Stablecoins Pose Lower Risks Than Bank Deposits, New Policy Paper Argues

Updated: 29 July 2023

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A recently published policy paper has spotlighted stablecoins and their potential risks to the financial system.

Stablecoins: Not Your Typical Bank Deposits, Says Paradigm’s Policy Paper

Authored by former Federal Reserve Board analyst Brendan Malone for tech investment firm Paradigm, the paper contends that equating stablecoins with traditional bank deposits is too simplistic due to their unique attributes.

Stablecoins, cryptocurrencies pegged to assets like the U.S. dollar, differ notably from bank deposits in their avoidance of “maturity transformation”—where banks use short-term deposits for long-term loans, thereby creating constant risk management demands.

The recent Silicon Valley Bank collapse exemplifies the dangers of maturity transformation, as a discrepancy between long-term client deposits and immediate withdrawal demands led to financial instability and regulatory intervention.

Conversely, the study points out that stablecoins, particularly those tethered to fiat currencies, generally exhibit fewer risks due to their reserve assets typically being backed by short-dated Treasuries and kept separate from the issuer’s other assets.

These features, along with potential federal regulation, could prevent the duration mismatches seen in traditional banking.

Stablecoin holders also have the ability to redeem at par on demand, further reducing maturity transformation risks.

Unique Features of Stablecoins and Regulatory Considerations

The policy paper clarifies the distinct roles of stablecoins and money market funds, with the former used mainly for pegged-value transactions and the latter as investment or cash management tools.

Unlike money market funds, large dollar-pegged stablecoins offer no return on reserves, acting as a digital cash equivalent instead.

The paper suggests a nuanced regulatory approach to manage stablecoin issuers, warning that strict bank-like regulation could stifle competition and create market monopolies.

It proposes measures specifically addressing stablecoin risks while fostering innovation.

Balanced stablecoin legislation can bolster confidence in these digital currencies and prevent power concentration among market players.

The paper’s release coincides with a wave of digital asset bills presented to the U.S. Congress since 2022, including the Stablecoin TRUST Act and the Stablecoin Innovation and Protection Act, aimed at regulating stablecoins.

Crypto expert commentary on stablecoin stability further validates the paper’s assertions.

Since we are all discussing Stablecoin bills again, I wanted to come back around and give my thoughts on this in public, hopefully in a mildly more concise version.

From a first principles perspective, a stablecoin that is actually going to fulfill the promise of being stable is…

— Austin Campbell (@CampbellJAustin) July 25, 2023