Last week, Chair Powell mildly told the Senate Banking Committee that he favors a federal stablecoin framework without yielding to the temptation and saying what it should look like. This is doubtless because Mr. Powell is under such virulent attack in so many quarters that he wisely decided not to pick yet another fight with a President demanding speedy action. But, if pressed, I suspect Mr. Powell would agree with the startling conclusion in an unusually blunt report last week from the Bank for International Settlements:
Society has a choice. The monetary system can transform into a next-generation system built on tried and tested foundations of trust and technologically superior, programmable infrastructures. Or society can re-learn the historical lessons about the limitations of unsound money, with real societal costs, by taking a detour involving private digital currencies that fail the triple test of singleness, elasticity and integrity.
To be sure, one must parse more than a bit of central-bank speak to understand why the BIS is so worried. “Singleness” is a concept rarely spoken of when it comes to money, but it’s the entire point of having a fiat currency. Except when it’s counterfeit, a dollar is treated the same no matter how it’s obtained or from whom thanks to hard lessons learned in the 19th century about “free banking” and the chaos it spawned.
The dollar-for-dollar reserve assets backing stablecoins as in the GENIUS Act legislation is designed to ensure singleness when it comes to ready exchange of a stablecoin for dollars, but each stablecoin issuer is different in terms of its actual capacity to redeem coins at par, especially under stress. Thus, stablecoin elasticity – i.e., ready willingness to accept them — is uncertain, especially under stress. An issuer’s integrity – read honesty and resilience – is also uncertain given the legislation’s light-touch regime.
What, then, is the real stablecoin value proposition? The BIS argues that it’s largely the anonymity of monetary instruments that can easily elude anti-money laundering, counterterrorism, and sanctions compliance enforcement. Just last week a global body concluded that illicit finance has indeed largely switched over to stablecoins. Pending legislation intends to prevent this, but all the violations evident even in far more heavily regulated banks suggest that illicit finance will remain a go-to product benefit for a long, long time.
There is, though, actually a strong stablecoin value proposition on the right side of the law. This eluded the BIS as it’s a unique feature of U.S. law and rule. Unlike most other nations, credit-card interchange fees here are unregulated and, merchants believe, thus way too high. Banks and card companies differ, but merchants want lower fees and stablecoins might just get them there.
With stablecoins, merchants can keep as much of the fee for themselves as they want for as long as retail-price and interchange-fee competition allows. And, of course, receiving payment income is a nice new way to compete not just for merchants, but also for giant tech-platform companies that often control which merchants sell how much to whom. Pending legislation attempts to govern all the conflicts these interconnections allow, but, as our in-depth analysis makes clear, the bill’s provisions here have wide open spaces for huge nonbanks to roam free.
Do stablecoins have real use cases beyond the obvious ones for illicit finance and the understandable – if conflict-rich — ones for merchants and tech platforms? Interestingly, PayPal’s CEO last week acknowledged limited use cases for his core consumer-focused payments business, but saw real opportunity in cross-border transactions So do I.
As I recently learned the hard way, even ordering flowers to be delivered in Europe comes with a transactional price tag close to that of a large bunch of trans-Atlantic roses. More importantly, remittances are often brutally expensive, especially for the lower-income households that need them for life-essential purposes. I can afford the payment price of an occasional cross-border thank-you; they can’t handle routine extraction of far too much from hard-earned dollars.
Thus, if stablecoins can reduce retail cross border-payment friction, then they will have a strong use case. The tricky bit is, though, still illicit finance. Most of the costs in retail cross-border payments have nothing to do with know-your-customer requirements and instead reflect concentrated market power by a very few dominant providers. Competition will do them good, but a lot of speed could well facilitate far more crime, especially given stablecoin exemptions and uncertainties.
Could a system of tokenized deposits do for cross-border payments what stablecoin advocates hope for themselves? JPMorgan is quickly developing a gross-settlement tokenized-deposit system. It’s largely for wholesale payments and initially only for JPMC customers, but it paves the way for instant, lower-cost transactions using funds that are covered by the FDIC, pay interest to depositors, offer recourse for fails, and importantly promote financial intermediation by the bank.
Tokenized deposits will have to play a very fast, very hard catch-up game to prevent retail-payment outflows to stablecoins, but they have key advantages for consumers and a strong policy rationale due not only to AML-prevention and macroeconomic value, but also for a raft of other rules protecting consumers and the payment-system itself.
Clearly, the race is on between stablecoin issuers and a very few banks with the infrastructure and market power to pursue complex products such as tokenized deposits. Smaller banks are right to fear that they will again be frozen out of a technology-driven industry transformation, but blocking federal law authorizing stablecoins isn’t the way to salvation. It won’t work.
The future instead depends on regulators willing for the first time in my memory to encourage innovation and – again a first – also on smaller banks willing and able to take a chance on their own, in consortia, or even partnerships with third-party providers.
The BIS is right: tokenizing critical financial instruments is essential. If U.S. banks as a sector aren’t able quickly to create them, then stablecoins will quickly become dominant where their value proposition is strong and lever up from there to prove one of the greatest challenges ever to the fast-crumbling regulatory perimeter and to banks, whose franchise value still depends on it.