The case against stablecoins

There's a lot going on. The news flow from Iran, the Middle East and the Gulf is relentless, but we mustn't take our eye or ear off other stuff. One of the other things bubbling up now is stable coins, crypto-flavored kinda dollars that live in the virtual world. Donald Trump took a break from Iran earlier this week to lash out at banks which have been pushing back at efforts to draw stablecoin operators into the heart of the financial system.

That is unacceptable, he said. We are not going to allow it. In other words, let the crypto in. Now listeners, do yourself a favor and make a note of this because maybe not today, maybe not tomorrow, but one day The impact of giving crypto a seat at the highest tables in finance will bite. We'll tell you why.

This is Unhedged, the Markets and Finance podcast from the Financial Times and Pushkin. I'm Katie Martin, a markets columnist in beautiful sunny springtime London, and I'm joined, as usual, by the Bald Eagle himself, Robert Armstrong. Off of the Unhedged newsletter in New York. Rob, say hello or give us a squawk. Hello.

But also, we've got an actual brain box in the London studio with me to unpack what's going on. Brendan Greeley of Princeton University, a proper expert on banks, banking, economic history, and money. Brendan, welcome back. I'm a financial historian and I'm here to help. So listeners, there's me and then there's two rich baritone American voices here today. If you get confused

The one who knows what he's talking about is Brendan. So, Brendan, I'm gonna put words in your mouth here. I'm waiting. And say that you don't like crypto very much. I just don't think it's that novel. Right. I just don't think it's special. I so I I have students and they t they all half of them want to go into finance. And they you know, they they agonize. Do I want to go into uh Defy.

Or TradFi. And I have this talk that I give them. The crypto world or TradFi, which is, you know, I g I guess all of the rest of history. And I have this talk I give them where I'm like, my dude, you're going into Fi. It's all the same thing. It's all the same fi. So the way I think of crypto is that uh it's a big fancy word that applies to a lot of different things and a lot of different technology. And I think of crypto as finance as if the past never happened.

Everything we're going to talk about today, and everything that we talk about under this wide umbrella of crypto has an analog. Um that we already know, that we already understand, that we already regulate. So But that we've conveniently memory hold or f completely forgotten. So the crypto universe, for the to the extent that we're gonna talk about it today, splits up into two areas. There's

There's crypto, right? So there's tokens effectively, like Bitcoin or Dogecoin or Melania coin or whatever you like. They're all fundamentally the same thing. They just have different values attached to them. People always say to me, Oh, I don't understand crypto. Surely it's just like a bit of you know, it's just a token and it goes up if people buy it and it goes down if they don't and I'm like, nope, you definitely do understand crypto. That's all there is to it.

And then the stable coins, which th they're designed to be like a dollar that lives in the crypto ecosystem. So you buy one of these tokens, effectively, one of these coins, and it's backed by a dollar that's held by somebody else. So a couple of important things have happened this week. So Bitcoin itself got a bit of a boost earlier this week.

It went up to about$72,000. For me, that's$72,000 above fair value, but whatever. Um, and that's because Trump wrote on his social media platform, Truth Social, that. And I quote, The Genius Act is being threatened and undermined by the banks, and that's unacceptable. We're not going to allow it. Right. What is the genius act? What is he talking about?

So the Genius Act uh ha you know has already been passed. What he means is the progress that was made under this piece of legislation that's already been made law. uh is is being threatened. So what it did was um define for US regulators, uh US bankers, what a stable coin is. It basically said We're going to allow them?

Um and they're going to be regulated at the state level. That means a lot in the United States. It's actually very difficult for audiences abroad to figure out like how the American banking regulatory model works because it's so complicated. Uh but broadly there are two different ways to regulate banks at the federal level. And at the state level. And so very crucially, um the not just crucially, very crucially. Um the Genius Act took stablecoin regulation.

And it put it at the state level. You get a state charter to be a stablecoin provider. Then it said, um, you absolutely have to have a hundred percent reserve. If I give you a deposit of my fiat dollar. Um and you're a stablecoin provider. That's just like a normal dollar. It's not a small Italian dollar. With wheels. A Federal Reserve dollar. Um, you have to hold a hundred percent of that dollar in

reserves, liquid high quality assets. So if I give my dollar to a stablecoin operator like Tether or Circle, they have to go out and buy a dollar's worth of something to be there on their book. Yeah. For as long as I have that dollar with them. Yeah. So r Rob and I had this conversation when the act was passed. We were looking at the law and trying to figure out like what's the profit in being a stablecoin provider if in fact uh you have to

Hold a hundred percent of uh the dollars that are given you in some kind of liquid asset. That that doesn't seem like there's a very high return there. I think there are a couple of answers. Um one of them is it looks like that you can also hold repo where the returns are a little higher. What that means is a a repo is just a a repurchase agreement. It's an agreement to buy something briefly overnight and then sell it back tomorrow. Yeah, like really short term stuff.

So you can do some funny stuff with the money. But even if you don't do the funny stuff with the money, even if you just put it in short term government debt securities. I, as somebody who holds a tether or a a a circle token, I earn nothing from that. The operators take all of the interest payments. That's right.

Happy days. Isn't that I mean we do that already. That's called banking, Katie. This is this is my frustration with stable coins. They're just banks. Every time I have a conversation with a crypto dude, they're like, no, no, it's. It like absolutely clears at par with a dollar. Like, congratulations, my dude. That's a bank. Banking is you you know, you take in a deposit and then you promise to return that deposit.

Um, because you're holding on to some liquid investment that's gonna give you a small return. That's banking. So Rob, over there on your side of the Atlantic. Stablecoins are great, crypto is great. Is this sort of portrayed over there as like a huge wave of innovation and I don't know, democratizing finance or like what like why is it such a big deal? I think the excitement

Around crypto in America can be summed up in four words, which are uh I just got rich. So anybody you talk to anybody you talk to in America who's excited about this technology is excited about it because they've either earned money on Bitcoin or similar things, or they're starting a business they're gonna sell to somebody and make a It's a uh it's a speculative frenzy, Katie, as far as I can tell. Yeah.

And so like so Brendan, as you say, Genius Act has been passed, which means that stablecoins are a thing, as you say, regulated on a state level. What is the opposition that's coming from the banks and does it make sense? So they want another run at it. So the the new piece of legislation we're talking about is called the Clarity Act, which is a very important thing.

Yes. Yeah. Um so uh what they don't like is in the in the Genius Act, which is now law, you cannot pay interest on a stable coin deposit. They want another crack at that. They want to be able to offer offer some kind of a reward. It looks like maybe what'll happen is um you'll have a stable coin, uh you you'll you'll hold it with a company and the company will offer you rewards in the form of other tokens.

Uh if if you're taking a step back, Brendan, just briefly. And why what was the idea behind the original prohibition on paying interest? uh on a stablecoin deposit. Was that to to to discourage the stablecoin managers from taking too much risk? I think yes, because if you're paying interest, then you you gotta go out and buy something risky uh to to to make a profit. I think more importantly, the banks hate that.

Because they compete with banks. Yeah. So the the problem with this conversation in general, not the conversation I'm having with you two lovely people, but the conversation in general is um the banks aren't the good guys. We just know how banks work. When we look at stable coins in banks, there is a long two hundred year history. of Americans figuring out how do we f how do we

How do we keep banks from blowing up? And when they do blow up, how do we keep them from blowing up people's dollars that they use for normal daily transactions? Right? This is crisis after crisis after crisis, regulatory response after regulatory response. We've built up this framework. Um so now we have this framework. So at the very least, we're going to do that.

We know how banks work. We know roughly how to control them and we've been fighting that fight. And normal people don't need to think about dollars. Yeah. So in you know, in the nineteen twenties, um if you uh this was before federal deposit insurance, when you look at bank advert advertisements. They would advertise. their assets, you had to know as a consumer who was keeping your money with a bank how stable the money it was because you had to know how

how h the assets the bank was holding to make sure that your money had meaning. That stopped after deposit insurance. Again, 1932, another crisis. A lot of banks in America closed their doors. People didn't have access to their deposits.

Um, we opened the banks back up uh by figuring out how to buy those assets and give them Federal Reserve dollars and we very quickly in America passed a national deposit insurance act where every bank now pays in t pays an insurance premium every year to make sure that if their books blow up

um that their dollars continue to have meaning. So um stable coins basically offer exactly what a bank has always offered, except without any of that regulatory apparatus that we've been slowly building up for two centuries.

So So how does how does the stable coin blow up in the style of a bank? That was the same thing. Okay. They have to own pretty basic stuff backing up the deposits. Mm-hmm. Right? It's like short term treasuries and dollars, isn't it? So I I mean if they if they follow that rule How can they blow up? How do we know they're following the rule? We don't have to in this age though, Brendan, I'm gonna push you. Okay in this age, you don't need some

like fellow in a stiff collar wearing pince nez going into the vault of the crypto coin. Yeah we do. Uh but don't you I mean can't you do it electronically? Right? Because like Well yeah, but what are the ad so all of the problem with the stable coin is when we talk about crypto, it it sounds super whiz bang like all of this stuff is on the internet and you can see it. But a stable coin, it's a company.

With a fiduciary responsibility to make sure that its tokens have value in the exact same way that a bank is. You can't see what they buy. We don't know what they're holding. They tell us, but we there's no we the regulation isn't that intrusive. And so the reason you need bank regulation. Right. You can't just have laws. You need regulators and you need regular periods where they can go in and they are given complete access to the bank's books because, you know, banks

They kind of fudge it a little bit if they're if they're allowed to. That's a natural instinct. So So broadly speaking, the way this this whole debate is developing in the UK at the moment is that the Bank of England, uh Andrew Bailey at the Bank of England, governor of the Bank of England, has said

Okay, people want to launch sterling stable coins. They have to be two things. First of all, they have to be stable, so they have to be properly backed and we have to be able to check whenever we like. that the backing is all there. And second of all, they have to be coins, which effectively means not physical coins, but you have to be regulated right up the wazoo in exactly the same way as banks are. We have to be

up in your stuff day and night. We want to know who's in charge of what. We want to know what your processes are. We you know There's like there's rules that come with operating like a bank. So this is the challenge and this is why we have to make this

America's weird banking system clear to a non-American audience. You have state regulation and you have federal regulation. And my fear right now, if we're gonna lay down a marker today and say this is all gonna blow up and we're gonna be on the hook for My fear right now is what we did with the Genius Act is that we took stablecoin regulation and we gave it back to the state.

We are at the status quo of the early nineteenth century in America. Back to the future. And Katie's absolutely right. What you need if you want to have stable, stable coins, is that you need to be all up in their business. States are going to be competing. To see how far up the wazoo you go. as a regulator. And so how not far exactly a race the other direction. It is going to be a race down the wazoo, if you will. I'm really sorry I've all wazooed it.

But yes, it it will be a it'll be uh let's let's wipe the metaphor slate clean. It will be a race to the bottom. And you will have certain states that will become we're gonna have a Delaware of stablecoins and certain states Um it looks like Wyoming is already one of them, but you know, states will compete for the privilege of being able to say, um, come open your stable coin here. Uh we're not gonna be that intrusive. You can just give us a pinky promise once a year and we're good.

Come to Texas, home of the Wazoo coin. And then Stop it with that, Katie. Okay. And then the problem is, again, I'm just making sure uh I'm envisioning this apocalyptic scenario correctly. The problem is that the stable coin do we call them operators, managers? I think what whatever they are. Come on. Providers. Providers. Providers. These providers. They invest in something besides Dollars and short term treasury is another very safe thing.

Yeah, that's that's the worry. So the problem is you can give people all the legal reassurances uh you want that what they hold is not an actual dollar and that it's actually a speculative instrument. Um but if people come to think that what they hold is a dollar. If that dollar blows up and the a and the balance sheet of the stablecoin provider uh is not what they promise uh it is, um and that dollar suddenly doesn't have value, people get angry.

And this we see this again and again. Uh private banknotes in the nineteenth century, uh private bank deposits in the late nineteenth century and early twentieth century, um uh money market funds. Uh uh in two thousand eight. You know, the the one of the one of the many crises that happened, we all remember this was when a money market fund slipped below a par when it broke the buck. All of a sudden a dollar was not a dollar.

People got used to the idea that if you hold this thing, no matter what the lawyers tell you, you feel like it's a dollar and you make it the government's responsibility to make you whole if it suddenly is not a dollar. And that is where we're headed with state.

So the th you actually don't even have to go back as far as oh eight to see an example of this. Twenty twenty three, Silicon Valley Bank blew up. There was a bunch of regional banks in the US that that went belly up. When SVB died, it turned out that Circle, one of the stablecoin operators, had Countum. three billion US dollars on deposit at SVB. And so suddenly they were like,

Oh, we're gonna be needing a federal bailout here because otherwise we're stuffed. So th there are vulnerabilities in in stablecoins, but I just wanna pivot really quickly onto the other piece of importance Crypto news that came out this week. Kraken, a crypto exchange. I don't like using the word exchange, but it's a place where you can buy cryptos. It's called Kraken. It said it had been granted access to the Federal Reserve's core payment system.

is going to be able to connect directly into payments infrastructure, including the central bank's Fedwire service. Uh I'm reading from the FT here. The Fed's decision to grant Kraken access to its payments network brings the digital assets group in line with major banks and credit unions. Brendan Greeley, briefly, what can go wrong? And you don't have much time.

So what we're already seeing uh is I guess um what you could charitably call experimentation at the state level. So I worry about the race to the bottom. Uh an optimist would see that as experimentation and a good thing.

Um, you know, Wyoming has uh positioned itself as uh as as a state that's gonna be friendly uh to crypto in a lot of different ways. Um and they granted a state level charter um to uh to Kraken under a brand new uh institutional uh charter that they just created in twenty nineteen, which is a Special purpose depository institution. Katie Martin, how do you feel when I see that? Say the word special purpose in finance.

I have the overwhelming urge to complete your sentence with the word entity. But vehicle Um But Yeah, for for listeners who weren't familiar. Special purpose vehicles went. very badly wrong oh seven, oh eight were big part of the I'm gonna say shit show that came afterwards. Um so people who've been around in markets quite a lot just do not like to hear the words special and purpose together very often.

Um and so what that means is the special purpose depository institution uh charter uh in Wyoming um uh allows you to uh as a uh as an exchange. Actually hold on to people's deposits um and make transfers to other banks through the Federal Reserve's balance sheet in the way that banks make transfers to each other.

Through the Federal Reserve's balance sheet. Um I suspect the Fed is doing this because there's a lot of demand for this and it's coming and uh Kraken is smaller than some of the other exchanges. It exists. Wyoming exists. It's actually in Wyoming. Um so in in a way that they can grasp, I'd rather this stuff be regulated at the federal level, but the very least, like there is a legislature and law in Wyoming.

Um and I think that they're trying an experiment on a in a small way to see how this works. Because they suspect that this is coming. What does access to these Fed payment rails do for crack? What can it do now that it couldn't do before? So w I'm having trouble this is one of those things where they're promising things in a press release and it's hard to figure out what they actually mean.

uh by the press release. One of the things that alarms me the most is um they want you to be able to get out your crypto earnings through uh a a debit card. in Federal Reserve cash um somewhere. So this is the thing is like I and it feels like I'm out over my skis right now only because we're guessing what's going on actually in on the payment rails based on what Kraken is promising. Um, but what they're saying is you can transfer what you have at Kraken.

uh in dollars, some sort of stable coin, um uh to another bank. Uh if Kraken is a bank you can transfer it to uh you can make payments with it. Does that mean you can have a debit card and like pay pay for your groceries effectively kind of with crypto? And yes, maybe. I th when they say debit card, that's what I suspect they're getting after. But what I think this actually means for those of us who think about balance sheets is um it's going to be very easy on Kraken to move

wealth back and forth between what you just earned in crypto and you cash it out and then it becomes actual dollars and you hold that in your Kraken account and then you can use that to pay for things. So it's basically a base account that is then used to invest um uh in in other less valuable, even less reliable coins that are on Krakens exchange.

Really quickly, Brendan, what is the time frame for how long it takes for this to go wrong and cause a problem? W is it gonna become a problem during the Trump administration or will this be something that bites the next president in the neck. I think this is gonna be the next president's problem. I think that's the problem with financial deregulation. In in America, everybody blames uh George uh W. Bush uh for the financial crisis.

God knows there are many things to blame George W. Bush for. Uh but that one that one's on Clinton. Um and the Clinton Treasury and their rush to deregulate in the late nineties the finance industry. Uh so the problem with Easing up on regulation and oversight. It's not just regulation, it's not just the law, it's how often you check the wazoo to see what's in there. Um

Uh uh and in a lot of ways um the Trump administration has signaled that um law kinda doesn't matter right now in finance. Uh even if you do nominally break the law. You're not gonna get punished for it. They're not checking you out. They're they're not building a case. You can do no wrong. So um the problem is it does take a while. We don't I can tell you this thing is gonna blow up.

I can't tell you when. I can't tell you what crappy asset uh some stable coin provider is gonna be quietly buying. I can't tell you how that stable coin is going to have burrowed its way into other parts of the financial system. Uh as as a payment medium? We just don't know. But we'll find out and when we do

I think we all agree, or at least Katie and I agree, the United States government will have to make every holder of a stable coin whole. That's step one, and then we'll have to do all the regulation that we didn't do this. And the reason you're so certain again, just trying to make your apocalypse clear to the listener, you're the reason you're so certain this goes wrong is that the desire of uh providers of banking services. Mm-hmm.

To put bad stuff on the asset side of their balance sheet. In other words, the side of the balance sheet on the other side from the deposits of the crypto coins or whatever else. The desire to put bad stuff on the asset side of the balance sheet.

Is like a human universal that is eternal and always happens. That's the thesis here. Aaron Ross Powell Yes, absolutely. It is a human and sometimes laudable instinct to want to take huge risks on the balance sheet. And I think It's up to us as democracies to make sure that we take that human and sometimes laudable instinct and check up on it regularly to make sure that people that are taking acceptable risks that aren't gonna blow up money for the rest of us.

Brendan, I'm gonna read back to you a line that you put in a column last year for the F T about crypto saying You're just a dad worried, standing in front of another dad who is not. Now you've made all of our listeners worried as well. So congratulations. And on on that achievement, we're gonna break and come back in just one second with long shorts.

It is time for long short, that part of the show where we go long a thing we love or short a thing we hate. Brendan Greeley, whatchain? I am long Maidstone United, the football team in Kent County in England. Amazing. I spent this week in the Kent County Archives. Uh looking at the seventeenth century banking papers of John Banks. Those archives happen to be right next to the stadium for Maidstone United, the football team. I uh I went, I watched, I stood right next to the field.

Um that stadium is absolutely perfect. There's a pub in the stadium and um there's also a place in the woods near the stadium where you can um not have to pay the entrance fee and stand in the woods and drink and I saw a guy doing exactly that. Everything was perfect about this football game. Good times in in provincial England. Go you stones. Rob, what are you saying?

I'm sure T S Elliott. You know why? No, I think he's the guy he's the guy wasn't he the guy who said that April is the cruelest month? Cruel that was T S Elliot. Well something. Well anyway, it's not. March is the cruelest month. March is the worst. It's still winter, but you're kind of thinking that it's supposed to be spring. It's just thirty days of torture.

So you're short March March the whole month. Okay, fine. I am long the people who are hurrying back to Dubai to avoid incurring large tax bills by spending too long outside the Emirates.

So there are lots of people trying to get out of Dubai because of the conflict going on in the whole region. There have been explosions in Dubai over this whole thing with Iran. But at the same time there are a bunch of people who are trying to get back there so that they're not in the UK, for example, for too long and they don't end up getting taxed over here. I just think

There's never been a better way to show to people who you really are. And uh and yeah, no notes, perfect. So listeners, we are going to be back in your ears on Tuesday. Please listen up then. Unhedged is produced by Jake Harper and edited by Brian Erstadt. Our executive producer is Jacob Goldstein. We had additional help from Topha Forhead. Cheryl Brumley is the FT's global head of audio. Special thanks to Laura Clark, Alistair Mackey,

Greta Cohn and Natalie Sadler. FT Premium subscribers can get the Unhedged newsletter for free, and a 30-day free trial is available to everyone else. Just go to FT.com/slash unhedged offer. I'm Katie Martin. Thanks for listening.