1/ FED's NEW PAPER ON STABLECOINS today deserves both praise & a response. It contains something BIG (1st time I've seen the Fed say this🚨🔥) but it misses things too. Wonky topic: how #stablecoins fit into plumbing of #tradfi, which is right up my alley.
2/ The NYFed's 3 conclusions + my reactions here: 1. Stablecoins tie up liquidity unnecessarily💯✅🎯 2. Stablecoins that do not tie up liquidity are risky & less fungible❌🤔 3. We already have an efficient form of digital money/just need to adapt it to a new environment: ✅&❌
3/ Let's dig in. First, in this🧵we're talking abt fiat-collateralized #stablecoins, not algo or #crypto-collateralized ones that never touch USD payment systems. Central bankers' real concern has (rightly) always been impact of fiat-backed #stablecoins on trad system plumbing.
4/ 🚨🚨🚨NEWS--the Fed, for the 1st time that I'm aware, "went there" & said this out loud
5/ The Fed is right🎯--#repo/pledged collateral market experts have warned of it too: fiat-backed #stablecoins create collateral siloes that suck already scarce collateral out of the very markets upon which #WallSt banks rely for funding. 2008 fin crisis was a run on these mkts⚠️
6/ ...so, anything that could gum them up will catch central banks' attention. Foremost expert on this, Dr. Manmohan Singh of @IMFNews, has been warning abt #stablecoin collateral siloes for a while (eg,👇co-authored w/ Kahn & someone you may recognize😉)
7/ Since 2008 fin crisis, there have been ~4 episodes of #repo mkt disruption (depends on how you count 'em), to which Fed usually responds to de-gum it. In other words Fed watches these mkts VERY closely. Repo mkt is huge, leveraged & prone to disruption.
8/ So, it's significant that the NYFed's economics arm "went there" (the NYFed runs the Fed's trading desk, deals with #repo mkt issues & executes monetary policy partly thru repo). Translation: Fed knows the status quo for fiat-collateralized stablecoins is unsustainable. Yep💯
9/ Next, let's look at Fed's 2nd conclusion--that private money is risky & less fungible. Fed cites papers about the Free Banking ("wildcat") era that have been heavily debated (Fed should've acknowledged that). I won't rehash debate here bc there's a more interesting analogy.
10/ The MUCH better analogy for #stablecoins is checks issued by banks in the pre-Fed era, instead of wildcat banking. Here's what Singh, Kahn & I wrote about the analogy to checks in the @CentralBanking_ article cited above:
11/ Here's the key Fed paper on the topic. Private check-clearing networks in pre-Fed era didn't deliver fungibility for checks issued by different banks--it wasn't until the Fed later started guaranteeing pymt of checks at par that checks became fungible. richmondfed.org/~/media/rich…
12/ But I'd caution readers NOT to assume that a Fed guarantee of pymt of #stablecoins at par (by analogy to checks) would create stablecoin fungibility--bc stablecoins have near fungibility already w/o needing such a guarantee. Here's what Singh, Kahn & I wrote on this topic:
13/ In other words, the near-fungibility of #stablecoins today comes from their TECH: network effects, speed & ease of integration w/ the platforms on which stablecoins are issued (eg, a ubiquitous, open, permissionless protocol like #Ethereum). Comparing the near-fungibility...
14/ ... achieved by #stablecoins today to the lack of fungibility of private check clearing networks in the pre-Fed era, it's clear stablecoins have gone FAR toward solving the old fungibility problem using tech alone (w/o a Fed guarantee).💡🚀 Re: whether stablecoins are risky:
15/ ...of course it depends. Risky compared to what? Is a stablecoin fully backed by T-bills riskier than a bank deposit? A corporate treasurer holding billions in a bank deposit (of which only $250k is FDIC-insured) certainly doesn't think of that bank deposit as riskless.
16/ All the corporate treasurers w/ whom I worked on #WallSt did counterparty credit risk analysis on their banks--bc legally, a bank deposit that exceeds the insured limit is same as buying unsecured debt issued by the bank. Are fully-backed stablecoins really riskier?🤔Unclear.
17/ Finally, to the Fed's 3rd conclusion: the authors advocate for adapting existing bank deposits to the new tech-forward environment by tokenizing them & letting them circulate on a #blockchain!!!🔥🚀Great idea!!!💡🎉But then they throw in a curve ball that would ADD risk.☠️
18/ They want insured & leveraged (fractional-reserve) banks to issue #stablecoins. TERRIBLE IDEA🤢bc that would concentrate big risks into the very core of the financial system. Why? bc leveraged banks issuing #stablecoins would massively increase the risk of bank runs.🤮Why?
19/ bc: (A) there's a much higher risk of bank runs when settlement speeds up (equally true w/ all forms of fast settlement, incl FedNow, real-time ACH, #stablecoins or other mechanisms), & (B) most US banks simply do not have the tech stacks capable of handling fast settlement.
20/ There's a reason why the vast majority of US banks still only settle up w/ the Fed 1x/day--most banks simply don't have the tech capability to do it more often. The biggest banks (G-SIBs) do have the tech to handle this tho. (Fed article linked to a JPMorgan press release🤔
21/ Why does fast settlement=more risk of bank runs? Most banks are leveraged & they "borrow short & lend long." Payments that settle fast (in minutes) mean a bank run could start intraday & the bank might not even know it until it settles up at the end of the day. Be careful. 🚧
22/ So...bringing it all together, GREAT IDEA to allow tokenized bank deposits to circulate🎉but TERRIBLE IDEA that, practically speaking, in reality only big, leveraged banks could issue them. This would increase bank run risk at the very core of the financial system. Ugh.☠️
23/ There's a safe & sound way to tokenize bank deposits w/o increasing bank run risk at the financial system's core: ring-fence the bank issuer, prohibit it from taking on leverage, back its obligations 100% by central bank reserves rather than let it trap scarce collateral...
24/ ...don't let it become overdrawn at the central bank (even intra-day) + more common-sense ways to prevent bank run risk from spilling into the financial system's core. (PS--#Wyoming special-purpose depository institutions fit that description, & @AvantiBT is a Wyoming SPDI).
25/ In sum, the Fed paper has big issues but it also did advance the ball. PS--here's a Nov 2020 speech abt how to safely integrate #stablecoins w/ #tradfi--mentions "tradable bank deposits" (not too diff from Fed's "tokenized bank deposits" terminology)🤠theblockchaintest.com/upload…
Original posted on twitter by Caitlin Long