Stablecoins Are Not New. So Why Are Regulators Attacking Paxos?

Former Paxos head of portfolio management for BUSD argues that stablecoins can be as safe as regulated financial products like money market funds.

AccessTimeIconFeb 14, 2023 at 4:00 p.m. UTC
Updated Feb 15, 2023 at 4:14 p.m. UTC
AccessTimeIconFeb 14, 2023 at 4:00 p.m. UTCUpdated Feb 15, 2023 at 4:14 p.m. UTC
AccessTimeIconFeb 14, 2023 at 4:00 p.m. UTCUpdated Feb 15, 2023 at 4:14 p.m. UTC

What is a stablecoin? A common answer would be that a stablecoin is an instrument that attempts to maintain a steady value by either arbitrage or explicit backing represented on a private or public ledger.

Stablecoins are thought of as new technology, but looking closely at this definition reveals there are already over $22.8 trillion of U.S. dollar stablecoins in the world, primarily composed of $17.9 trillion of bank deposits and $4.8 trillion of money market funds. Also, there’s the $125 billion worth of stablecoins on blockchains.

Jesse Austin Campbell is an adjunct professor at Columbia Business School and the former head of portfolio management at Paxos.

This is likely a surprising statement for both crypto natives and traditional financial people, but here is the simple reality: Stablecoins aren’t new, except for the bit about being on a blockchain. Fiat-backed stablecoins share the exact same underlying structure as many traditional financial instruments, and the only novel part is putting them on a slightly different technological ledger.

So what’s different about a stablecoin? It’s on a public ledger that’s open 24/7 instead of Wells Fargo’s internal books or a share held at DTCC [Depository Trust & Clearing Corporation, a centralized clearinghouse]. What else? Not much.

Money market funds are investment funds with the primary goal of principal protection and a stable $1 price, while still paying yield to investors. Bank deposits are deposits held at a bank, which reloans that capital and pays a paltry yield to savers.

In the United States, we have well-defined regulatory frameworks for these kinds of things. For banks we have charters, capital requirements, risk weights and operational controls that need to be in place for all of our depository institutions. For money market funds, stable value funds and many similar types of insurance products we have specific requirements about holdings, liquidity and structure in place to protect consumers.

Yet, how many regulators have been willing to engage with or approve a product on a blockchain built to maintain a steady $1 NAV [net asset value] in the United States? Arguably one, if you count the efforts of the New York Department of Financial Services {NYDFS).

Even in that case, New York financial regulators have allowed only very limited deployment of stablecoins on the Ethereum chain (primarily GUSD, BUSD and USDP, the latter two of which I helped manage while at Paxos), with reserve and management guidelines significantly more conservative than the average government money market fund.

If the NYDFS licensed stablecoins were standalone banks, they would be far and away the safest bank in the United States!

Equal footing

Yet, we don’t allow stablecoin issuers full access to the banking system, for reasons that have never been clearly articulated. We’ve never had a fully functional regulated stablecoin in the United States that stands on equal footing with other financial instruments.

The difficult parts of issuing fiat-backed stablecoins are often misunderstood. The biggest problem is that crypto is a 24/7 system, while the banking system is a relic of antiquity that functions approximately 25% of the hours of the week (less when there are holidays). Matching liquidity between these systems so that the creation and destruction (or the minting and burning) of stablecoins can be instantaneous around the clock is a difficult problem. But it’s not difficult because of crypto. It’s difficult because the legacy system is hilariously outdated.

Stablecoins are arguably on better rails and are less risky than traditional mutual funds. Their reserves, the assets kept to back the stablecoin, are rarely leveraged out and consist of safer backing instruments than any bank in the United States.

Yet, we are now told stablecoins are too risky to be allowed to exist. If this is true and stablecoins are a dangerous threat to the system, then prime money market funds are a forthcoming nuclear war and JPMorgan merely existing is the equivalent of the moon potentially crashing into the Earth.

Despite the fact that stablecoins are materially less risky in economic terms, federal regulators continue to attempt to force stablecoins offshore leaving U.S. consumers earning low rates of interest in their bank accounts despite banks reaping record profits.

See also: Can Banks Issue Stablecoins? | Senior Fellow at the American Institute for Economic Research Thomas Hogan

It’s clear regulators prefer interacting with banks because banks are centralized and easy to control. Reading between the lines, the real risk stablecoins pose is creating a system less amenable to government efforts of control. But technological progress is not going to stop.

Economic activity is simply going to move elsewhere in the world if we continue down this path. United States regulators believe they face a choice between allowing or banning stablecoins, but in reality they face a choice between allowing stablecoins onshore or having them be primarily offshore.

Already, the biggest winner of the current U.S. attack on crypto is likely Tether, the largest stablecoin issuer with a less-than-reputable past. Stablecoin tether (USDT) is growing again while Circle’s USDC and the Paxos-issued BUSD, both of which are more transparent, more regulated and safer for consumers, are shrinking.

Are stablecoins a risk to the system? Yes, but primarily because blocking the development of properly functioning stablecoins onshore is going to lead to the future rails of finance being laid down offshore, outside the reach of the United States, without the consumer protections that exist onshore and potentially not even using the U.S. dollar as the main unit of exchange.

The greatest risk to the U.S. financial system is not allowing stablecoins. It is banning them.

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Austin Campbell

Austin Campbell is the founder and managing partner of Zero Knowledge Consulting, and an adjunct Professor at Columbia Business School. Previously, he was the head of Portfolio Management at Paxos.