Stablecoins: Beyond The Hype- Reserves

Stablecoins are the crypto du jour. The hype has been turned up several notches after the passage of the GENIUS act. I wrote about the genius of the GENIUS act. The genius of the act is to convince the crypto-universe that it is beneficial to them while promoting TradFi like rails for issuing, custodying and exchanging stablecoins, with a freeze and seize mechanism and KYC/AML. Elements of the act include

1. Reserve requirements
2. Yield
3. KYC requirements
4. Rehypothecation of reserves
5. Stablecoins as collateral

In addition several scholarly and lay articles have been published, before and after the passage of the act, listing the various possible intended and unintended consequences of the act.

1. Parallel to eurodollars, maintaining par
2. Stablecoins and the effect on the velocity of money
3. Skinny Fed Accounts
4. Zero Lower Bound and Monetary policy
5. Breaking the buck-run on stablecoins
6. Stablecoins on other currencies and de-dollarization

The GENIUS act covers only “payment” stablecoins. The act does not help us distinguish between a payment stablecoin and stablecoin for any other use. Stablecoins have seen rapid rise in total value due to the rise of DeFi. It is used in swap protocols such as Uniswap where a stablecoin is the stable part of a swap pair, the other being a volatile crypto-currency. For traders, a stablecoin is a stable shelter when they take a break from trading crypto-currencies. This can be overnight, when they sleep or any other occasion when traders are not devoting their full attention to the market. In addition, some remote workers can opt to be paid in stablecoins. They will do so if they are based in countries with high inflation or a currency weakened in other means. I have not been able to find any breakdown on stablecoin transactions that separates out payment use cases from others.

In this article, the Reserve aspect of Stablecoins will be explored, subsequent articles will look at the other aspects of the act.

Reserves (GENIUS act 4.(1). A)

“Maintain identifiable reserves backing the outstanding payment stablecoins of the permitted payment stablecoin issuer on an at least 1 to 1 basis, with reserves comprising at least one to one of the following”

1. Coins and currency or balance in a Fed Account
2. Bank deposits, properly issued
3. Treasury bills with a max maturity of 3 months (93 days)
4. Repos and Reverse Repos under certain conditions to reduce counterparty risk.

This list has an embedded hierarchy. At the top are the obligations of the Federal Reserve. Wonder what will happen if a CBDC joins the list at the top. There is no need to wonder in the United States, as talk, experimentation and research on CBDCs have been effectively censored. This is even as Federal Reserve obligations are at the top of this hierarchy. It is a shame that the public will never have access to a CBDC which is a digital form of a Federal Reserve obligation. This is even as there is a discussion on “skinny” Fed accounts to support stablecoin issuers.

It is also telling that on demand bank deposits can be a direct backing for stablecoin issuers. On demand is any account that the customer can withdraw at any time. Such on demand obligations are the primary cause of bank runs as the customers can show up en-masse to withdraw their on-demand deposits.

Any bank under the federal reserve or a regional bank with a charter can issue stablecoins, but this needs a completely segregated account as stablecoins need the deposits to be 1:1, not 1:10 or so for other use cases. Usually that 1:10 ratio is popularly known as fractional reserve banking. An analysis of banking by the BoE proves that they generate deposits as part of a credit market, not as fractional reserve banking. The spread between the interest generated by a loan and the interest paid on deposit deposit accounts power the profits of a chartered bank.

There is nothing in the act that prevents banks from funding reserves with deposits that they generate on the fly as they have proper tier 1 and tier 2 capital ratios. There is a gap in the issuance of stablecoins by the back door that does not follow the one to one reserves in the act.

Another stipulation of the act is the fact that stablecoins cannot be covered by deposit insurance. What if stablecoins are backed by deposits that are covered by deposit insurance? Will this coverage at a remove protect stablecoins?

Reserves are needed for redemption, which is meant to be 1:1. One USDC equals one dollar. We will address this fully in the next article on the singleness of money and the maintenance of par.