Not a fan of crypto but this Odd Lots podcast offers a concise update on the use case for stablecoins.
Also concludes with an interesting summary of three things that crypto tends to mis about conventional finance, banking and money
omny.fm/shows/odd-lots/the-booming-crypto-use-case-thats-happening-right
Tony – From the Outside
… arguably too complicated.
Interesting post here by JP Koning exploring the differences between the way PayPal’s two forms of payment mechanisms are regulated. His conclusion might surprise you.
Here is a link to his post
jpkoning.blogspot.com/2023/09/there-are-now-two-types-of-paypal.html
This is the short version if you are time poor
Which type of PayPal dollar is safer for the public to use? If you listen to Congresswoman Maxine Waters, who in response to PayPal’s announcement fretted that PayPal’s crypto-based dollars would not able to “guarantee consumer protections,” you’d assume the traditional non-crypto version is the safer one. And I think that fits with most peoples’ preconceptions of crypto. Not so, oddly enough. It’s the PayPal dollars hosted on crypto databases that are the safer of the two, if not along every dimension, at least in terms of the degree to which customers are protected by: 1) the quality of underlying assets; 2) their seniority (or ranking relative to other creditors); and 3) transparency.
Let me know what I (and JP) might be missing
Tony – From the Outside
JP Koning offers an interesting post here speculating on the reason why Wise can pay interest to its USD users but USDC can or does not. The extract below captures his main argument …
It’s possible that some USDC users might be willing to give up their ID in order to receive the interest and protection from Circle’s bank. But that would interfere with the usefulness of USDC. One reason why USDC is popular is because it can be plugged into various pseudonymous financial machines (like Uniswap or Curve). If a user chooses to collect interest from an underlying bank, that means giving up the ability to put their USDC into these machines.
This may represent a permanent stablecoin tradeoff. Users of stablecoins such as USDC can get either native interest or no-ID services from financial machines, but they can’t get both no-ID services and interest.
Let me know what I am missing
Tony – From the Outside
One of the mysteries of life is why a country as advanced as the USA seems to be so far behind in its payment system. JP Koning suggests that the answer lies in part in the large number of banks that is a feature of the US system.
— Read on jpkoning.blogspot.com/2023/04/zelle-vs-interac-e-transfer-or-why-its.html
Tony – From The Outside
Matt Levine, like me, loves discussing stable-coin business models. In a recent opinion column he concludes that there is at least some prima facie evidence that transparency is not rewarded. At least not in the short run.
I have covered this ground in previous posts but at a time when the banking industry is seemingly demonstrating a perennial incapacity to learn from past mistakes, it is worth examining again the lessons to be drawn on the role of information and transparency in banking.
So starting with the basics …
Most of the leading crypto stablecoins have a pretty simple model: You give some stablecoin issuer $1, the issuer keeps the dollar and gives you back a dollar-denominated stablecoin, and the issuer promises to redeem the stablecoin for a dollar when you want. Meanwhile, the issuer has to hang on to the dollar.
Next he dives down a bit into the mechanics of how you might go about this. Matt identifies two basic models …
1.The issuer can try to work nicely with US regulators, get various licenses, and park its money in some combination of Treasury bills, other safe liquid assets, and accounts at regulated US banks.
2. The issuer can be a total mystery! The money is somewhere! Probably! But you’ll never find out where.
In practice Matt argues we have two examples of these different strategies …
USDC, the stablecoin of Circle, is probably the leading example of the first option. USDT, the stablecoin of Tether, is probably the leading example of the second option.
Matt, like me, is a traditional finance guy who struggles with the crypto trust model…
Me, I am a guy from traditional finance, and I’ve always been a bit puzzled that everyone in crypto trusts Tether so completely. You could put your money in a stablecoin that transparently keeps it in regulated banks, or you could put your money in Tether, which is very cagy and sometimes gets up to absolutely wild stuff with the money. Why choose Tether?
But over the recent weekend (11-12 Mar 2023) of banking turmoil USDC’s transparent strategy saw USDC depegged while USDT did not. The interesting question here is whether Tether is being rewarded for better portfolio risk management choices or something else was going on.
Matt sums up …
One possible understanding of this situation is that Circle made some bad credit decisions with its portfolio (putting billions of dollars into a rickety US bank), while Tether made excellent credit decisions with its portfolio (putting billions of dollars into whatever it is putting billions of dollars into). And, by extension, the traditional regulated US banking system isn’t that safe, and Tether’s more complicated exposures are actually better than keeping the money in the bank.
Another possible understanding, though, is that banking requires mystery! My point, in the first section of this column, was that too much transparency can add to the fragility of a bank, that the Fed is providing a valuable service by ignoring banks’ mark-to-market losses. Circle does not provide that service. Circle keeps its money in a bank with financial statements, and that bank fails, and Circle dutifully puts out a statement saying “whoops we had $3.3 billion in the failed bank,” and people naturally panic and USDC depegs. You have no idea where Tether keeps its money, so you have no idea if anything went wrong. This has generally struck me as bad, but it might have some advantages.
Tony – From the Outside
Frances Coppola argues in a recent post that proof of reserves as practised by the crypto finance community proves nothing. I would be interested to read any rebuttals, but the arguments she advances in support of this claim looks pretty sound to me.
Frances starts with the observation that the concept of “reserves” is not well understood even in conventional banking.
In the banking world, we have now, after many years of confusion, broadly reached agreement that the term “reserves” specifically means the liquidity that banks need to settle deposit withdrawals and make payments. This liquidity is narrowly defined as central bank deposits and physical currency – what is usually known as “base money” or M0, and we could perhaps also (though, strictly speaking, incorrectly) deem “cash”.
“Proof of reserves is proof of nothing” Coppola Comment 16 Feb 2023
This certainly rings true to me. I often see “reserves” confused with capital when reserves are really a liquidity tool. If you are still reading, I suspect you are ready to jump ship fearing a pedantic discussion of obscure banking terminology. Bear with me.
If you have even a glancing interested in crypto you will probably have encountered the complaint that traditional banks engage in the dubious (if not outrightly nefarious) practice of fractional reserve banking. A full discussion of the pros and cons of fractional reserve banking is a topic for another day. The key point for this post is that the crypto community will frequently claim that their crypto alternative for a TradFi activity like deposit taking is fully reserved and hence safer.
The published “proof of reserves” is intended therefore to demonstrate that the activity being measured (e.g. a stablecoin) is in fact fully reserved and hence much safer than bank deposits which are only fractionally reserved. Some of the cryptographic processes (e.g. Merkle trees) employed to allow customers to verify that their account balance is included in the proof are interesting but Frances’ post lists a number of big picture concerns with the crypto claim:
Crypto people complain that traditional banks don’t have 100% cash backing for their deposits, then claim stablecoins, exchanges and crypto lenders are “fully reserved” even if their assets consist largely of illiquid loans and securities. But this is actually what the asset base of traditional banks looks like.
Let me know what I missing ….
Tony – From the Outside
J.P. Koning offers an interesting contribution to the crypto regulation debate focussing on the problem with using money transmitter licences to manage businesses which are very different to the ones the framework was designed for …
The collapse of cryptocurrency exchange FTX has been gut-wrenching for its customers, not only those who used its flagship offshore exchange in the Bahamas but also U.S. customers of Chicago-based FTX US.
But there is a silver lining to the FTX debacle. It may put an end to the way that cryptocurrency exchanges are regulated – or, more accurately, misregulated – in the U.S.
U.S.-based cryptocurrency exchanges including Coinbase, FTX US, and Bianca.US are overseen on a state-by-state basis as money transmitters.
— Read on jpkoning.blogspot.com/2022/11/lets-stop-regulating-crypto-exchanges.html
Tony – From the Outside
There is a lot written about how bad the US payment system is and why crypto solutions are the future. Against that background, Tom Noyes recently published an interesting post setting out his thoughts on a project JPM Chase is running to reengineer their payment system. Tom’s posts are normally restricted to subscribers but he has unlocked the first in a 5 part series exploring what JPM Chase is doing.
His post is definitely worth reading if you are interested in the future of banking. The short version is that the traditional banking system is not sitting still while crypto and fintech attempt to eat its lunch.
Tony – From the Outside
A few months back I flagged a podcast where Grant Williams interviewed Luke Grommen discussing his analysis of the role of the USD in the international financial system. One of the issues covered was the way in which the USD pricing of oil has underwritten demand for USD and thereby supported the USD.
Tether recently released a post where it seems to be arguing that demand for Tether recycled into demand for USD safe assets can take over the role in US monetary policy that recycling demand for petrodollars has played under Bretton Woods II.
Not sure if the US government has any plans to respond formally to this generous offer but anyone interested in this latest instalment in the ongoing Tether story might find it useful to revisit Luke’s analysis of Bretton Woods II. In particular Luke’s contention that petrodollar driven demand for USD has had some downsides.
I recommend you listen to the podcast (to ensure nothing was lost in translation) but this is how I summarised Luke’s argument in my earlier post
The USD’s role as an international reserve currency has been described as an “exorbitant privilege” but Gromen argues that the arrangement has also come at a cost via the role it has played in the loss of US domestic manufacturing capacity (Triffin’s Dilemma).
The consequences of this trade off has come under greater attention post the GFC, initially as the social consequences of lost jobs started to impact domestic politics, and more recently as globalised just in time supply chains struggled to respond to the economic shocks created by the response to Covid 19
Gromen argues that the USD Department of Defence has wanted to see repatriation of the US industrial base for some time and hence will be happy to see a decline in the USD’s role as an internal reserve currency because they believe it will enhance national security
There is also the question of whether stablecoin driven demand just exacerbates a shortage of safe USD assets. I have talked about this issue here and more recently flagged a post by Steven Kelly on the same topic. This quote gives a flavour of Steven’s argument…
market- and regulation-inspired migration towards safer crypto assets is making stablecoins more popular, but that means there are more investment vehicles gobbling up the safe assets that otherwise grease the wheels of the traditional financial system. Absent rehypothecation, stablecoins will be a [giant sucking sound][1] in the financial system: soaking up safe collateral and killing its velocity.
Tony – From the Outside
Quite a lot has been written about the backing of stablecoins but Matt Levine uses the Tether use case to pose the question how much it matters for the kinds of activities that Tether is used for …
The point of a stablecoin is not mainly to be a secure claim on $1 of assets in a bank account. The point of a stablecoin is mainly “to grease the rails of the roughly $1 trillion cryptocurrency market,” by being the on-blockchain form of a dollar. We talk somewhat frequently about stablecoins that are openly backed by nothing but overcomplicated confidence in their own value; to be fair, we mostly talk about them when they are crashing to zero, but still. The thing that makes a stablecoin worth a dollar is primarily that big crypto investors treat it as being worth a dollar, that they use it as a medium of exchange and a form of collateral and value it at $1 for those uses. Being backed by $1.003 of dollar-denominated safe assets helps with that, but being backed by $0.98 of dollar-denominated assets might be good enough?
Matt draws no distinctions above but I don’t I think his argument is intended to apply to stablecoins that aim to challenge the traditional payment service providers (“payment stablecoins”) operating in the broader financial system. It does however pose an interesting question about how much stability crypto traders really require.
Tony – From the Outside
From the outside 