Former Federal Reserve Policy Analyst: Stablecoins Offer Lower Risk Than Bank Deposits

In a recently published policy paper commissioned by Paradigm, a technology investment firm, Brendan Malone, a former analyst of the Federal Reserve Board, offers a fresh perspective on the risk landscape of stablecoins in comparison to traditional bank deposits.

The paper delves into the intricacies of stablecoins and their potential impacts on the financial system. It also highlights ongoing discussions in the United States regarding legislative proposals that aim to incorporate cryptocurrency payment instruments into the existing banking and securities frameworks. Malone makes a bold assertion, stating that stablecoins, contrary to common belief, pose lower risks than bank deposits and also differ significantly from money market funds.

For context, stablecoins are cryptocurrencies designed to maintain a stable value relative to a specific asset, often a fiat currency like the U.S. dollar. On the other hand, money market funds are mutual funds that invest in short-term assets, cash, and cash equivalents, boasting lower risks compared to other types of mutual funds.

Malone points out a crucial factor that distinguishes the risk profile of traditional banks from that of stablecoins. Banks practice “maturity transformation,” wherein they accept short-term deposits and utilize those funds to provide long-term loans that might not be repaid for several years. This strategy exposes banks to perpetual risk, necessitating continuous risk management efforts.

A recent real-life example exemplifying the vulnerabilities of maturity transformation is the unfortunate collapse of Silicon Valley Bank, which occurred in March. The bank had reportedly allocated client deposits to long-term assets, leading to regulatory intervention and eventual closure due to a bank run.

Contrary to such risks, Malone contends that stablecoins, especially those pegged to fiat currencies, do not inherently pose similar threats. He elucidates that these cryptocurrencies typically have their reserve assets backed by short-dated Treasuries, segregated from the issuer’s other assets. Moreover, he emphasizes that federal regulations, if implemented through new legislation, can enforce specific safeguards that eliminate the duration mismatch between short-term liabilities (where stablecoin holders can redeem at any time at face value) and long-term or risky assets.

Stablecoins also serve a vastly different purpose compared to money market funds. Malone emphasizes that stablecoins are predominantly utilized as payment mediums or for transactions based on their U.S. dollar peg, rather than serving as investment options or cash management vehicles. In essence, holders of major U.S. dollar-pegged stablecoins do not receive any returns based on the reserves; instead, these stablecoins function as equivalent to cash itself.

The paper urges caution when regulating stablecoins, highlighting that applying existing frameworks without considering their unique characteristics could lead to excessive bank-like oversight of stablecoin issuers. Such a move may inadvertently stifle competition and consolidate power among a few dominant players in the market.

Advocating a balanced approach, the paper suggests that regulatory measures should be tailored to address the specific risks associated with stablecoins while still encouraging innovation within the space. It emphasizes that by implementing regulatory guardrails, confidence in stablecoins as a viable form of money can be preserved, while preventing undue concentration of power in the hands of a select few market participants.

The backdrop of this discussion is a flurry of digital asset bills introduced to the U.S. Congress since 2022, encompassing a wide range of topics, including stablecoins and U.S. regulatory jurisdiction. Several of these bills seek to regulate stablecoins, such as the Stablecoin TRUST Act and the Stablecoin Innovation and Protection Act. As the regulatory landscape evolves, the policy paper by Brendan Malone serves as a timely contribution to the ongoing debate surrounding stablecoins’ future and their potential role in the financial ecosystem.

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