The White House is wrong about stablecoins. Here’s why.
Written by Ivan Hong & Sherry Jiang
Executive summary:
- Payments running on correspondent banking rails today are deeply problematic, at home and abroad.
- Stablecoins may be less risky than bank deposits. Unregulated stablecoin issuers now have more cash to satisfy withdrawals than regulated banks. Some stablecoin issuers have proven better at withstanding bank runs — than actual banks.
- Domestically, instant payment systems/CBDCs face barriers to adoption from special interest groups. Instant payment systems and CBDCs are inherently political, and thus cannot provide a truly global cross-border settlement layer.
- A global economy needs a global form of money. Stablecoins can fix many of the deficiencies with correspondent banking rails today.
Payments are broken
Payments running on correspondent banking rails today are broken. Even the White House agrees. The 2023 Economic Report of the President, published by the Biden Administration, highlighted some of these critical failures.
For one, legacy banking rails are incredibly costly. In 2019, it was estimated that slow payment systems cost American households more than $7 billion a year in bank overdraft fees, or by forcing consumers to use high-cost alternatives like check cashers and payday lenders.
More egregiously, these costs weigh heaviest on those who can ill afford them. The report notes that “Black households have disproportionately higher rates of being unbanked and underbanked (FDIC 2022)”.
In contrast, the White House notes: “many crypto assets do not impose minimum account requirements or charge overdraft fees, in contrast to some traditional banking institutions” with many unbanked individuals and minority households “citing such attributes as primary reasons they do not have bank accounts (FDIC 2022)”, as well as being likely the reason “why they are more likely to have invested in crypto assets than other households (Faverio and Massarat 2022)”.
The costs arising from the deficiencies of today’s legacy banking rails are enormous globally. A 2021 study by Accuity estimates that failed payments alone cost the global economy $118.5 billion in fees, labour and lost business in 2020. Shockingly, the study also found that 80% of organisations polled were willing to tolerate a failed payments rate of 5%.
One might be forgiven for thinking that in the face of such compelling evidence, the White House might be changing its tune about decentralised finance (DeFi) services and cryptocurrency payment rails.
But predictably, the White House launches into a 40-page tirade against cryptocurrencies. The report mounts a hastily-cobbled defence of why governments and central banks — despite their egregious failures to date — can do a better job than stablecoins, or DeFi.
In this article, we interrogate the arguments advanced by the White House, and defend our long thesis on the future of on-chain payments with stablecoins.
Stablecoins could be less risky than bank deposits
At the heart of the White House’s assault on stablecoins is the argument that they are inherently more risky than bank deposits. But this is demonstrably false.
Firstly, the White House alleges that a fundamental problem with stablecoins is the risk of “bank runs”, citing the implosion of the abortive TerraUSD stablecoin. Bank deposits — the White House says — are superior for payments because unlike stablecoins, “banks aim to maintain parity between deposits and dollars; that is, $1 deposited in a bank account can be withdrawn for $1 at a later point in time” (emphasis added).
Yet, the system of fractional reserve banking used by virtually all banks today are inherently vulnerable to bank runs. Bizarrely, the White House seems to be hoping that no one will notice if they simply feign ignorance of the events of 2008, and the current banking crisis precipitated by the run on Silicon Valley Bank.
In an incredulously feeble defence, the report then goes on to cite a 1975 paper, which argues that “deposit insurance has removed a chief cause of panics and bank runs, namely loss of public confidence in the banking system’s ability to convert demand deposits into cash”.
This is self-evidently untrue in 2023, particularly as the world just stood witness to the fastest bank run in history. As we explained in a recent article, written in the wake of Silicon Valley Bank’s collapse — the tools developed in the 1900s to prevent bank runs are increasingly failing in an era of social media and digital banking.
On the contrary, apart from algorithmic stablecoins, centralised stablecoin issuers have thus far proven to be more resilient to bank runs — than actual banks.
In February 2023, New York Department of Financial Services (NYDFS) has ordered stablecoin issuer, Paxos Trust to stop the issuance of dollar-pegged Binance USD (BUSD) stablecoin, shortly after the United States Securities and Exchange Commission (SEC) issued a Wells notice to Paxos alleging that BUSD is an unregistered security. Just a month later, concerns over cash deposits held by stablecoin issuer Circle, at the collapsed Silicon Valley Bank briefly caused a sell-off that saw the price of USDC dip below $1.
Yet, in both cases BUSD and USDC today trade at par with the dollar, while regulated banks like Silicon Valley Bank, Signature Bank, Credit Suisse have shuttered, with more feared to come.
The White House’s second salvo at stablecoins concerns redemption rights for holders of centralised stablecoin issuers. They argue that the terms of service of some stablecoins like USDC and USDT do not grant U.S. retail users redemption rights. This may be a particular concern for issuers like Tether.
But the fact still remains that Circle’s own terms of service states: “USDC … represents your right to redeem USDC for an equivalent amount of USD through your account with Circle”. Therefore the mere fact that a retail user cannot redeem USD for USDC 1:1 without a Circle account is a rather feeble point considering that anyone who does have a Circle account, can.
The White House report further argues that, “One important distinction between stablecoins and bank deposits is that in the United States, bank deposits are subject to a comprehensive set of regulatory and supervisory requirements. In contrast, stablecoins are not subject to requirements designed to maintain this exchange rate (of deposits to dollars)”.
But in fact, regulated banks’ promise to allow depositors to redeem their deposits for dollars is no better — and possibly even worse — than stablecoins issuers’ promise to do the same.
The White House is only too happy to conveniently omit the fact that some stablecoins like Circle’s USDC have more cash held in reserves to meet withdrawals than banks.
Reserve requirements stipulate what percentage of customers’ deposits banks cannot lend out, and must hold with the central bank. Historically, this has been set at approximately 10% by law in the United States.
But in March of 2020, the U.S. reduced reserve banking requirements from what was historically around 10%, to zero percent. With the stroke of a pen, we went from a fractional reserve banking system to a zero reserve banking system.
With the stroke of a pen, we went from a fractional reserve banking system to a zero reserve banking system.
In contrast, at the time of writing, Circle says it has $5.6B in cash to back $34.6B in USDC, or a reserve ratio of about 16.2% undeployed deposits, held as cash. That is not only 6.2% more than the historic legal reserve requirement once imposed on banks, it is now also 16.2% more than than the zero reserve requirement on banks in the United States. Even Tether, widely considered to be the least soundly collateralized stablecoin issuer, says that it holds 9.66% in cash reserves.
In his 1983 book, “The Mystery of Banking”, economist Murray Rothbard explained “Put another way, a bank is always inherently bankrupt, and would actually become so if its depositors all woke up to the fact that the money they believe to be available on demand is actually not there”.
Depsite the absence of legally-binding reserve requirements, stablecoin issuers maintain higher cash-to-deposit ratios than American banks today. Not motivated by the fear of laws, or out of the goodness of their hearts — but merely by the commercial necessity of maintaining user confidence in a competitive market.
Despite all of regulators’ talk about protecting investors and depositors, we now live in a world where unregulated stablecoin issuers now have more cash to satisfy withdrawals than regulated banks. A world where some stablecoin issuers can better withstand bank runs — than actual banks.
That is not some distant, hypothetical future, it is our present reality. A reality that the White House seems desperately eager for us to ignore.
Will instant payment systems render stablecoins useless?
So if the White House says stablecoins are not the answer, then what is?
Surprisingly, the report is not particularly fond of blockchain-based central bank digital currencies (CBDCs) either. The report cites concerns over the fact that a CBCD “could reduce the aggregate amount of deposits in the banking system, which could in turn increase bank funding expenses, and thus could reduce credit availability or raise credit costs for households and businesses”, as well as the fact that “the ability to quickly convert bank deposits into a CBDC could make systemic bank runs more likely or more severe”.
Instead, the White House believes that the answer lies in something called “Instant Payment Systems”. We’ll explain what they are, and why we believe that they do not replace the value proposition that stablecoins offer.
Domestic payments. Instant payment systems by central banks are growing in popularity around the world. They allow for instant, and often fee-free, interbank transfers via phone number, QR code, or contact names within a country. Brazil has PIX, India has its Unified Payments Interface (UPI). As of 2022, 65+ countries are expected to have access to a live, or upcoming real-time payments system.
In 2023, the United States too, will soon have its own instant payment system, FedNow. Like other instant payment systems fielded around the world, FedNow promises to deliver instant, 24/7, possibly fee-free, interbank payments. In other words, “A Peer-to-Peer Electronic Cash System”.
But there’s a catch — a big one. By their own admission, the White House notes that “FedNow requires commitment and active engagement by the private sector to make it interoperable … While noting that interoperability can take different forms, the Federal Reserve has maintained that it alone cannot fully establish the interoperability of FedNow; achieving this will require active partnership and collaboration with the financial industry”.
In other words — the White House wants you to believe that the same banks and financial institutions who currently extract enormous profits from the walled gardens of today’s financial system, will somehow come to see the light.
In contrast, interoperability is baked into the very ethos of DeFi. Not only are all applications on the same blockchain inherently interoperable, there are tremendous efforts at developing cross-chain interoperability infrastructure.
Cross-border payments. There is another major sector of the economy that instant payment systems are not designed to solve: cross border payments. Instant payments systems, and traditional financial services are primarily designed to serve domestic payment needs. But a global economy needs a system of global money.
A study by Uniswap Labs and Circle estimates that stablecoins could reduce remittance costs by as much as 80%, saving unbanked and underbanked individuals $30 billion per year. The study explains “For a $500 remittance, the cost of on-chain FX conversion and on/off-ramping is as low as $4.80, a small fraction relative to the average cost of remittance of $28.00 through banks and $19.04 through traditional remittance operators”.
Instant payment systems were not designed to solve these problems with cross border payments. Yet, some countries like Singapore have gone one step further. Not content merely with ensuring that her own citizens can enjoy instant payments domestically, the Singapore central bank has pursued bilateral projects linking up its own domestic instant payment system, PayNow, with other countries like India, Thailand, and Malaysia.
Put simply, subject to certain transaction limits, a Singaporean can enjoy the same Venmo-like experience with their friends overseas, while their regional neighbours can similarly do the same when they visit.
But for those tempted to extrapolate Singapore’s heroic successes to the future of global cross-border payments, consider the following:
Firstly, these are bilateral arrangements. Or in network theory, a “dyad”, not a triad. Simply put, as a Singaporean, I can proudly enjoy a Venmo-like experience with my friends in Bangkok and Delhi. But my friends cannot say the same with each other.
Secondly, to believe that the central banks of the United States, Russia, and China will follow in Singapore’s enlightened footsteps, you must be either ignorant of, or delusional about the political realities of global finance.
For instance, the rampant use of the SWIFT interbank messaging system as a tool to impose financial sanctions by the European Union, the United Kingdom, Canada, and the United States has encouraged other large countries around the world to consider building systems of their own.
Rather than bring a truly global system of payments, central banks’ instant payment systems are likely to become balkanized along the divided political and economic interests of incumbent financial institutions, and national alliances.
A global economy needs global money
In contrast, anyone can pay anyone, anywhere in the world with stablecoins today. It is a truly global, peer-to-peer electronic cash system that facilitates the borderless movement of both labour and capital.
It is worth pointing out that interoperability here is more than just about being able to pay your foreign friends for poker games or beers. As the White House notes, payments pervade all aspects of economic life, including “salaries, consumer and corporate bills, interest payments, dividends, and Social Security payments”.
Stablecoins are a global form of money that enables the globalisation of economic opportunities. One way this is happening is the rise of remote-first, globally-distributed teams. Since 2021, just three of the leading crypto payroll applications have processed at least $600 million dollars in total.
At the time of writing, Request Finance has processed over $300 million in crypto payroll, expenses, and invoices. As at January 2023, Utopia Labs’ posted a total payments volume of over $208 million. In May 2022, Coinshift disclosed a total crypto payments volume of $80 million.
Remote work is better for employees, better for employers, and better for nations. Employees can better raise families while pursuing careers, and pursue global employment opportunities. Employers can choose from a wider, global talent pool, and save on unnecessary overheads like rent.
Nations too, can enjoy economic growth without having to make the typical trade-offs. Emerging economies need not suffer brain-drain as their best and brightest leave for jobs elsewhere, while advanced economies need not contend with the politics of immigration.
Payment rails also connect savers to investment opportunities at home, and around the world. On today’s payment rails, it is difficult for someone in Jakarta to connect to and invest in the NYSE. Someone living in New Jersey would find it quite impossible to deploy their savings in a private credit fintech lending platform in Singapore.
In contrast, access to DeFi platforms today are borderless. Simply connect your wallet, and you can begin to trade, invest, save, or swap currencies, from anywhere around the world.
A schoolteacher in Portugal, or a nurse in Texas can now invest into previously inaccessible opportunities like private credit in Singapore through Goldfinch, automobile loans in Brazil via Credix, or Asian fixed income instruments via Bluejay Earn.
Concluding thoughts
The White House report concludes with a renewed plea for people to place their trust in central banks, and governments. “Certain innovations, such as FedNow and a potential U.S. CBDC, could help bring the U.S. financial infrastructure into the digital era in a clear and simple way, without the risks or irrational exuberance brought by crypto assets.”
Yet as we have shown, the White House report ultimately falls on its own sword, because it is the very expression of the fundamental problem that will consign central bank digital currencies (CBDCs), and centralised financial services to a constrained future.
Domestically, the adoption of instant payment systems, and hopes for better banking supervision are also vulnerable to regulatory capture by special interest groups. The incumbent financial institutions that continue to profit from a system that privatises profits and socialises losses, cannot be expected to embrace the interoperability that will make it easier for depositors to leave for better alternatives.
Globally, insofar as financial services like the SWIFT interbank messaging network are designed to be instruments of political interests, they are subject to geopolitical rivalries on the international stage. It is irrational to expect competing civilizations to embrace free capital flows across borders, when they have most vigorously sought to prevent it on their own competing terms.
The White House wants you to believe that cryptocurrencies have failed to live up to their promise. They want you to believe that — despite their egregious failures to date — they promise to do a better job than stablecoins, or DeFi platforms ever can. But it is these very same government failures — at home, and abroad — that were responsible for the creation of cryptocurrencies in the first place.
To conclude our defence of an on-chain future for financial services and digital payments, we could not think of more fitting words than those which unveiled the Bitcoin White Paper. Words which continue to ring true in this current banking crisis, as it did in the previous one, when Satoshi wrote:
“The root problem with conventional currency is all the trust that’s required to make it work. The central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust. Banks must be trusted to hold our money and transfer it electronically, but they lend it out in waves of credit bubbles with barely a fraction in reserve”.
While we may not agree that Bitcoin will hit $1 million anytime soon, we have a high conviction that stablecoins have properties which make them uniquely suited to become a critical catalyst of a truly global economy.
