Issue #27: Governments and Stablecoins

This issue was inspired by a recent conversation with @thatsauchward. Thanks Sam!

I’ve wanted to write about the relationship between governments and stablecoins for a few months, but it is particularly timely now in the face of increased regulatory chatter.

For those of you reading this on Sunday, earlier in the week the President of the United States’ Working Group for Financial Markets met for the first time during Biden’s administration and committed to publishing recommendations on stablecoin regulation within a few months.

There was also a paper published last week by Gary Gorton (Yale) and Jeffery Zhang (Board of Governors of the Federal Reserve System) advocating for stablecoin regulation and analogizing this new form of private money to the free banking period in the mid 1800s.

Like I said, timely.

In full disclosure, I didn’t study economics in college (music business actually…yep, I thought I was going to be a rap producer), and I’m not an expert on monetary policy or the history of banking (despite having read The Ascent of Money by Niall Ferguson). What I do have some perspective on is the value proposition of stablecoins, the reach they have by virtue of living on public blockchains, and the relationship the government could have with the tech companies issuing them.

I’ll walk through each area of perspective, but the “bottom line up front” or BLUF is that the US government should be doing everything in its power to support the tokenization of the dollar on public blockchains.

Let’s zoom in…

Quantifying the Market

Some statistics to keep in mind…

  • The total market cap of stablecoins is approximately $115B, up from $12B a year ago.

  • Over 99% of stablecoins in circulation are pegged to the price of one US dollar (important for later!)

Why Stablecoins Exist?

I’ve heard a lot of explanations for the creation of stablecoins, but they all boil down to one thing:

A stable store of value is critical to any modern financial system. Stablecoins exist because crypto users want/need a stable store of value, and in the absence of governments issuing tokenized dollars on public blockchains, the tech industry has stepped in to fill the gap.

Let’s unpack this…

  • There are two sets of financial infrastructure operating in parallel today - old financial infrastructure (mainframes), and new financial infrastructure (public blockchains).

  • The government issues dollars on one (the old one) but not the other.

  • Both sets of infrastructure need a stable store of value to support financial activity.

  • In the absence of governments issuing currency on public blockchains, tech companies have stepped in to fill the gap.

  • These companies serve as a “bridge”, taking dollars on the old infrastructure and issuing a digital representation (stablecoin) on the new infrastructure.

  • Most stablecoins are backed 1:1 by dollars in bank accounts.

Stablecoins act like dollars in a new financial system where real dollars don’t exist yet.

Global Reach

Public blockchains are relevant to this discussion because they are the infrastructure stablecoins live on. Stablecoins are both issued, and move, on blockchains like Ethereum, Solana, Algorand and others.

Blockchains exist on top of the Internet, so they naturally adopt all the characteristics of the Internet. One of those characteristics is being global.

By virtue of being on top of the Internet, public blockchains are inherently global. Since they are financial infrastructure, the future of public blockchains is therefore global financial infrastructure. One or more public blockchains will support the world’s 8 billion people and trillions of dollars of financial activity.

This also means assets issued on public blockchains inherently have global reach. The moment a digital asset is created, in theory everyone with an Internet connection has access to it. DeFi is making the last sentence even more true.

Therefore, a US Dollar denominated stablecoin has global reach by virtue of being issued on public blockchains. Public blockchains are the most efficient distribution system for the US dollar ever!

What government should do

As I led with, I believe the US government should do everything it can to support the tokenization of dollars on public blockchains. For me, it’s not a question of if, but how.

My opinion on how was inspired by comments from Brian Brooks, former Comptroller of the Currency under President Trump, on the Unchained Podcast last October. If you haven’t heard his perspective, you are missing out. Brian was also the former General Counsel of Coinbase, and is now the CEO of Binance.us.

Brian’s opinion, and one I share as well, is that to accomplish this objective, governments and the tech industry should focus on their respective strengths.

Governments are bureaucratic and slow moving. These characteristics can be advantageous when you are drafting legislation or rolling out new economic policy. When it comes to innovation though, these characteristics are crippling.

The tech industry on the other hand moves fast, fueled by billions of venture capital every year, and has a product-first mindset. These characteristics are advantageous for developing and scaling new technologies.

The relationship that I want to see, and that I think we will see, is the largest tech/fintech companies serving as implementation partners for the dollar. They won’t create supply, but they will distribute supply to the population. The beautiful thing about this model is that it isn’t new. It’s the same relationship the Federal Reserve has with banks today.

The Fed creates and manages our money supply but they don’t distribute dollars directly to each person in the country. None of you reading have personal accounts at the Fed. Instead they use banks, who are naturally closer to the end user, to disseminate money into the population through mortgages, small business loans and credit cards. This tiered distribution system works quite well.

Stablecoin issuers today are essentially occupying the same position as banks, except instead of issuing dollars into circulation, they are implementing the dollar on new infrastructure (public blockchains).

The value of this relationship for the US Dollar’s brand is enormous.

Let’s circle back to reach for a second. The reach of the largest tech companies dwarfs that of the largest US banks. JP Morgan, the largest bank in the US in terms of assets ($3.2T) operates in 60 countries worldwide.

Coinbase operates in over 100. Paypal operates in 200+ countries and regions. A DeFi protocol like Uniswap operates anywhere there is Internet access. The reach tech/fintechs have by virtue of being Internet-native is an asset.

Combine this with the reach of public blockchains, and the government has potential partners that can distribute the dollar to every corner of the world hyper efficiently. The government would be short-sided not to leverage this reach for their benefit.

As I highlighted up front, 99% of stablecoins are already pegged to the US Dollar. By all measures, the US is accidentally winning the stablecoin race, and it’s doing it by letting the tech industry do what it does best…innovate and implement.

Stablecoins vs. CBDCs

Now there’s another force in the market that effects the stablecoin narrative - CBDCs (central bank digital currencies). CBDCs are digital currencies issued and managed by a central bank.

Some critics of stablecoins suggest CBDCs are a superior model. I don’t agree for a few reasons:

  1. 92% of the world’s currency is already digital. Physical cash and coins make up less than 10% of the money supply. The value add of a CBDC to the end user is incremental at best.

  2. CBDCs are likely to be technologically inferior to their stablecoin peers. I’m not optimistic governments can develop technology products better than the tech industry, and we’ve already established the reach (and therefore utility) of stablecoins will be limitless in the future.

  3. The majority of CBDCs are what we call “wholesale” models, used to facilitate transactions between the central bank and its member banks only. No retail component. Interestingly, this makes CBDCs and stablecoins complimentary, not competitive. CBDC’s are bank to bank, and stablecoins can be the retail leg.

  4. And probably most important, CBDC proposals don’t contemplate leveraging a public blockchain like Ethereum. Not surprisingly, governments wants to own the infrastructure. The irony here is that if CBDCs are issued on separate infrastructure, tech companies are likely to do exactly what they are doing now - take dollars from that infrastructure and implement them on public blockchains because that is where demand is. Supply will follow demand.

Parting Thoughts

One thing I didn’t touch on in this issue was regulation because I feel it’s a secondary concern. You first have to buy in to the future that every asset will eventually live on public blockchains. Once you accept this, the regulatory conversation becomes more productive. Outlawing stablecoins isn’t the answer. Regulating their issuers so stablecoins are safe for the average consumer is.

I am all for reasonable regulation of new financial products, and there are concerns raised by stablecoins that are worthy of review. For example, near zero or negative interest rates have motivated some stablecoin issuers to diversify the reserves backing tokens in circulation. USDC and Tether, the two largest stablecoins by market capitalization, aren’t backed 1:1 by dollar reserves. Both have diversified reserves into other things with higher yields, because at the end of the day, these are products that need to generate revenue.

If regulation required 1:1 dollar reserves, these products would be less profitable. It’s an issue I expect to be hotly debated over the next year.

Thanks for reading,

Andy

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