The stablecoin Landscape: A Primer

Stablecoins, digital currencies designed to maintain a stable value relative to a reference asset like the U.S. dollar, are increasingly under scrutiny. the core concept is straightforward: a stablecoin issuer functions as a bank, and the stablecoin itself acts as a bank deposit.This analogy simplifies understanding the complexities surrounding thes digital assets.

Consider this: if an entity accepts money, invests it, and provides a redeemable liability at par, that entity operates as a bank, and the issued instrument is a deposit. This holds true irrespective of its request, whether it’s facilitating crypto market transactions, enabling cross-border payments, or even dispensing gumballs.

Banks eye Stablecoin Opportunities

Traditional banks are exploring the issuance of joint stablecoins to compete with the burgeoning cryptocurrency industry. This move is driven by the potential for stablecoins to streamline routine transactions, such as cross-border payments, which can be significantly faster than traditional systems.

The nation’s biggest banks are exploring whether to team up to issue a joint stablecoin, a step intended to fend off escalating competition from the cryptocurrency industry . . . banks have been bracing for the possibility that stablecoins could become widely adopted under President Trump and siphon away the deposits and transactions they handle . . . Banks see an opportunity for stablecoins to speed up more routine transactions, such as cross-border payments that can take days in the traditional payments system.

The Wall Street Journal

The Genius Act: A Framework for “Banking Lite”

The Guiding and Establishing National Innovation for US Stablecoins (GENIUS) Act represents a move toward regulating stablecoins as a new form of bank.This legislation aims to establish a framework for the light-touch regulation of this emerging financial sector.

A key provision of the act mandates that stablecoins be backed 1:1 by reserve assets,including U.S. dollars, U.S. central bank reserves, demand deposits at insured depository institutions, Treasury bills, notes, or bonds with a remaining maturity of 93 days or less, treasury bill repo or reverse repo agreements, or shares in money market funds that invest only in the other permitted assets.

The act also requires monthly disclosure of reserves and annual audits for issuers with more than $50 billion in coins.Furthermore,it stipulates that stablecoin regulators should issue regulations covering capital requirements,reserve asset diversification,and risk management.

Notably, the act insists that a stablecoin “does not offer a payment of yield or interest.” This provision could be viewed as either a safeguard to prevent issuers from competing on yield or as a handout to the crypto industry by legally forbidding them from paying depositors interest.

Risks and Benefits: A Balanced Viewpoint

Assessing the risks and benefits of stablecoin issuers is crucial. One potential risk lies in issuers’ deposits in insured depository institutions. The FDIC insurance only applies to deposits up to $250,000, not to the institutions themselves.

The failure of Silicon Valley Bank (SVB) in 2023 highlighted this vulnerability when Circle, the issuer of the USDC stablecoin, had $3.3 billion of its reserves deposited at SVB. This situation led to a government bailout of USDC holders, along with SVB’s other depositors.

If stablecoins reserves can be bank deposits, stablecoins are runnable – and the stablecoin could be the cause of the run, if enough coin holders want to redeem their deposits for cash.

Limiting coin reserves to Treasury bills alone could mitigate this risk but might also create challenges related to payment settlements and Treasury issuance strategies.

Make [stablecoins] look like government money market funds – but that could get messy 1) if they’re truly to be used for payments, which will require some bank reserves to settle withdrawals from the cryptosphere, 2) if the Treasury doesn’t alter its issuance strategy to help meet that demand for bills, 3) if bills sell off or are illiquid, such as around debt ceiling dates.

On the benefit side, stablecoins have the potential to address the inefficiencies of the current payment system, particularly for cross-border and domestic transactions.

The Future of Payments: A Tokenized Deposit System?

An choice approach involves banks and the Federal Reserve tokenizing deposits using a publicly agreed blockchain technology. This could capture the speed and clarity benefits of stablecoins without the need for an intermediary currency.

In this scenario, stablecoins could revert to their original purpose: serving as chips in the cryptocurrency casino, a manageable form of banking.