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Banks can bring stability to the stablecoin market

Not all stablecoins are created equal. The reality is that there is a spectrum of stablecoins. Algorithmic stablecoins like TerraUSD are at one end of the stability and scalability risk spectrum, while centralized reserve-backed stablecoins like Tether and USD Coin pose different, but potentially significant, risks. In all these cases, stablecoins are less stable, less scalable and riskier than bank-issued tokenized deposits. Tokenized deposits are fundamentally different from existing stablecoins, providing for the rapid settlement, low-cost structure and programmability of a stablecoin but with the regulation and protection of a bank deposit. 

Tokenized deposits can be distinguished from stablecoins in one critical way. Stablecoins are digital assets that are newly created by the stablecoin issuer and are designed to have a stable value typically by being pegged to a currency or commodity. Tokenized deposits, on the other hand, are the digital representation of existing liabilities — demand deposit claims — that a bank has on its balance sheet. Importantly, tokenized deposits are obligations of banks, which are highly regulated and closely supervised by bank regulators.

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Tiffany Hagler-Geard/Bloomberg

TerraUSD, a stablecoin purported to be worth $1, lost its dollar peg and collapsed earlier this month, and is now hovering around 10 cents. The recent turmoil in the stablecoin market shines a light on the risks of stablecoins and the reality that they are not the safe, stable assets they aim to be. 

These cracks in the stablecoin market are showing at a time when stablecoins matter more than ever. Stablecoins bridge the cryptocurrency and fiat world and are fundamental to the blockchain ecosystem. Today, stablecoins facilitate billions of dollars of crypto transactions and blockchain-based payments. They also unlock massive efficiencies and cost savings when used with smart contracts that transform them into programmable money, automating transactions.

Last month, acting Comptroller of the Currency Michael Hsu said that the $2 trillion cryptocurrency market is supported by $180 billion in stablecoins, noting that stablecoins are the “oxygen of the crypto ecosystem.”  TerraUSD contributed to about 10% of the stablecoin market before it failed, causing disruption in the broad crypto markets. It is difficult to see how the current stablecoin market can scale to the multiple trillions of dollars needed to support a growing digital economy.

As ideas about how to regulate the existing stablecoin market swirl, the best answer lies in what we already have today: banks. Banks are best situated to provide a mechanism of representing money on blockchain that maximizes consumer protections. Banks are the only institutions that can safely scale to meet consumer demand for digital money. The commercial banking industry currently safeguards $18 trillion in deposits versus the stablecoin market of $180 billion.

There is a safer way to meet consumer demand for digital money, and banks hold the keys. Banks need to come together to create interoperable tokenized deposits, as part of an effort to bridge the gap between traditional finance and blockchain. When tokenized deposits proliferate, they will provide a truly stable mechanism for blockchain transactions, and they will also remove a major impediment to broad adoption of blockchain across financial services.

The President’s Working Group Report on Stablecoins endorsed the idea that banks are best equipped to control for the risks of stablecoins. Banks are the most highly regulated financial institutions in the country and are subject to a panoply of prudential regulations designed to ensure that they operate in a safe and sound manner. Moreover, banks can offer federal insurance for deposits that underlie tokenized deposits. As sources for responsible innovation, technology-forward banks are ready to leverage their expertise in payments and finance, their customer network, and their customer protections to be part of the blockchain landscape by minting a bank alternative to stablecoins. There has never been a better time than now.

And yet, notwithstanding the increasing recognition among policymakers and regulators that banks should play an essential role in the stablecoin market, and the strong legal foundation for banks to engage in such activity, there is not currently a clear path for banks to obtain regulatory approval to do so. The best way to advance prudent regulation as the market develops and the best way to protect consumers is to allow banks to use emerging technologies to act as intermediaries in the financial markets.

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