Frequent readers of the newsletter are by now aware that I enjoy writing about issues related to money. I see good monetary economics as grounded in price theory. I mean this both in terms of pure price theory, but also in terms of emphasizing the role of exchange. Studying money also requires grappling with innovation as well as political economy and the role of the state. This week, I would like to combine discussions of innovation, political economy, and the role of the state in light of some comments made by a former vice presidential candidate.
One recent innovation in money is the use of stablecoins. A stablecoin is a particular type of crypto token with a value that is pegged to some real-world asset, like a dollar. These can come in many forms. I have written before about catastrophic attempts at algorithmic stablecoins. However, the stablecoins that have historically been able to maintain their value have been backed by non-bank institutions that actually operate a lot like a bank.
It might help to explain how stablecoins work by appealing to a particular example. There is a stable coin called USD Coin (or USDC) that was created by Coinbase (a cryptocurrency exchange) and a company called Circle. For someone who wants to use this stablecoin, the process is easy. One can deposit dollars in an account with Coinbase and then use those dollars to buy an equal amount of USDC. The person can then transfer that USDC to a cryptocurrency network like Ethereum, where they can use it to make transactions or trade it for some other cryptocurrency or lend it out, etc. Of course, you don’t have to go through Coinbase. Instead, one could just use their existing cryptocurrency and exchange it for USDC. Conceivably, the benefits of stablecoins are that (a) they are able to give people access to dollars who otherwise wouldn’t have access to dollars or for whom it might be prohibitively costly to acquire dollars, and (b) dollar-based payments (at least in theory, not always in practice) can be faster and cheaper than using some traditional payment systems.
From the consumer side, stablecoins don’t seem all that different from bank deposits. Traditionally, people who are issuing dollars or claims to dollars would be a bank. If I take a dollar to a bank and deposit the dollar, the bank issues me a claim to one dollar. Since dollars are fungible, it doesn’t have to be the same dollar, but they owe me a physical dollar nonetheless. In addition, I can transfer that dollar to other people. I can send you a dollar from my account. If we use the same bank, the bank simply updates its books by adding one dollar to your account and subtracting one dollar from my account. If we use different banks, my bank will subtract one dollar from my account and use the payment system to transfer a dollar to your bank and your bank will add the dollar to your account. With stablecoins, the issuer is creating a digital token that is a claim to a claim of a dollar. You can cash out the stablecoin through an exchange and then transfer the new dollar claim to your bank and then go to the bank to claim your physical dollar. But you can also use the stablecoin for payments. However, rather than going through the traditional payments system, the payment network is some cryptocurrency network that records all the transactions on a blockchain.
That is the consumer side, but the parallels extend to what is happening on the back end as well. If I take my physical dollars to the bank and deposit them, I get a claim to a dollar in return. Conceivably, banks are going to receive a lot of dollars and, as I said, those dollars are fungible. Thus, they can set aside some dollars in case people come back for them, but they can use the other dollars for other purposes.
The same is true for stablecoin issuers. Despite the fact that they are not banks, they actually behave remarkably like a bank. Someone gives the stablecoin issuer a dollar (well actually a claim to a dollar) and the issuer gives the person a token worth a dollar. Conceivably, people want the tokens and not the dollars. Like a bank, the issuer is now sitting on a lot of dollars, which they have promised to give people back if they want to turn in their tokens. Just like a bank, the stablecoin issuer knows that a lot of people aren’t going to try to redeem their tokens.
So, what do stablecoin issuers actually do with these extra dollars? The answer is that they tend to buy U.S. Treasury securities. These issuers therefore seem like a very limited bank. They issue debt claims in the form of these tokens that pay zero interest. They then take a lot of the dollars they receive and buy U.S. Treasury securities, which do pay interest. A very simply bank. A very straightforward way to make a profit.
But why does this matter?
Well, in my last post I wrote about the “Treasury Standard,” or the fact that the U.S. dollar is the global reserve currency and the U.S. Treasury security is the global reserve asset. One of the things that I mentioned in the post is that it is in U.S. policymakers interest to create and reinforce network effects that help to maintain this status. In my paper on the subject, I discuss the lengths that policymakers went to following the collapse of Bretton Woods to keep the dollar and the Treasury security in these roles. Furthermore, I mentioned that rising levels of U.S. government debt are a potential threat to the system.
It was therefore interesting to see the comments from Paul Ryan, the former candidate for Vice President of the United States, during a recent Bloomberg interview. In the discussion of what Congress could potentially accomplish, he explicitly mentioned the possibly of stablecoin legislation. He noted that the importance of such legislation is that it would provide a legal framework for stablecoin issuers. More importantly, he noted that the reason this was important is that it would give the dollar an edge with regards to digital currency and because stablecoin issuers buy U.S. Treasury securities. He pointed out that legislation could pave the way for “trillions of dollars” of stablecoins.
To me, this was important not only because it demonstrates a link between innovation and political economy, but also represents out-of-sample evidence consistent with my discussion of the Treasury Standard. It seems clear that policymakers (and former policymakers) are aware of the situtation that the U.S. finds itself in and the challenges they will face to maintain the dollar’s status going forward.