The document discusses stablecoins such as USDT and USDC from a classic economics point of view and tries to assess their value as “private money”. It is also concerned with how policymakers will adjust our regulatory framework to handle stablecoin growth and evolution in the coming years.
The authors compare the current state stablecoin issuance and governance processes to the Free Banking period in the US, which lasted from 1837 to 1863.
Free Banking Era
During this period, US banks issued their own banknotes backed by the deposits of gold and silver within their vaults. These notes did not trade one for one (they were non-fungible), and their value mostly depended on the capitalisation of the issuing bank. Issuing paper currency wasn’t just limited to banks; even drugstores and railroad and insurance companies could issue their own “money”.
Almost half of these banks failed, and their average lifespan was five years. The free banking era ended in 1863 when a system of national banks was introduced.
Researchers explore questions like “are stablecoins money?” and “are stablecoin providers banks?”, as seen from economics and law point of view.
The issuance of stablecoins is compared to demand deposits and the issuers are likened to unregulated banks.
Are stablecoins money ?
According to a traditional definition, anything that we call money must satisfy three properties: store of value, unit of account, and a medium of exchange. The last of three is assumed to hold by default for the money we are used to. This perception is altered when we talk about crypto.
For stablecoins to become a medium of exchange, the NQA principle – ‘no questions asked’ – needs to be satisfied. It means they should be accepted in a transaction without due diligence on its value.
The authors point out a couple problematic examples (Appendix): Stronghold USD and Facebook Diem stablecoins have unknown market cap, Tether (USDT) and Centre (USDC) can delay money redemption due to KYC. In addition, limited credibility is inherent to the backing of the produced tokens for almost any issuer.
The paper draws a parallel with “private money” issued by the US banks in mid 19th century. Page 41- “The use of private bank notes was a failure because they did not satisfy the NQA principle”.
Are stablecoin providers banks ?
We read on page six: “Depositors” buy stablecoins and, for each dollar deposited with the issuer, they receive that number of stablecoins in exchange. Supposedly, depositors can redeem coins at par and at will for cash, just like demand deposits and money market funds.”
The researchers thus dub stablecoin issuers as “essentially unregulated banks”.
Gorton and Zhang provide a valuable example of why this might be a bad thing.
Any bank exists on a premise that no majority of its deposit holders will suddenly decide to withdraw all their money at the same time. But even for such an unlikely case, insurance agreements were introduced within the classical banking system. For instance, FDIC is providing such deposit insurance in the States since 1933.
Stablecoin providers have no such confidence in their tokens’ backing. Just last month, TITAN – a DeFi project once valued at $2 billion – suffered a sweeping collapse of its native currency, the Iron Titanium Token. It went from $64 to nearly zero within 24 hours due to panic selling.
The paper therefore states that stablecoin issuers have a limited understanding of the risks they bear.
The aforementioned limitations of the stablecoin space were, in part. known to economists since the Free Banking Era.
Both researchers are clearly sceptical about the sustainability of stablecoins and propose a combination of possible solutions: replacing all existing stablecoins with a central bank digital currency, use Treasuries or central bank reserves for backing, impose insured-bank regulations on existing tokens.
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