The Big Miss in the Biden Administration’s Stablecoin Report

With due respect to Jamie Lee Curtis, Eddie Murphy and Dan Aykroyd, the best piece of cinema ever made about financial markets is not “Trading Places” but “The Big Short.” It opens with a quote about the limits of knowledge: “It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.”

Whether you agree with that explanation for the financial crisis, there is a double irony in that opening quote. The movie attributes it to Mark Twain, without evidence. Instead, the quote, or something close to it, first appeared in a book about the history of Persia published in England in 1747, and was later bowdlerized by a different and less famous mid-19th century humorist, Josh Billings.

Tom Brown is a partner at Nyca Partners. This article is part of Future of Money Week, a series exploring the varied (and sometimes weird) ways value will move in the future.

The unintentional irony of starting a movie about the limits of knowledge with a misattributed quote about the limits of knowledge has been on my mind of late as I watch the fight about stablecoins play out. The U.S. Federal Reserve and the President’s Working Group’s recent stable commentary echoes the response to the financial crisis.

Bank regulators are, rightfully, obsessed with a repeat of the 2008 meltdown. The prevailing view among bank regulators and the more progressive lawmakers about the cause of the financial crisis is twofold: (1) financial innovation made something that should be easy to understand, a 30-year mortgage, too complicated for consumers to understand; and (2) bank regulators failed to protect consumers from taking out loans they had no ability to repay, which let risks build up to the point that they nearly swamped the global financial system.

Viewed from that perspective, the sudden interest by the Federal Reserve and the Biden administration in stablecoins makes sense. For years, consumer interest in cryptocurrency was safely ignored, until a bridge between the crypto economy and the banking system appeared.

Stablecoins are that bridge, and they create two types of risk for the banking system. First, stablecoin reserves are often held in the form of bank deposits. Second, when they are not held by banks, those reserves are often held in the types of securities that banks and other systemically important financial institutions also hold – i.e., Treasury bonds and short-term corporate paper. Stablecoins, thus, create a risk that a sudden drop in the value of crypto assets could affect the real banking system.

The obvious solution to the problem posed by stablecoins is to eliminate intermediaries: Rather than create an instrument that is a digital proxy for a dollar, just create a digital dollar. Unfortunately, the response proposed by the President’s Work Group to these potential risks doesn’t make as much sense. They recommend Congress pass a law giving banks a monopoly on stablecoin issuance.

Banks in the United States have had a monopoly on enabling firms and households to use money to pay their bills or make investments – what’s sometimes called the “convenience premium.” Technology has been whittling away at that premium for decades. Crypto is an example, but hardly the only one. PayPal, Square Cash and other peer-to-peer (P2P) money movement systems allow people to make and receive payments without having those funds touch a bank account.

As Matt Harris pointed out in a recent piece for Forbes, the technologies perfected by these companies is very quickly enabling firms and households deploy capital instantly and cheaply around the world. This makes it difficult for bank regulators to ensure that firms and households keep their wealth at banks.

Also part of Future of Money Week:

The Radical Pluralism of Money – Matthew Prewitt

Aligning Social and Financial Capital to Create Better Money – Imran Ahmed

The Transhumanist Case for Crypto – Daniel Kuhn

Shiba Inu: Memes Are the Future of Money – David Z. Morris

7 Wild Scenarios for the Future of Money – Jeff Wilser

The Downside of Programmable Money – Marc Hochstein

Unlike Matt Harris, I don’t think fiat currency is going to disappear by 2040. I’m quite certain I’ll still be paying my taxes in fiat dollars in 19 years. I’m also quite confident that I’ll be paying my mortgage in those same dollars. But, like Matt, I believe that in between those payments, assets will move across a range of investment opportunities.

Some of those opportunities are likely to be denominated in dollars, but others won’t. Rather than trying to use the law to force the toothpaste back into the tube, bank regulators in the United States should be preparing themselves and their regulated institutions for a world where firms and households can choose to earn to 0% on their capital in exchange for being able to pay their bills or pursue risk-free returns elsewhere.

Or, as not-Mark Twain would have it, we know it “just ain’t so” that banks will continue to rule the payments landscape. So why give them oversight over stablecoins?

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