Taming Wildcat Stablecoins, Gorton and Zhang, September 2021

Gary Gorton and Jeffrey Zhang argue that stablecoins cannot function effectively (or efficiently) as a form of money as at 2021 because questions remain regarding the quality of the assets that back the claim users have on the stablecoin issuer. This they argue creates two problems: firstly that the instruments cannot reliably be exchanged at their par value and secondly that the instruments are vulnerable to run risk.

They draw on the historical experience with both Money Market Funds (MMF) and with private bank demand deposits to explore policy options for ensuring that stablecoins achieve the “no-questions asked” status they believe is essential for them to achieve true money like status that other forms of private money inside the regulatory perimeter currently enjoy.

This note attempts to summarise the paper with some commentary on strengths, weaknesses and questions posed by their evidence and analysis.


In the authors’ own words …

Cryptocurrencies are all the rage, but there is nothing new about privately produced money. The goal of private money is to be accepted at par with no questions asked. This did not occur during the Free Banking Era in the United States—a period that most resembles the current world of stablecoins. State-chartered banks in the Free Banking Era experienced panics, and their private monies made it very hard to transact because of fluctuating prices. That system was curtailed by the National Bank Act of 1863, which created a uniform national currency backed by U.S. Treasury bonds. Subsequent legislation taxed the state-chartered banks’ paper currencies out of existence in favor of a single sovereign currency. 

The newest type of private money is now upon us—in the form of stablecoins like “Tether” and Facebook’s “Diem” (formerly “Libra”). Based on lessons learned from history, this article argues that privately produced monies are not an effective medium of exchange because they are not always accepted at par and are subject to runs. This article therefore presents proposals to address the systemic risks created by stablecoins, including issuing stablecoins through insured banks, backing stablecoins one-for-one with safe assets like Treasuries and central bank reserves, and establishing a central bank digital currency. 


The core of this paper is the argument that stablecoins should be viewed as the latest iteration in a long history of privately produced money and, as a consequence, raise many of the same issues that have confronted private money creation for centuries.

“While the technology changes, and the form of privately produced money changes, the issues with privately produced money do not change—namely, private money is a subpar medium of exchange and is subject to runs.”

Gorton and Zhang argue that the fundamental problem with any privately produced form of money (including bank demand deposits) is the capacity to satisfy what they refer to as the “no-questions asked” principle …

… money also must satisfy the no-questions-asked (“NQA”) principle, which requires the money be accepted in a transaction without due diligence on its value. In other words, NQA means both parties to a transaction must agree that the money be accepted at par—a ten-dollar bill should be accepted as being worth ten dollars, not a penny less. Achieving the characteristic of NQA has, historically, been very hard. Few remember that demand deposits were unable to achieve NQA without deposit insurance. 

The paper is organised as follows:

  1. Part I defines what stablecoins are, some key market developments and addresses the question whether they qualify as “money”
  2. Part II uses the examples of problems that Money Market Funds to provide some historical context to the issues that increased use of stablecoins as an alternative form of money will generate
  3. Part III goes back to the Free Banking Era to explore what lessons that period offers for dealing with privately produced money
  4. Part IV offers Gorton and Zhang’s policy suggestions for dealing with the rise of stablecoins
  5. Part V concludes with a call to arms arguing that the issues raised need to be addressed before stablecoins become systemically important
Part I. Digital Money in the 21st Century

Gorton and Zhang here set out their argument for why “credibility issues with respect to their backing” lead them to conclude that stablecoins do not satisfy the NQA principle and hence do not yet qualify as money.

A. What are Stablecoins

Gorton and Zhang define stablecoins as a “… digital form of privately produced money where each coin is supposed to be backed with safe assets.

“Depositors” buy stablecoins and, for each dollar deposited with the issuer, they receive that number of stablecoins in exchange. Supposedly, depositors cab redeem coins at par and at will for cash, just like demand deposits and money market funds”

As a result, they conclude that “… issuers of stablecoins are essentially unregulated banks”. They note that stablecoins issuers as a whole seem to be very aware of the need to convince holders that the coins are backed by an adequate pool of safe assets but some seem to do a better job than others in providing reliable and credible evidence of their backing.

B. Are Stablecoins “Money”

Gorton and Zhang qualify the standard textbook three prong definition of money, arguing that the NQA principle is also necessary for money to function efficiently as a medium of exchange.

Students in introductory economics know that money has three important properties. It must be a store of value, a unit of account, and a medium of exchange. But this is not complete because it is just assumed that the object will be used as a “medium of exchange.” For that to happen, the object must satisfy the NQA principle, a necessary condition for money to be a medium of exchange. 

The NQA principle seem intuitively right to me but some of the details of the theory Gorton and Zhang use to support it are less obvious. I don’t think the concerns I have invalidate the general principle but I will lay them out for completeness.

Drawing on papers that Gorton has authored or contributed to previously, Gorton and Zhang argue that private money that reliably trades at par value on a NQA basis can be achieved by backing that private money claim with debt. So far so good. The most controversial part of this analysis (for me at least) is the conclusion that the asset side of the issuer’s balance sheet “… should consist of loans that are opaque and about which it is costly to produce information” They specifically nominate loans to small business and home mortgages as examples of what they have in mind.

I buy the idea that money like claims should be “information-insensitive” but struggle with the argument for deliberate opacity. It seems to me that the users have to believe that their claim on the issuer is so unquestionably strong that they do not need to think about the soundness of the assets backing their claim. An unquestionably strong capital position (to use the Australian terminology) is part of the answer but so is a highly over-collateralised claim (i.e. having first claim on the assets of the issuer), backed up with some form of deposit insurance.

What I like about Gorton and Zhang’s NQA principle is that it highlights the weakness in the approaches adopted to date by stablecoin issuers. All have chosen some form of disclosure with varying levels of transparency but the opacity and vagueness of some of these stablecoin attestations simply feeds doubts about the credibility of the claim.

There also seems to be a common assumption that an attestation that the stablecoins are backed 1:1 by assets in the relevant (typically USD) fiat currency is sufficient. Indeed some will even argue the that a 1:1 claim on the reserve assets is better than a fractional reserve backed bank deposit without considering (or understanding?) the value of capital, seniority and insurance that underpins the NQA basis of private money claims created by the regulated banking system.

C. Are Stablecoins “Demand Deposits”

Gorton and Zhang argue that stablecoins certainly are certainly designed to function like demand deposits …

By design, a stablecoin is redeemable by the holder of the stablecoin for the underlying asset. It’s an explicit or implicit contract between the stablecoin issuer and the stablecoin holder— one stablecoin for one U.S. dollar. From the perspective of economic incentives, a stablecoin is a demand deposit. If people give $1,000 to a stablecoin issuer in exchange for 1,000 stablecoins, they will behave precisely as if they have $1,000 in deposits at a bank that’s available for withdrawal at any time. It’s functionally equivalent.

… but the determination of whether they are in fact demand deposits is less clear from a legal perspective. The legal analysis looks first at the question of whether the contract holder of the stablecoin and the stablecoin issuer is an equity contract or a debt contract. A demand deposit will be a debt contract. In the case of Money Market Funds, notwithstanding some functional similarities to demand deposits, the US Department of Justice concluded that MMF holders “owned” the assets held by the fund so redemption is simply a transfer of ownership and there is no debtor/creditor relationship.

Using the legal logic that has been applied to MMF, Gorton and Zhang argue that most stablecoins should be considered to be debt because the holders have no ownership rights over the underlying reserve assets. The one exception is Tether because the issuer is not obligated to exchange one Tether for one USD (it has the right to meet redemption demands by selling a share of its underlying assets and delivering the proceeds of that sale).

So a case can be made that stablecoins (excluding Tether) function like demand deposits and have one of the key legal features of a demand deposit.

D. Are Stablecoin Issuers “Banks”?

Their short answer is no, not legally anyway. They do engage in some activities that are similar to those conducted by banks (so they are arguably part of the long tradition of shadow banking) but they do not meet any of the legal criteria that define a bank. Some of the relevant criteria listed by Gorton and Zhang for a financial institution to be a bank include

  • FDIC insured
  • A charter from a proper federal government authority (e.g. the Office of the Comptroller of the Currency (OCC) or a proper state government authority (e.g. the State of Connecticut Department of Banking or the New York State Department of Financial Services) and has a master account at the Federal Reserve

As a practical matter having a master account at the Federal Reserve is essential. Gorton and Zhang note a variety of initiatives that offer charters designed to meet the needs of fintech and stablecoin issuers but none of these override or otherwise compel the Federal Reserve to provide master account access …

In this vortex of innovation, interest in gaining access to a Federal Reserve master account is growing among FinTech companies. However, Reserve Banks can decide which institutions receive master accounts regardless of whether the institution has a charter from the OCC or from a state like Wyoming or Nebraska. Thus, in a practical sense, stablecoin issuers cannot become banks simply by receiving a charter from the OCC or from a state banking authority.

Part II. Money Market Funds in the 20th Century

Gorton and Zhang use the runs MMF experienced in 2008 and in March 2020 to argue that it was a mistake to label MMF as securities rather than regulate them as equivalent to demand deposits.

A. Regulation Q

They argue that MMFs developed in response to the Glass-Steagall Act (1933) which prohibited paying interest on demand deposits and gave the Fed authority to set a cap on rates of interest paid on savings deposits. MMF enabled retail level investors to tap into the higher interest rates they were on offer in the wholesale money markets but denied in the regulated retail banking market

Money markets funds arose as a creature of regulatory arbitrage

Unlike other mutual funds, MMF traded on the promise that investments in the fun could always be redeemed at par value of $1.00 per share plus the interest earned on the period invested.

B. The 2008 Run on Money Market Funds

Gorton and Zhang note that this system worked well enough up until the 2008 GFC when the Reserve Primary Fund “broke the buck” (16 Sep 2008) due to its exposure to debt issued by Lehman Brothers which had declared bankruptcy the previous day. This led to a run on other MMF and threatened to destabilise the entire short term credit market.

The US Government felt forced to step in by announcing two extraordinary measures. Firstly a guarantee programme similar in substance to the deposit insurance that supports bank deposits. Secondly, the Fed established a liquidity facility that provided non-recourse loans secured by high quality asset-backed commercial paper. The guarantee was intended to limit the extent to which investors felt compelled to redeem their MMF holdings while the liquidity facility allowed banks to meet redemption requests without having to actually sell commercial paper into a distressed and illiquid market.

C. The 2020 Run on Money Market Funds

Gorton and Zhang next describe how the US responded to the events of 2008 and why these reforms still proved insufficient. The SEC response was first to implement a series of reforms effective from 14 October 2016. One required prime institutional MMFs to “float the NAV” (so that redemption at PAR value was no longer promised). Another provided for MMF investing in non-government paper to employ tools like liquidity fees and redemption gates to address run risk.

These measures proved insufficient in the face of Covid related volatility prompted investors to start redeeming their investments in prime and tax-exempt MMF in March 2020. On 18 March 2020, the Fed announced the establishment of the Money Market Mutual Fund Liquidity Facility (MMLF). This facility was similar to the one implemented in 2008 but had the added benefit of $10bn in credit protection provided by the Treasury Department’s Exchange Stablisation Fund which enabled to expand the pool of eligible collateral to a much wider array of short-term securities.

Gorton and Zhang conclude that policymakers can draw a couple of lessons from the runs on MMF experienced in 2008 and 2020.

Two runs in twelve years. Policymakers can learn a couple of lessons from studying money market funds. First, given the fact that stablecoin issuers are essentially taking deposits, holders of stablecoins will run when market volatility spikes. In fact, this has already occurred. Second, one way to eliminate contagion-inducing runs is to bring stablecoin issuers within the regulatory perimeter for deposit-taking institutions. As the market for stablecoins grows and become more systemically important, runs on stablecoin issuers could pose the same risk to destabilizing the financial system as runs on money market funds in both 2008 and 2020 

Part III. The Free Banking Era of the 19th Century

Gorton and Zhang next review the Free Banking Era of the 19th century to see what lessons can be extracted from the experience of privately produced money during this period. To be precise they explore the Free Banking Era in the USA – some critics of the paper take issue both with the way that Gorton and Zhang present this experience and with the fact that they ignore other examples of free banking (such as Canada or Scotland) which the critics argue worked pretty well.

There are three main takeaways from the historical experience of the United States. First, the use of private bank notes was a failure because they did not satisfy the NQA principle and were subject to runs. Second, the U.S. government took control of the monetary system under the National Bank Act and established public bank notes. Third, the requirement to back bank notes with Treasuries had unintended consequences. Because of a shortage of Treasuries, bank notes were under-issued and another form of private money arose in the form of demand deposits. Runs on demand deposits only ended with the implementation of federal deposit insurance in 1934. 

I will not get into the details of the counter arguments in this set of notes but it is useful to understand that Free Banking did not mean unregulated. Regulations did apply and it has been argued (CITATION?) that the poor design of these regulations was to blame for the problems that Gorton and Zhang describe.

A. The Creation of Private Money

Gorton and Zhang argue that the Free Banking Era, when entry to banking was relatively easy and banks could issue their own bank notes, offers a close analogy to stablecoin issuance today. During this period from 1837 up to the passing of the National Bank Act in 1863, anyone operating in a Free Banking state could open a bank subject to complying with state based rules. The main requirement cited by Gorton and Zhang was that banks had to back their note issuance one-for-one with state bonds that were deposited with the state treasurers.

Gorton and Zhang argue that Free Banking suffered from the fact that private bank notes did not trade at par away from the issuing bank. They describe the process that developed to help users navigate the varying exchange values of the various notes. Notwithstanding the catchy title of the paper (“Taming Wildcat Stablecoins”), Gorton and Zhang do not believe that “wildcat banking” was as big an issue as is often alleged

For many years, the literature asserted that there were wildcat banks during this period. These were banks that either (1) did not deposit the requisite bonds, or (2) in some states, where bonds were valued at par and not market value, defrauded the public by issuing notes that they would never redeem in specie (gold or silver). Counterfeiting was a big problem, but the system was not chaos. Bank failures were not due to wildcat banking as has often been alleged. In fact, it functioned well from the point of view of efficient market theory…

The market was an “efficient market” in the sense of financial economics, but varying discounts made actual transactions (and legal contracting) very difficult. It was not economically efficient. There was constant haggling and arguing over the value of notes in transactions. Private bank notes were hard to use in transactions.

In short, Gorton and Zhang’s key observation from the Free Banking Era is that the broader economy these banks served did not have an efficient form of money because privately issued notes did not exchange at par value on a NQA basis. They conclude that stablecoins that suffer from the same shortcoming will similarly not be able to function efficiently as money.

B. The National Bank Act

The National Bank Act was passed in 1863, establishing national banks in the United States. These banks could issue national bank notes, but they had to be backed with U.S. Treasury bonds deposited with the U.S. Treasury. Subsequent legislation imposed a prohibitively high tax on bank notes other than national bank notes. In other words, the era of privately issued bank notes was over. For the first time in U.S. history, there was a uniform currency that satisfied the NQA principle

The National Banking Act did not however represent the end of banking panics. The reason, according to Gorton and Zhang, lay in the requirement that national bank notes be backed by Treasuries. Banks responded to this requirement by growing their reliance on demand deposits which came to represent another vector by which banks became vulnerable to runs.

Since Treasuries had (and still have) a convenience yield and were in limited supply, banks did not want to use all of their Treasuries for the purpose of backing their notes. As a result, banks under-issued notes, which led to the development of another source of private money: demand deposits. Demand deposits paid interest and grew significantly. Thus, during the National Banking Era, runs were on demand deposits, not bank notes.

The creation of a national currency via the National Banking Act did not in itself result in the demise of state backed private notes. Congress subsequently passed legislation that required all banks to pay a 10% tax on any payments made in a currency other than national bank notes. This was challenged by one of the state chartered banks but the Supreme Court ruled that Congress did in fact have the power not only to issue a uniform currency but also to impose a tax to ensure that its uniform currency was universally adopted.

The power to issue fiat currency was also constitutionally contentious but was eventually resolved.

Part IV. Policy Choices

Gorton and Zhang’s conclude that, based on the historical lessons to be drawn from the Free Banking Era and the development of MMFs, the government has the following policy choices for responding to the rise of stablecoins

  • Transform stablecoins into the equivalent of public money either via requiring that they be issued through FDIC insured banks or by requiring that they be backed one-for-one with Treasuries or central bank reserves
  • Introduce a central bank digital currency and tax private stablecoins out of existence
A. Transform Private Money into Public Money
1. Issue Stablecoins Through Banks

Gorton and Zhang start with the observation that the Glass-Steagall Act (Section 21) prohibits a non-bank entity from engaging in deposit-taking. MMF are not captured because the Department of Justice ruled that MMF holders are considered to be equity owners of the underlying assets of the fund. Building on their earlier observation that the majority of stablecoin issuer arrangements create a debtor/creditor relationship with the holders, one path to NQA public money status is for the issuers to be required to become, or operate through, FDIC insured banks.

This is the path proposed by the recent PWG report on stablecoins but Gorton and Zhang identify two potential problems. Firstly the risk that some stablecoin issue arrangements modeled on MMF might escape the regulatory perimeter. Secondly the risk that e-money payment platforms might be captured as well.

First, from a legal perspective, not all stablecoins are redeemed via explicit debt contracts. It’s possible that stablecoin issuers modeled after money market funds could escape the regulatory perimeter. Of course, the Department of Justice’s interpretive letter is not dispositive, as federal authorities could issue a more expansive reading of section 21(a)(2),115 or Congress could pass new legislation that strengthens section 21. Indeed, the United States should not have a regulatory regime in which a stablecoin issuer could escape the appropriate regulations simply by changing its consumer disclosures to create a contract that is not explicitly a debt contract on its face.

Second, this interpretation could have broader policy ramifications beyond stablecoin issuers. It could impact e-money payment platforms as well. The defining feature of modern payment platforms is that they issue multi-purpose monetary liabilities that are close functional substitutes for conventional bank deposits. This includes other bank-like entities such as PayPal, Venmo, WeChat Pay, and AliPay. These platforms accept cash, checks, and electronic funds transfers in exchange for the issuance of monetary liabilities. And they allow customers to make and receive multiple payments. This can involve accumulating positive balances akin to deposits in a bank. Thus, depending on the specifics on the interpretation, these payments platforms also could be brought within the regulatory perimeter

2. Require Stablecoins Be Backed One-For-One with Treasuries or Reserves

Gorton and Zhang note that one of the legacies of the 2008 GFC is the Financial Stability Oversight Council (FSOC) which is tasked with addressing risks associated with systemic non-bank financial companies. The FSOC has the power (under Title VIII of the Dodd-Frank Act) to designate stablecoin issuance as a “systemic payment activity”. This in turn would give the Federal Reserve the authority to regulate stablecoin issuance including requiring stablecoins to be backed one-for-one with safe assets like Treasuries or central bank reserves.

One challenge with this approach is that it could be argued that stablecoin use is too limited to be systemically important. That is arguably a fair assessment of the current state of play but Gorton and Zhang argue that the industry is growing rapidly and that the FSOC has the ability to designate payments that “are, or are likely to become, systemically important”.

The larger concern seems to be the potential for one-for-one backing to have unintended consequences for monetary policy, financial intermediation and financial stability.

The problem from a monetary policy perspective is that the Fed uses its balance sheet to implement monetary policy but these activities might be made more difficult to implement if the Fed was also required to increase the size of its balance sheet to accomodate money moving from the conventional baking system to this new class of super safe “narrow bank”.

The option to place funds with stablecoin issuers could also see money move from the repo market thereby reducing market liquidity and making it harder for banks to borrow against Treasury securities in times of stress.

A existence of a stablecoin “narrow bank” also creates another vector by which money might flow out of the conventional fractional reserve banks thereby increasing the risk of runs under stress.

Gorton and Zhang note that these problems are not insurmountable , which sound right to me, but the more interesting concern is the potential impact on the money supply which they discuss next.

Gorton and Zhang’s description of this problem is (too me at least) not a model of clarity

“… backing one-for-one by Treasuries produces a suboptimal currency, because this requirement would tie stablecoins to a limited form of money at a fixed ratio. (Recall that Treasuries have a convenience yield and are a form of money for storing value safely.) Following the National Banking Act, national banks could issue national bank notes by depositing Treasury bonds with the Treasury, which would then print the bank’s notes. The idea was to create a demand for Treasuries so as to finance the North during the Civil War. An unintended consequence was the under-issuance of national bank notes. The reason behind the under-issuance was a shortage of safe debt, which meant that banks had other uses for Treasuries and did not want to use all of their Treasuries to back national bank notes. As a result of this under-issuance, another form of money—one that is subject to runs—is likely to develop to fill the gap. Back in the National Banking Era, the new development was demand deposits, which were the source of multiple banking panics throughout the National Banking Era.”

My take on this starts with the observation that pretty much no one cares much about what happens to banks so the potential for dis-intermediation can seem more like a feature than a bug of this option. There is a tendency therefore for many people to lose interest when they hear the word “dis intermediation”. I get why many people are keen to see the banks suffer or be punished but it is worth digging a bit deeper to be sure that we all understand what the consequences (intended and unintended) are before we sign up for the policy choice.

The way I read the risk Gorton and Zhang are flagging is that the narrow bank model ties the supply of safe money like assets “one for one” to the supply of Treasuries. The problem is that this may or may not equate to the amount of money the economy needs to function optimally. A complete assessment of the risk would require us to explore the history of the Gold Standard (and bimetalism), the merits of the Austrian economic model and associated crtiques of central bank money printing. That is a huge topic that lies outside the scope of this note.

3. New Legislation

In this section of the paper, Gorton and Zhang explore a more ambitious regulatory agenda that targets not only stablecoins but also addresses existing concerns with what they refer to as “all forms of runnable financial instruments that are functionally equivalent to deposits”.

By harmonizing the legal definitions with the standard definitions understood by financial economists, Congress could bring both stablecoin issuers and money market funds inside the bank regulatory perimeter. Of course, such a legislative change—particularly given its impact on the multi-trillion-dollar money market fund industry—would be met with resistance. Critics would allege that these financial entities provide credit to the broader economy and that additional regulations would reduce their ability to provide that credit. That is true, but the benefits outweigh the costs. In both 2008 and 2020—when market volatility spiked due to the failure of Lehman Brothers and the onset of COVID-19, respectively—“depositors” lost confidence that money market funds could maintain the implicit contract and so rushed to redeem their shares for cash. Facing surges in redemptions, money market funds had to fire sell their assets, which sent short-term funding markets into disarray and spread contagion throughout the financial system. Both times, the U.S. Treasury and the Federal Reserve had to step in to backstop the money market fund industry. The benefit of increased financial stability would be tremendous. 

This they argue “… would fix the underlying definitions related to banking that have created sub-optimal regulatory arbitrage for decades” and set up the system to better cope with future attempts to create new forms of private money with new technology.

It would also help ensure that the potential for regulatory arbitrage embedded in the current approach which has seen the OCC and state banking regulators experiment with approaches that provide access to some of the advantages of being a bank while limiting the amount of regulatory oversight and barriers to entry. “Multiple special charters and no uniform regulatory framework” is they argue “... the least desirable outcome“. They concede that it potentially allows experimentation that may produce superior outcomes, but it is equally possible (arguably likely given the experience leading up to the 2008 GFC) that it simply results in financial institutions being able to “… cherry pick the most lenient regulators and supervisors

B. Replace Private Digital Money with Public Digital Money

Plan B for addressing the risks of stablecoins is to issue a Central Bank Digital Currency as a substitute to privately produced digital money like stablecoins. In the most extreme version of this policy option, the government taxes or legislates the stablecoin out of existence consistent with the historical precedent established with the establishment of a national currency in the later half of the 19th century.

Countries will not use paper and metal coins forever. In the 19th century, as the form of money evolved, the federal government instituted a uniform national currency via the National Bank Act and then taxed the remaining privately produced money out of existence. The present-day analogue is for the federal government to create a central bank digital currency. The question then becomes whether policymakers would want to have central bank digital currencies coexist with stablecoins or to have central bank digital currencies be the only form of money in circulation. As discussed previously, Congress has the legal authority to create a fiat currency and to tax competitors of that uniform national currency out of existence.

1. Benefits of Digital Currency

Gorton and Zhang nominate three benefits of a central bank digital currency

  • An increase in the convenience yield
  • A reduction in the costs of payment systems
  • Maintenance of monetary sovereignty

These benefits are distinct from monetary policy objectives (such as breaking through the zero lower bound for interest rates) or fiscal policy (such as targeting helicopter drops of money).

The convenience yield benefit they describe captures the efficiency dividend associated with digital transfers of money with the greatest potential lying in cross border payments. They do not specifically address this point but it would have been useful to have seen some discussion of the extent to which developments in fast payment systems (in which the US has been a slow follower) already deliver most of the domestic payment convenience yield benefits and the value add of a CBDC lies solely in the cross border domain.

With respect to costs, the paper cites statistics on payment costs ranging up to 3% of GDP to argue that there is plenty of room for improvement. The argument that payment systems have a lot of room for improvement sounds right to me but the paper does not really get into the detail. Some of the statistics cited seemed to be dated and (as with the convenience yield) there was no discussion of the extent to which the benefits could be secured via fast payment systems (or indeed properly regulated stablecoins) without recourse to a CBDC.

The monetary sovereignty argument is covered in the next section of the paper.

2. Coexistence Between Private and Public Currencies

Gorton and Zhang pose the question …

Can privately produced stablecoins – ones that are not insured by the government and are not required to be backed one-for-one at the Federal Reserve – coexist with public money?

Their response is that …

The provision of NQA money is a public good, which only the government can supply

They argue that this conclusion is supported both by the historical record that government have tended in practice to legislate in favour of having a monopoly on banknote issuance and on the basis that not everyone has the skills, or the time required to keep sufficiently informed, to make accurate judgements about the fair value of the units of private money being exchanged.

The first part of the argument showing the preference of governments for having a monopoly over bank note issuance does not look that compelling to me. The second argument however stands on its own as a rationale for government having a responsibility to provide money as a public good. The arguments that I have seen favouring some form of Darwinian competition between alternative forms of money and reliance on market discipline seems to assume that people have the ability to make informed judgments about something that even technical experts like bank regulators can fail to get right.

3. Design of Digital Currency

The paper notes that the design of a retail CBDC is outside its scope. The authors simply sketch out the high level choice between an “indirect model” in which the consumer deals with an intermediary for the day to day administration of their digital claim on the central bank and a “direct model” in which the consumer engages directly with a branch of the central bank. Given the two models, Gorton and Zhang make the case that indirect “

Under the first design option, a central bank digital currency would be issued as a digital version of physical cash. Thus, if you were to withdraw $50 from your bank account, you could choose the $50 to be either in the form of digital cash (on your phone or in your blockchain “wallet”) or physical cash.


The more things change, the more they stay the same. It is still the case that regulation is being outpaced by innovation—thereby creating an uneven playing field—as it is easier and cheaper for more technologically advanced firms to offer similar products and services.

In this case, it is also true that the problems associated with privately produced money are the same as they were one hundred and fifty years ago. We stress three points from our review of history. First, the use of private bank notes was a failure because they did not satisfy the NQA principle and were subject to runs. Second, the U.S. government took control of the monetary system under the National Bank Act and subsequent legislation in order to eliminate the private bank note system in favor of a uniform currency—namely, national bank notes. Third, backing bank notes with Treasuries led to the development of another type of private money—demand deposits, and runs on demand deposits only ended with federal deposit insurance in 1934.

Currently, it does not appear that stablecoins are used as money. But, as stablecoins evolve further, the stablecoin world will look increasingly like an unregulated version of the Free Banking Era—a world of wildcat banking. During the Free Banking Era, private bank monies circulated at time-varying discounts based on geography and the perceived risk of the issuing bank. Stablecoin prices are independent of geography but not independent of the perceived risk of their backing assets. If they succeed in differentiating themselves from fiat cryptocurrencies and become used as money, then they will likely trade at time-varying discounts as well. Policymakers have a few methods to address this development: issuing stablecoins through insured banks, backing stablecoins one-for-one with central bank reserves, or establishing a central bank digital currency.

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