  Exploring the transformation of value in the digital age By Michael J. Casey, Chief Content Officer July 23, 2021 If you were forwarded this newsletter and would like to receive it, sign up here.
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I find the increasingly contentious conversation around stablecoins fascinating, perhaps as much as the fraught global debate around Bitcoin.
Whereas Bitcoin is still a ways off from the mass adoption needed to effect its promise of a sweeping paradigm shift, stablecoins pose a more immediate challenge to the stewards of the legacy financial system. That stems from the fact that this rapidly growing class of blockchain tokens – designed to hold a steady value versus the U.S. dollar or some other instrument – constitutes a less radical, more evolutionary change. It's a smaller, first step in reimagining money, which is why incumbents can't kid themselves (as they are prone to do with Bitcoin) that it's not a threat.
So, with regulators, armchair accountants and investors all now obsessing over what stablecoins mean for the future of finance, this week's newsletter is entirely focused on them.
So, too, by the way, is the accompanying Money Reimagined podcast episode, in which Sheila and I chat with the ever-insightful Caitlin Long, founder and CEO of Wyoming-based digital assets bank Avanti, and George Selgin, an influential monetary historian who is the director of the Cato Institute's Center for Monetary and Financial Alternatives. Have a listen after you read the newsletter.  And before we hit the column, a big thank you to my colleagues Adam Levine, Marc Hochstein, Teddy Oosterbaan and my editor, Ben Schiller, for putting out two excellent editions of this newsletter in my absence over the past two weeks.
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The risks of a rush to regulate stablecoins  Illustration: Rachel Sun/CoinDesk The 2021 start of the Northern Hemisphere summer may go down as the moment in which U.S. regulators suddenly woke up to the reality of stablecoins.
The wake-up started late last month when Eric Rosengren, president of the Federal Reserve Bank of Boston, detailed what he saw as the risks these stable-value tokens pose to the financial system. Rosengren's take was followed by an almost diametrically opposed position from Randal Quarles, the Fed's vice governor, who gave a surprisingly forward-thinking speech calling on the U.S. to encourage stablecoin innovation.
Then, this week, U.S. Treasury Secretary Janet Yellen convened a meeting of the President's Working Group on Financial Markets to discuss stablecoin regulation. It included top-ranking officials from the Treasury, the Fed, the Securities and Exchange Commission, the Commodities Futures Trading Commission, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp.
Not much has been forthcoming from those talks, but one attendee, SEC Chairman Gary Gensler, suggested some stablecoins whose prices depend on the performance of traditional securities might themselves be securities and so subject to his agency's oversight. Gensler's staff is working to meet a demand from Sen. Elizabeth Warren (D-Mass.) that the SEC lay out a broader framework for crypto regulation by July 28.
Systemic risks? It's not just letters from U.S. senators that have stirred regulators into action. It's also the remarkable growth of stablecoins.
As you'll see below in the newsletter's chart section, the total value outstanding from the top 10 stablecoins – including Tether's USDT, Circle's USDC, Binance's BUSD and MakerDAO's DAI – now stands at $108.7 billion. That's up fourfold from the start of this year and three times more than the $35.6 billion that PayPal Holdings held on account for its PayPal and Venmo customers at the end of the first quarter.
This explosive growth – along with the aggressive investigation of leading stablecoin issuer Tether by the New York attorney general's office, which ended in a settlement requiring greater transparency from the company on the breakdown of the reserves that back its tokens – has raised concerns about "systemic risk."
That's a phrase that conjures memories of the 2008 financial crisis, when investors were dumping assets to cover their rapidly evaporating mortgage investments, creating a de facto "bank run" on the financial system. The fear is that in a world where reserve-backed stablecoins are ubiquitous, doubts about the size, quality and liquidity of the assets backing the tokens could exacerbate a financial crisis. Mass stablecoin redemptions could bankrupt their issuers, critics say, and create a similar effect of panic and cascading credit risks across the economy.
It is the legitimate responsibility of governments to mitigate such risks. In fact, boosting confidence in that way would likely be a boon for stablecoin usage, much as the provision of federal deposit insurance did for the U.S. banking system in 1933.
So regulation should be welcome by the industry. But what will that regulation look like? Will it encourage or restrict innovation and access? And will the right rules be applied to the right scenarios? Or will a one-size-fits-all approach be applied that does more harm than good?
Haste is not conducive to the kind of nuanced regulatory approach that's needed. Nor are alarmist analogies such as "bank runs," which for various reasons don't really apply here.
History lessons Some of the urgency was stoked this week by Gary Gorton, an economist at the Yale School of Management, and Jeffery Zhang, an attorney at the Fed. In a paper that was no doubt placed in front of all members of the President's Working Group, they called on the U.S. government to extend "public money" control over "private money" stablecoins – either by compelling them to be federally regulated as banks or by replacing them with a central bank digital currency.
"If policymakers wait a decade" to act, the paper authors argued, "stablecoin issuers will become the money market funds of the 21st century – too big to fail – and the government will have to step in with a rescue package whenever there's a financial panic."
To make their point, the authors used the United States' 19th-century experience with underegulated "wildcat banking," when different banknotes issued by private banks circulated, sometimes at varying prices relative to their nominal at-par value. But the Cato Institute's Selgin, a monetary historian and a guest on our podcast this week, tore apart the analogy in a convincing tweet thread. Reading it, one is left with the idea that that past experience with "private money," if stripped of 19th-century constraints around geographic and information transparency that shouldn't exist in the digital age, shows its potential for the 21st century.
For the most part, Selgin wrote, the private banknotes traded at par within the states to which the banks belonged and were discounted only when they were carried across state lines to places far from where they could be physically redeemed in those banks' branches.
Selgin noted that a 10% federal tax was needed to stop people from using the state banknotes, which meant that "despite their inability to pass at par everywhere," users considered them "good as if not better for certain purposes than their national counterparts."
Contrary to popular myth, Selgin continued, shutting the so-called wildcat banks did not deliver efficiency payoffs to many poorer Southern states, whose post-Civil War development was held back for decades because of insufficient credit in the wake of the state banks' closures.
Fast forward to the more transparent, digitally ubiquitous model that the internet affords, and it's hard to see how discounting, by itself, is a big enough problem to offset the optionality and innovation that stablecoins offer to users. If everyone recognizes that a sought-after token is not the equivalent of national fiat currency but is merely expected to hold close to its value, then people will continue to use it for convenience, programmability and ease of access.
Certainly, if you look at the 90-day trading price for USDT and that of USDC on CoinGecko, that's what the market is telling us. The prices vary by a few cents with the ebb and flow of demand and supply, but average around $1.00. Is that a problem? Every major user has known the questionable state of Tether's reserves for months, if not years. But they don't worry about it because they can see the price any time and adjust their contracts accordingly.
What kind of regulation? This is not to argue regulation wouldn't be valuable. Rules to compel transparency could further breed overall confidence in the system so that price spreads narrow even further.
And it might be that a heavier-handed bank charter model, one that removes all doubt about the par value of 100%-reserved tokens, is needed to get large compliance-constrained corporates to use stablecoins and ramp up their usage across the economy.
Certainly, that's what Long, the other guest on this week's podcast, is betting on. Long is the founder and CEO of Avanti Bank, which took advantage of Wyoming's new crypto-friendly special purpose depository institution (SPDI) bank charter and is using that to lobby the Fed backing for its new digital dollar token, Avit.
As Gensler noted, some stablecoins could be securities. And as Gorton and Zhang note, Tether's terms and conditions give it equity issuer-like optionality on how and when to honor redemptions, unlike other reserve-backed stablecoin issuers, which treat their customers' fund deposits as debt obligations.
Perhaps Tether should be regulated as a money market fund, but the others as deposit takers. How will that distinction affect the market?
And what about "synthetic" stablecoins such as Dai, an ERC20 token whose value is managed algorithmically by smart contracts over the Ethereum blockchain – and which got no mention in Gorton and Zhang's paper. They aren't reserve-backed at all. Are they now illegal? Who's the regulated person or entity in a case where the system is run by a decentralized community? The thousands of geographically scattered Ethereum nodes that execute the smart contracts?
One could take the argument of Rohan Grey – an assistant professor of Willamette University College of Law who drafted a bill for Rep. Rashida Tlaib (D-Mich) calling for all stablecoins to require banking licenses that the developers of MakerDAO protocol behind Dai. But as difficult as that already is to enforce, it is about to become even harder now that the legal entity they formed, the Maker Foundation, is shutting down and turning over governance to a decentralized autonomous organization.
If regulators are serious about promoting innovation, financial access for all and the freedom to produce code, regulators will have to work through these issues deliberately and carefully.
As an African proverb says, "Haste and hurry can only bear children with many regrets along the way."
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Off the Charts Off the Charts: The year of stablecoins Most of this week's chart speaks for itself, at least in terms of the observations made in the column above.
Pulled together by CoinDesk's Shuai Hao from Coin Metrics data, it tracks the market capitalization of ten stablecoins, which because of their 1:1 valuation offers a proxy for issuance and circulating supply.
That "up and to the right" trend you see – that's what's jolted regulators to pay closer attention.  Credit: Shuai Hao/CoinDesk You'll see that the industry is dominated by four players -- Tether (USDT), Circle (USDC), MakerDAO (DAI) and Binance (BUSD) – and by the first two of those in particular.
Also notable: the fact that the black line of Tether has dipped lower in recent months, while all others have risen.
Why? Well, one unproven conspiracy theory ties this to bitcoin's price decline, as it argues that Tether issuance was being used to manipulate the price of bitcoin higher but now that it is being more closely monitored per the NYAG's settlement, both price and issuance have fallen. But it might also simply be a combination of market forces and Tether's legal challenges, with the latter hurting confidence and driving customers to seek out alternatives such as USDC.
Either way, it will be interesting to come back to this chart some months after new U.S. regulations are written.
The Conversation That paper  Illustration: Rachel Sun/CoinDesk The Gorton and Zhang paper kept the Crypto Twitterati engaged for quite a while this week.
My former Wall Street Journal colleague and co-author Paul Vigna spotted a line that was bound to be a trigger for the Bitcoin community.  As mentioned, George Selgin attacked the paper in not one, but three tweet storms. Here he is leveraging the work of his Cato colleague Lawrence H. White to again highlight what he sees as its historical inaccuracies.  Wharton Professor Kevin Werbach, a business scholar who has dived deeply into crypto, including having written a respected book on blockchain technology, lamented that these authors haven't done similarly with regards to stablecoins.  But economist and New York Times columnist Paul Krugman, who has called cryptocurrencies a Ponzi scheme held up with "technobabble" and "libertarian derp," loved the paper.  On the other hand, financial expert and CoinDesk columnist Frances Coppola, who has been highly critical of cryptocurrencies and certain aspects of stablecoins, ripped it to shreds.  Nonetheless, warned Michael Green, chief strategist at Simplify Asset Management, the paper is likely to have some real influence among those who matter most in this process. 
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Relevant Reads Out of the stables  Continuing with the stablecoin theme, there was plenty of news on the topic this week.
Frances Yue reported that New York-regulated trust company Paxos revealed that the reserve assets for its PAX stablecoin and for BUSD, which it issues on behalf of Binance, comprise 96% cash and 4% Treasury bills. That's quite a conservative breakdown, one quite different from Tether's and Circle's asset declarations, which showed a wider – some would say riskier - array of assets.
Tether might be losing market share in the U.S., but stablecoins aren't just dollar-backed. Sebastian Sinclair reports that European exchange Bitstamp will support Tether's euro-backed stablecoin in response to the increasing demand for it.
Sinclair also reports on a new stablecoin that's just been granted a U.S. patent for a model that pegs its value to government debt, not a currency. I suppose that's a way to tokenize sovereign bonds.
It has been fun covering the stablecoin regulatory outlook in this newsletter, but for the best insights, you have to read the master, Nikhilesh De. In another, highly informative catch-up on regulatory trends, Nik's "State of Crypto" newsletter this week walks through the back-and-forth in Washington, including in Congress, on this issue. Sign up for his newsletter here.
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