GiD Report#198 — How stablecoins break the monetary system

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GlobaliD

7 min readFeb 8, 2022

Welcome to The GiD Report, a weekly newsletter that covers GlobaliD team and partner news, market perspectives, and industry analysis. Check out last week’s report here.

This week:

How stablecoins break the monetary system
When regulators get it right
9 things you need to know about web3
This week in Solana
Tweet of the week — Wormhole edition
Stuff happens

1. How stablecoins break the monetary system

When people think of money printing, they typically think of central banks like the Federal Reserve.

But outside of extreme circumstances such as quantitative easing in response to once in a generation disasters like the financial crisis in 2008 and the recent global pandemic, the Fed has historically outsourced the creation of money to banks.

Which makes sense. Banks have branches and customers. They have closer ties to the community. Banks are better positioned to understand where new money should go.

It’s a way to decentralize money creation.

That new money is created through a process called fractional reserve banking, which is really just a fancy term for how really boring banking works. Banks take in deposits. They also lend money. The amount of money they lend is greater than the number of deposits they take in — hence, their reserves are only a fraction of their lending.

When banks lend out more money than they have, they’re essentially creating new money out of thin air.

The Fed is generally happy with this system. It’s also why they’re worried about stablecoins. Unlike fractional reserve banking, many stablecoins are set up with 1-to-1 reserves. That’s not an issue in and of itself — some people prefer their coins to be stable.

The problem is the potential impact on the rest of the system.

Here’s Matt Levine (via /rcb):

A less obvious risk of stablecoins is that they might be too stable. A stablecoin is, among other things, a substitute for putting money in a bank. Banks are generally very safe places to put money, but they are not perfectly safe. There can be runs on banks; banks can fail. For most U.S. retail bank accounts this is not a very salient problem, since they are backed by government deposit insurance, but many large institutional pools of money (corporate cash accounts, money-market funds, etc.) park their money in short-term bank instruments and are sensitive to risk. If a bank gets riskier, it will lose deposits. And if a stablecoin is so stable that it is safer than a bank, then banks generally will lose deposits.
Why is this a risk? Well, banks do useful stuff. Classically, they take people’s deposits and lend them out to other people to start businesses and buy homes. The provision of credit by banks helps the economy grow. More to the point, the withdrawal of credit by banks hurts the economy, and the risk here is wrong-way. If people get nervous about banks and pull out all their money to put it in safer stablecoins, then (1) that will probably happen at a time when the economy is shaky and (2) that will definitely make the economy shakier. The bulk of the response to the 2008 financial crisis involved preventing runs on banks, because those would have made all of the problems of the crisis much worse.

In other words, the existence of stablecoins could potentially exacerbate a retreat in money supply during economic downturns. It would also generally undermine the way modern money works.

Adding fuel to the fire are the returns being offered for stablecoins on certain platforms, which far exceeds what you’d get with a typical bank savings account.

(On the other hand, the world’s biggest stablecoin, Tether, doesn’t appear all that stable.)

Of course, none of these means that we should be writing off stablecoins. It just means there’s plenty to consider in the context of what this means for our monetary system going forward.

(The U.S. Senate will be looking at just that next week in a hearing scheduled to discuss stablecoins.)

As Matt adds:

I should say here that my sympathies are with the Fed researchers: I think that fractional reserve banking and credit intermediation are good, and accidentally getting rid of them would be bad. But I am also aware that lots of crypto people disagree; they got into crypto specifically because they are suspicious of the existing financial system and of fractional reserve banking. And while “U.S. regulators want to crack down on crypto to protect banks” sounds a bit like a conspiracy theory, it has some truth to it.

Relevant:

2. When regulators get it right

Here’s what happened, according to Coindesk (via /gregkidd):

A bipartisan group of U.S. House representatives has reintroduced a bill that would exempt consumers from paying taxes on crypto payments of less than $200.
The “Virtual Currency Tax Fairness Act” — an amendment to the Internal Revenue Service’s tax code announced on Thursday by Reps. Suzan DelBene (D-Wash.), David Schweikert (R-Ariz.), Darren Soto (D-Fla.) and Tom Emmer (R-Minn.) — would simplify tax burdens on daily crypto users who must now report even the smallest capital gains.

Relevant:

3. 9 things you need to know about web3

Consensys has a solid overview of the core principles of web3 (via /biancasmlopes). Naturally, it’s from an Ethereum-centric perspective, but the high level points are good:

Web3 is the new trendy name for the decentralized web.
Web1 is read-only, Web2 is read-write, Web3 is read-write-own.
Web3 is a money layer for the internet.
Web3 is an identity layer for the internet.
Web3 is a reaction to social networks not keeping our data secure, and selling it for their own profit.
Web3 is a way for artists and creators to not only own what they produce on a platform, but the platform itself.
Web3 is a new patron model for the internet.
Web3 makes it easy to set up cooperative ownership and governance structures.
Web3 is still not entirely decentralized.

Relevant:

4. This week in Solana

First, they released Solana Pay. Here’s Blockworks:

Solana has released a set of decentralized payment standards and protocols under a new product — dubbed Solana Pay — designed to cater to dollar-based stablecoin settlements, namely Circle’s USDC, for merchants and consumers.
The protocol will focus on enabling online and point of sales payments with the capacity to move “any volume of digital dollar currencies” transacting on Solana’s blockchain, according to a press release on Tuesday.
The point, Solana argues, lay in the product’s ability to facilitate immediate access to user funds while offering greater liability protection, no holding periods or bank transfer fees when compared to that of traditional financial institutions.

Coinbase and OpenSea are also both working on furthering Solana integration.

Relevant: