A policy paper written by former Federal Reserve Board analyst Brendan Malone on behalf of technology investment firm Paradigm argues that stablecoins should not be compared to traditional bank deposits in terms of risk. The paper explores the risks posed by stablecoins to the financial system, particularly in light of legislative proposals in the United States that aim to incorporate crypto payment instruments into existing banking and securities frameworks. Malone suggests that the risks associated with stablecoins are different from those of bank deposits and money market funds.
Stablecoins are a type of cryptocurrency that are designed to maintain a stable value relative to a specific asset, typically a fiat currency like the U.S. dollar. Money market funds, on the other hand, are mutual funds that invest in short-term assets with a lower level of risk compared to other mutual funds.
According to Malone, banks are exposed to a concept called maturity transformation when they accept short-term deposits and use those funds to offer long-term loans that may not be repaid for years. This creates an ongoing risk for banks and requires continuous risk management. He cites the recent example of the collapse of Silicon Valley Bank, where client deposits were allocated to long-term assets, leading to the bank being shut down by regulators.
Malone argues that stablecoins pegged to a fiat currency do not inherently pose the same risks as bank deposits because their reserve assets are usually backed by short-dated Treasurys and kept separate from the issuer’s assets. He suggests that federal regulation implemented under new legislation could require specific safeguards to mitigate risks. Unlike bank deposits, stablecoin holders can redeem their coins at any time at par on demand, eliminating the duration mismatch between short-term liabilities and long-term or risky assets.
In addition, stablecoins serve different purposes than money market funds. Malone points out that stablecoins are primarily used as a means of payment or transactions based on the U.S. dollar peg, rather than as an investment option or cash management vehicle. Holders of the largest U.S. dollar-pegged stablecoins do not receive any return based on the reserves; instead, the stablecoins are used as a form of cash.
However, the paper cautions that if stablecoins are regulated through existing frameworks without considering their unique characteristics, it could result in strict bank-like oversight of stablecoin issuers. This could limit competition and consolidate the dominance of a few large players in the market. The document emphasizes the importance of regulatory guardrails that preserve confidence in stablecoins as a form of money, while still allowing for innovation and addressing the specific risks associated with the technology.
In recent years, there have been numerous digital asset bills introduced to the U.S. Congress, covering various aspects of cryptocurrency regulation, including stablecoins. Some of these bills include the Stablecoin TRUST Act and the Stablecoin Innovation and Protection Act. The paper concludes by highlighting the need for stablecoin legislation that acknowledges the unique risks of the technology, while also encouraging innovation in the space.
Overall, the policy paper highlights the need for a nuanced understanding of the risks associated with stablecoins and emphasizes the importance of tailored regulation that balances risk mitigation with fostering innovation in the cryptocurrency industry. By addressing the specific characteristics and risks of stablecoins, regulators can help preserve confidence in this form of digital currency and ensure that control over the monetary system does not become concentrated in the hands of a few market participants.
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