Forget Myths: The Stablecoin Reality

Amanda Fischer is the Policy Director and Chief Operating Officer (COO) for Better Markets, overseeing the organization’s policy program areas and leading a team of policy experts. Before joining Better Markets, Amanda served as the Chief of Staff & Senior Counselor to the Chair of the SEC. She also served as the Policy Director at the Washington Center for Equitable Growth, and in multiple positions for members of Congress. 

Picture this: you’re sitting on your couch eating leftovers and a late-night infomercial comes on the television. The hosts lures you in by asking, “Do you love the risk of money market funds but hate earning a return? Do you love the zero interest paid on your bank deposit, but hate the protection of FDIC insurance? Well, do I have a product for you!”

If you know anything about money, you’d immediately change the channel. As a shrewd investor, if you’re accepting the risk of a money market fund, you want a return on your investment. And if you want a guarantee of protection, FDIC insurance is the way to go. But somehow, policymakers in Washington are being pitched with this “heads-I-win, tales-you-lose” infomercial as stablecoin legislation circulates in Congress. 

A number of people, often those who will benefit from financial products that they claim are new (and, oh by the way, are really great for you), have made lots of claims in support of Washington’s embrace of stablecoins. But they often present an overly rosy view on the benefits of this new-but-old type of financial instrument, and even more often neglect to mention key risks for consumers, businesses, and the safety of the economy.

Stablecoin Transfers are Unpredictable and Risky

First, they claim that stablecoins are just like paper cash – in that they’re available 24/7, unlike the stodgy world of money transfers via traditional banks. If only that were the case. 

Most crypto transactions done by ordinary retail customers aren’t peer-to-peer via a blockchain. Instead, transactions happen “off-chain,” or within the internal custodial records of intermediaries like Coinbase, Binance, and Kraken. And the problems with money transfers into and out of these crypto intermediaries are actually worse than at traditional banks. One need only go to Reddit forums or X.com to read cries for help from users having trouble with crypto platform outages impeding their ability to withdraw funds. In fact, while the CEO of one crypto intermediary recently cheered the demise of the CFPB, his firm reportedly had 1,734 complaints pending about customers’ inability to withdraw funds from his company. Not exactly the 24/7 future of money we think the American people want or need!

There’s also no shortage of operational barriers to stablecoin transfers directly on blockchains. In fact, outages on the Solana blockchain are so prevalent that they’ve inspired a rich tapestry of hilarious crypto memes: 

Even when they work, blockchain transfers are expensive. As Binance notes in a blog post, Ethereum “gas fees” – the toll users pay to transfer money on the blockchain – are “anything but…a nominal, consistent [or] predictable surcharge.” 

In contrast, the Federal Reserve’s systems for money transfers have gone out of service just once, for a period of about 3 hours. And in 2023 the Fed launched FedNow, a system for instant payments that continues to make progress in cheaply delivering funds to households and businesses in seconds. (Admittedly, the Fed has been indefensibly slow in getting FedNow up and running.) The Clearing House also offers real-time payments and many private firms are offering new non-crypto instant ACH transfers, too.

Stablecoins Ride the Coattails of the Regulated Financial System

Advocates also claim that a key feature of stablecoins is that they “don’t rely on central banks or complex interbank clearing and settlement arrangements.” 

Again, this is not true. The value of stablecoins’ reserves is highly interlinked with the safety of the traditional financial system. Reserve assets are custodied at banks, in money market funds (MMFs) and held in repo arrangements, whose safety is secured by Federal government rules and watchdogs. Stablecoin issuer Circle, for example, held $3.3 billion (or 8 percent of its reserve assets backing its USDC stablecoin) in uninsured bank deposits within Silicon Valley Bank. When bank regulators shuttered SVB, USDC’s value fell to $0.88 on the dollar until the U.S. government indicated that emergency measures would be invoked to make whole uninsured depositors. And any claim of independence from central banks has more than a shade of irony considering news this week of an incoming Executive Order from the President which would reportedly force the Federal Reserve to provide Fed bank accounts to certain crypto firms.

Stablecoins Aren’t Fit for Your Wallet

Stablecoins are unfit to ever replace real money, even with the modest safeguards provided by congressional legislation. As Better Markets has pointed out, history is rife with examples of so-called stablecoins losing their dollar peg. And even minor de-pegging can be a major event for households and the financial system.

For example, SEC rules around government money market funds – the safest funds invested in short-term, very high-quality assets – are required to report within one business day if their fund deviates from a stable dollar value by just a quarter of one percent. That confidential reporting is taken seriously at the agency and used to inform risk monitoring to ensure the protection of investors and stability of the wider financial system.  

Stablecoin de-pegging events may be an acceptable risk for crypto users, who trade in and out of volatile markets and use stablecoins as a store of value in between such trades. In other words, a stablecoin depegging by a few cents on the dollar may not be significant to a crypto trader accustomed to wild swings in the Bitcoin market. But now imagine replacing consumers’ fiat dollars for stablecoins. What would you do if you were a convenience store owner and all of a sudden one stablecoin depegged by one cent, another by three cents, and still another by 5 cents? Would you have a currency conversion terminal to manage the real-time exchange rate risk of all the stablecoins your store customers may use? What if you’re a worker that got your paycheck in stablecoins? 

Stablecoins are Less Stable Than Deposits

Proponents also make the case that stablecoin issuers are safer than banks because they hold reserves one-to-one (meaning, one dollar worth of assets for every stablecoin they issue), compared to traditional banks, which operate via fractional reserves (meaning, a bank keeps a fraction of deposits on hand and lends the remainder out to borrowers).

Better Markets has certainly argued for the need for higher bank capital requirements and better bank supervision. But it’s silly to suggest that stablecoin issuers are somehow more stable than traditional banks. 

These proponents, as well as congressional legislative sponsors, essentially promote stablecoins as a new form of “demand deposits” – money available to consumers at any time of day, no matter what. But the assets in which stablecoin issuers can invest under proposed legislation include relatively risky assets that may not be able to be liquidated quickly and turned into cash during certain market conditions. This includes uninsured bank deposits, money market funds, and repo loans to highly leveraged hedge funds. Some proposals also have provisions allowing regulators to approve other investments such as mortgage-backed securities and corporate debt, which are even less liquid.

These types of investments could be appropriate for a bank, whose deposit base should be big, diversified, and subject to routine examination and supervision by regulators. But stablecoins will tend to have a much more concentrated user base, full of crypto enthusiasts whose desire to get their money back will be highly correlated to the whims of the wider crypto market. Banks and money market funds where stablecoin issuers park their funds would be exposed to more risk, as stablecoin users’ correlated dash-for-cash will cause fire sales of assets that could cause big losses. This phenomenon of intragroup herding in the crypto and VC communities was a factor in the bank failures of 2023, and will be heightened by the light-touch to no-touch stablecoin issuer supervisory regime in congressional legislation. It’ll then be supercharged by recent policy reversals at federal regulators as it relates to supervision of crypto activities within banks. 

In short, March 2023 is just a preview of the risks that may come once stablecoins are highly integrated into the banking system.

Stablecoins’ Confusing Resolution Regime

Finally, proponents argue for a two-tiered resolution regime, with bank chartered stablecoin issuers going through the FDIC receivership process (minus the FDIC insurance) and other, non-bank issuers getting a new chapter within the bankruptcy code. This hybrid resolution process invites consumer confusion, with stablecoin users bound to mix up the protection afforded to them for their stablecoin money versus real money. It gets worse when you consider that the maximum amount a stablecoin customer can get back in bankruptcy is the value of the stablecoin when the failure happened – which likely will be less than dollar-for-dollar.

Further, certain stablecoins may trade at different discounts relative to others based on the market’s perception of the speed of the resolution regime. Again, that’s not exactly great for something that’s supposed to be money. The allowance for non-U.S. based stablecoin issuers only complicates matters. These fraught policy questions are unnecessary, as the U.S. already invented the FDIC and its attendant insurance system.

Conclusion

So why would a customer buy that infomercial product of a money market fund that doesn’t pay a return, or a bank deposit that isn’t guaranteed? Well, they probably wouldn’t. Once you separate the hype and marketing from facts and reality, it’s clear that stablecoins are a solution in search of a problem, at least in the real-world.

Charitably, the customers that use stablecoins do so because of the convenience of operating with crypto money on crypto trading platforms. Uncharitably, stablecoins are used for money laundering, tax evasion, and the long list of other nefarious activities that have been widely reported. 

It’s also potentially a way for payment apps like PayPal, Venmo, or Zelle to sidestep federal consumer protection payments law. If Congress creating a new loophole-ridden type of licensing regime with no explicit consumer protections, companies can migrate their payment apps to the blockchain and attempt to wiggle out of longstanding protections that apply when consumers transfer funds. At least one proponent notes that Congress should consider layering some form of payments protection onto stablecoin legislation.

Whenever an infomercial hawks “innovation,” buyers should kick the tires and examine whether claimed new technologies are actually all that new or innovative, and whether they benefit the public or merely sidestep consumer protections and call it “disruption.” Congress should do the same.

The opinions shared in this article are the author’s own and do not reflect the views of any organization they are affiliated with.

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