Still more on stablecoins

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Stablecoins part III: expert views 

A pair of recent letters focused on whether stablecoin issuers are more like banks or money market funds, how they might be regulated, and the difference between what they are functionally and the way they pitch themselves. The letters elicited great feedback from readers about crypto, payments and banks. 

Alistair Milne, professor of financial economics at Loughborough Business School, emailed to make a detailed version of an argument several readers proposed. Stablecoins, he says, are overhyped as a solution to the problems in our payment system. He wrote: 

The frictions [with current payment systems] come not from the payment tech itself (SWIFT banking messaging can send . . . money all around the world in seconds), but from the ancillary operations: customer services, risk and fraud management, and compliance, which slow down crediting of accounts. Stablecoins achieve speed by neglecting these ancillary operations — but can they actually compete as payment instruments without them?

These ancillary operations include chargebacks for mispayments and overpayments; integration into accounting and financial systems for automatic salary distributions and the like; “pull” payments where customers agree to let services providers, such as car hailing services, draw money from their accounts; payments to business and governments that, for tax and accounting reasons, can only accept a guaranteed exact nominal amount of fiat currency; customer services of the sort provided (to varying degrees) by the likes of card issuing banks and PayPal; identity verification to comply with “know your customer” and anti money-laundering laws. Finally there is fraud protection. As Milne writes, “Banks do this badly. But will stablecoins be any better?” He sums up: 

In most countries, for most purposes, payments work pretty much OK for most needs. Stablecoins need to find a killer application, not served by existing arrangements, attractive enough for sufficiently large scale adoption to scale . . . But what is this application?

I would argue that we already know exactly what this application is. It’s crime. 

On a separate point, Dan Awrey, a professor of law at Cornell and the author of a book on payment technology, argued to Unhedged that the Genius Act makes the mistake of muddling the regulation of money and finance and the regulation of payments:

When we talk about what money is, we often conflate [its functions as] a reliable store of value and as a convenient means of making payments. Banks and bank regulation are very good at the first thing and often very bad at the second. They keep our money safe, but [payment] technology has moved at a rate the banks and their regulators have struggled to keep up with . . . What if you had a regulatory category that was not a bank and . . . just focused on the technology-driven payment stuff?

The Genius Act, caught in this muddle, gives the benefits of federal financial regulation to a particular payments technology — distributed ledgers — that is, the blockchains that underlie stablecoins. “You don’t a need distributed ledger to [solve the problems with payments] but we are writing regulation for distributed ledger technology” only. What would a modern payment company that did not use a public blockchain look like? Like Stripe, but with access to the Fed’s payment rails:   

Stripe is a non-financial payments technology, basically a software company . . . but one of its biggest problems is making its API [application programming interface] interoperable with the banks, in part because their software and information technology are outdated. In a perfect world, Stripe would have an account with the Fed they didn’t use for anything other than holding customer funds, which were then not invested in anything other than the reserve asset. It’s just a representation of value in a software suite. [They need this because] these [Fed] master accounts are the nerve centre of the payment system . . . What they need to do is send and receive money without getting a bank involved . . . but if you are going to give these companies access to the federal payment rails you need a regulatory framework for them that says them “thou shall not do finance”

A better regulatory regime would give payments companies access to the Fed’s payment rails without allowing them to take and invest deposits, rather than creating a new, narrower, less-regulated form of deposit-taker — based on only one of many possible technologies — just for the sake of facilitating payments.

Amanda Fischer, policy director at the advocacy group Better Markets and a former SEC official, retweeted last week’s letters about the Genius Act and commented that “The fact that Congress is even debating a legislative structure for something clearly impermissible under 21(a) (2) of Glass-Steagall is a testament to the power of the crypto lobby.” Here’s what that section of Glass-Steagall says: 

It shall be unlawful . . . for or any person, firm, corporation, association, business trust, or other similar organisation, other than a financial institution or private banker subject to examination and regulation under State or Federal law, to engage to any extent whatever in the business of receiving deposits subject to check or to repayment upon presentation of a passbook, certificate of deposit, or other evidence of debt . . . unless [it] shall submit to periodic examination by the Comptroller of the Currency or by the Federal Reserve bank

That seems pretty clear. If you have on-demand deposit liabilities — as stablecoin issuers clearly do — you need to be regulated like a bank, or at least subject to bank examination. Stablecoin issuers as described in the Genius Act look to be unlawful, then. But why doesn’t that make money market funds illegal, too? As it turns out, this question has come up before. In 1979, the chair of a New York savings bank wrote to the SEC to ask why it was legal for money market funds to take deposits. A Department of Justice official argued in response that depositors in banks are creditors of the bank, whereas money market fund shareholders are owners of the fund, in that they are exposed to the fund’s gains and losses. Stablecoin owners do not own the stablecoin issuers — they’re depositors, and stablecoin issuers are banks (as Gary Gorton and Jeffrey Zhang have written in a paper Fischer recommended to me). She told Unhedged that:

The problem with the Genius Act is it provides a light-touch version [of] bank regulation, but it gives regulators many fewer tools. Plus, it allows issuers to go to lighter-touch states for their charters [and the state regulators control issues like reserve asset diversification and equity capital requirements]. Yes, the allowable reserve assets are somewhat narrow, but you have deposit run risk that’s Silicon Valley Bank on steroids . . . it’s crypto, so the deposit base will be concentrated and everyone will run for the exit when anything bad happens in the wider crypto market.

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