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