I’ll admit up front to my luddite tendencies. Technology and I are not the best of friends. I sort of understand the argument about Crypto at a very superficial level. Okay, I get the argument that Crypto is like gold; it’s expensive to make (mine) so becomes a storehouse of value because of its scarcity. It’s backed by, hey nothing but an algorithm, but as long as everyone agrees to the value proposition, it works as an asset class. Clearly, it has seen a broad take-up, albeit with considerable volatility in pricing. You can’t make stuff out of Crypto like you can out of gold, it’s not as pretty as tulips, but I guess we’ve invested in dumber things.
But what about Stablecoin? That’s something different entirely, isn’t it? While folks sometimes seem to conflate a store of value with a currency when talking about Crypto, Stablecoin truly is a private electronic currency. Stablecoin, or at least the ones I’m going to talk about here, the ones actually backed by currency and Treasuries, are truly digital currencies, made so by pegging their value to real world money, guaranteeing convertibility into, you know, proper money, stuff issued by governments with police and armies and such. Backed by blockchain technology (another thing I sort of, kind of, understand), it’s easier and quicker to settle transactions without the intermediation of a banking institution (it’s also really a nifty workaround for terrorists, criminals and other undesirables, but that’s a different story). The bulk of Stablecoin out there is tied to US dollar. The big names in the space are USDT issued by Tether Limited, USDC issued by Circle and PYUSD issued by PayPal. The Europeans have gotten into the act with EURS which is pegged to the euro (and note, there are loads of other issuers out there with considerably smaller positions). All in all, there are around $300 billion of Stablecoin issued and in circulation right now.
There are a variety of things out there which claim the cognomen of Stablecoin, but the one I’m really focusing on today is the fiat currency backed Stablecoin. This is the real alternative to traditional money. The other versions of Stablecoin seem to be a little thin on the stable part. Some are backed by crypto, some are backed by a cornucopia of securities and other assets including commodities, others are simply backed by an algorithm which maintains the peg by automatically balancing supply and demand. None of those seem a true currency and it seems to me they are going to function in some ways more like other crypto assets which are a depository of value rather than a true currency. If you buy that stuff, on your head be it.
The “Stablecoin” that’s backed by USD and US Treasuries (which I’ll refer to in the rest of this article as just Stablecoin) is growing the fastest and it the most widely disseminated and widely used of all the things claiming the moniker of Stablecoin. While there has been some minor variability around the peg, these fiat currency backed Stablecoins have maintained the promised correspondence with the underlying reference currency.
Is this as good as a pile of Franklins, as advocates say? The case indeed can be made that it is, but there remains some structural vulnerabilities which we should not overlook.
The US has toyed with private currencies in the past. Through the 1800s, there were hundreds of private currencies issued by banks around the country which generally functioned, and rarely well, as a currency and only within a small geographic region around the issuing bank. All of these suffered significant crises during their generally short lives. These remained in circulation until the Federal government began issuing greenbacks during the civil war and made private currencies obsolete. (Congress, in fact, taxed these to drive them out of currency.) That gave us the US dollar economy we know today.
One hardly needed the experience of 18th century’s volatility to realize that Stablecoin needed to be regulated. Private parties effectively taking on non-guaranteed deposits and issuing a currency (debt)…what could possibly go wrong?
In 2025, Congress passed and the President signed into law the Genius Act (Guiding and Establishing National Innovation for US Stablecoins Act – our glorious elected representatives love a good acronym). The OCC, its primary regulatory supervisor, is beavering away on implementing regulations and is supposed to all become effective no later than January 2027.
In a 50,000 foot sort of way, The GENIUS Act did several things. First, it provides a certification process for qualified issuers (banks and bank subsidiaries are easy, but private parties can obtain certification as well; presumably, not two guys and a Bloomberg, but more of that later). Second, it requires Stablecoin issuers to back tokens one on one with highly liquid assets held in a protected reserve, isolated from any of the issuers’ other assets and its operations. This regime requires periodic disclosure and certification about performance of the issuer and the quality of the reserves. Third, it requires the Stablecoins to be freely redeemable for the underlying currency it represents on a one-to-one basis. Fourth, it specifies that the reserves are composed exclusively of currency and a short list of short tenured securities that are based by the United States government. (I note in passing that some of the current cadre of issuers will have to clean up their act a bit to comply with the new Act. Based on recent Federal Reserve data, a not immaterial part of their reserves are in assets which will not qualify under the GENIUS Act.)
The GENIUS Act took several steps to ensure that asset isolation will be ironclad with specific changes to the Bankruptcy Act to protect the reserves and facilitate resolution if something were to go wrong. The Act also makes it clear the issuers can’t pay interest or yield on the Stablecoin they issue (which reinforces the notion that these are indeed currencies and at least provides a business reason for anyone to become an issuer in the first instance).
Other provisions in the Act give issuers comfort that Stablecoin is neither a security or commodity and so issuers won’t be troubled by SEC or CFTC oversight. It essentially provides that the OCC and certain state regulatory agencies will provide the principal regulatory oversight for these matters which makes some sense as this is essentially a private banking function.
There are significant monetary penalties and criminal liability for misbehavior. There is also a bunch of consumer protection and national security stuff tucked in here, but not really relevant to this conversation.
So, is Stablecoin a perfect simulacrum of paper money, a well-regulated new form of species that can transform how we settle transactions, and ultimately perhaps even replace the greenback entirely? I think there are still reasons to be concerned and reasons for this business to be surveilled in a very robust way if we are to harvest the benefits and not suffer the detriments of a private currency.
What could go wrong? I see two vulnerabilities. There is still a possibility of a liquidity mismatch, and, let’s face it, issuers can go bad. If anything bad happens, I then worry about contagion.
First, liquidity.
How can liquidity be a risk when Stablecoin is fully backed by currency and treasuries with tenures less than 93 days? You’re unlikely to have a Silicon Valley Bank type of problem where deposits were backed by Treasuries whose market value crashed as yields spiked. But redemptions could still become chaotic and result in losses which would have to be absorbed by someone.
If some sort of black swan event triggers a redemption wave, will the redemption process work smoothly? What happens if it doesn’t? Even though the bonds in the reserve are supposed to be short tenured, a rapid 100 bps spike in Treasury yields could produce a not insignificant short fall to the issuer if these assets had to be sold in a hurry (something over $20 million per $10 billion of OPB liquidated). There’s also the question of friction in terms of liquidating large pools of Treasury securities and in the moment supply and demand mismatches which could result in mispricing, not entirely attributable to changes in the shape of the curve. Yes, I know that the Treasuries are the most famous liquid market in the world, but it’s not perfect. Can every issuer out there easily digest a $20, 30 or 40 million hit when liquidating reserves to pay for redemption? Maybe, but it will depend upon their capitalization and as Warran Buffet famously said about investors, when the tide goes out, we’ll see who’s wearing shorts.
The second worry, of course, is fraud. Our economic life is not entirely ornamented by saints and angels and we have, on a fairly regular basis, seen examples of dramatic and dangerous fraud in places where no one had expected it. Think of good old Bernie Madoff. How about Enron? WorldCom? Do you remember Volkswagen’s effort to gain emissions testing? How about that whacky claim of blood testing by Theranos? And then there was Credit Suisse with such a giant tax fraud that it resulted in the Swiss government folding Credit Suisse into UBS? I could go on, right? In every one of these cases, there were laws, there were regulations, there was required disclosure, there were protocols in place to protect against it, and it didn’t work. It can happen again.
Might a less than perfect issuer get certified in this process and begin to issue Stablecoin? We’ve got multiple regulators including the states. Might politics play a role here? Might favoritism? Might the fix be in resulting in issuers that carry some baggage?
In some ways, don’t these sort Stablecoin issuers remind you a bit of the Structured Investment Vehicles (SIVs) of GSE fame? Those things were essentially CP conduits without a deep pocket guarantee. Real CP conduits were issued by regulated lenders and had an effective backstop to support a structure in the event of a meltdown. SIVs did not. Before the fall, its debt traded pretty flat to real CP because everyone knew they were money good, until they weren’t. A meltdown is what we got in the GFC and the SIVs began to blow up like fireworks on the Fourth of July. In some cases, responsible sponsors stepped back in to fix the problem, but in some cases they did not and significant losses ensued.
We’re going to have massive quantities of liquid assets sitting in a reserve, managed by issuers, some of which might not have what we might think of as a fortress balance sheet. Could that be an attractive nuisance for a bad guy, or a desperate one? Might such a hypothetical bad actor be tempted to try to find a way around the GENIUS Act rules to solve a temporary cash flow problem? Might someone convince themselves that it’s just a timing problem and they’re just fixing a temporary problem with they’ll square away tomorrow and no one will notice or be hurt? The temptation will be real. It’ll be particularly real for the ethically challenged. Some of the means and methods by which this liquidity could be tapped might be quite opaque and the reporting cycle might not pick up the problems until too late. Back leverage, derivative transactions and a range of arcane leverage strategies could be hard to see until the damage is done.
Moreover, as we know, even a whiff of a bad actor diddling the reserves would result in a massive redemption request. Such a redemption wave could spread well beyond the issuer with a problem in the first instance.
What worries me is when a loss occurs (and I think at some point, somewhere it will), we could see contagion. The failure of one Stablecoin could infect the others. It’s not impossible, and in fact, it probably is more likely than not. If multiple issuers had to wind down simultaneously, what would happen to the market? Would the government step in to shore this up (like they did during the GFC)? Probably, but that might be cold comfort to someone who is long in Stablecoin position in transactions where counterparties might come out of the woodwork and demand payment in fiat currencies…like yesterday.
Maybe nothing goes wrong and maybe all is swell and beautiful, but the risk of something going wrong seems…not zero. This would suggest that the market should be extremely supportive of robust regulations to ensure compliance and to make cheating as hard as possible. (I’m sure some of my readers might get the vapors seeing me suggesting a more burdensome regulatory state, but sometimes good regulation is indeed good regulation.)
What else? We better vet the issuers carefully. Some issuers actually might have limited financial backstop and that would be hugely valuable. Some would be affiliated with enormous financial institutions who have the wherewithal to fix problems as they occur. Some may not. Take a look at the allocation of assets inside the reserves. The more currency the better. The more arcane assets that are hard to understand and hard to price the least desirable. I’d make sure that there were no triggers out there in my counterpart relationships that would allow a third party to require substitution of currency for Stablecoin. Finally, I wouldn’t go all in at this point. Let’s see how this plays out in the next couple of years. Let’s see how this plays out when some significant financial disruption works its way through our economy (as it will at some point).
Maybe I’ve got this all wrong. Maybe Stablecoins really are a robust, virtually risk free 2.0 version of paper currency and they are the future. If you think that’s right and I’m wildly off base, please let me know. I’d love to hear from you. And if you’re right, it would free up some significant 3:00 a.m. worry time for me.