchoring:", "Performance and computational constraints:", "Friction and interoperability costs:", "Potential mitigations:", "Governance requirements:", "Legal due process:", "Cross-border enforcement:", "Practical potential:", "Policy implications:", "Broader benefits:", "**The Stablecoin Balancing Act**" ], "related": [ { "title": "The Stablecoin Balancing Act", "role": "document", "sourceUrl": "https://www.imf.org/-/media/files/publications/fandd/article/2025/09/duffie.pdf", "summary": { "path": "/-/media/files/publications/fandd/article/2025/09/duffie.pdf.md", "mime": "text/markdown" }, "binary": { "path": "/-/media/files/publications/fandd/article/2025/09/duffie.pdf", "mime": "application/pdf" } } ], "alternates": { "markdown": "/en/publications/fandd/issues/2025/09/the-stablecoin-balancing-act-darrell-duffie/index.md", "json": "/en/publications/fandd/issues/2025/09/the-stablecoin-balancing-act-darrell-duffie/index.json", "bundleManifest": "/en/publications/fandd/issues/2025/09/the-stablecoin-balancing-act-darrell-duffie/bundle-manifest.json" }, "generatedAtUtc": "2026-09-15T20:07:12.833Z" }