In a recent op-ed in American Banker, Judith Rinearson argues that stablecoins, cryptocurrencies with valuations tied to a real-world fiat currency, are safe because the state money transmitter requirements that they are subject to require them to be backed “100% by reserves.”
She contrasts the backing of stablecoins with bank deposits, for which the current “reserve requirement” is zero. However, Rinearson conflates vastly different meanings of the term “reserves” and is thus wrong on all counts. Unfortunately, the “stablecoins are backed by reserves” canard is a source of widespread misunderstanding.
It is difficult to decide where to begin.
First, insofar as the public can tell, stablecoins are backed mostly by commercial paper. Commercial paper is a short-term extension of credit to a corporation, essentially the same as a loan. The purchaser of the paper provides the corporation money that the corporation returns later with interest.
The two largest stablecoins in the United States, Tether and USD Coin, which together account for 77% of circulating stablecoins, are both backed primarily by commercial paper — essentially business loans. Furthermore, the commercial paper backing these stablecoins is not all highly rated. So, when you give a stablecoin issuer dollars, they take the dollars and lend them to businesses — in some cases, with poor credit ratings — and earn interest.
Second, if loans — and by that logic, basically anything of value, such as securities — count as “reserves” to those who endorse the safety of stablecoins, then bank deposits are backed by vastly more “reserves” than stablecoins. Banks are required by law to have more assets than liabilities, and deposits are the most senior part of those liabilities. As of the end of the first quarter of 2021, according to the Federal Reserve Bank of New York, U.S. bank holding companies had deposits of $17 trillion and assets, composed primarily of loans and securities, of $26 trillion. So, bank deposits are backed by 165% reserves!
Of course, in banking parlance, that’s not what anyone means by reserves. “Reserves” are completely safe and liquid assets with known value. Under this concept of reserves, Tether and USDC actually have low levels of reserves compared with banks. As of September, according to an auditor’s report, 28% of Tether’s assets were Treasury bills, which would qualify, and 10% were “cash and bank deposits.” But presumably the vast majority of those deposits are above the Federal Deposit Insurance Corp. insurance limit and are thus uninsured, so they are not riskless.
Moreover, under the heading of bank deposits, Tether also includes term deposits and fiduciary deposits. Term deposits are clearly not available to meet immediate redemptions. According to the FDIC, fiduciary deposits are “deposit accounts established by a person or entity for the benefit of one or more other parties,” and it is not clear how quickly those deposits could be withdrawn.
As for USDC, according to its auditor, the assets backing USD Coin are 100% “cash & cash equivalents” as of Oct. 29, which sounds good until you read the footnotes. “Cash equivalents” includes commercial paper with maturities of less than 90 days, which would capture most commercial paper. So, for all we know, USD Coin is backed 100% by commercial paper and holds no assets that could be considered safe enough to qualify as “reserves” in any reasonable sense.
The majority of the assets of many stablecoin issuers are not completely safe and liquid assets with known value. Thus, the representation by many stablecoin issuers that they are safe because they are backed by “reserves” does not amount to much more than saying that stablecoin issuers hold assets — of varying degrees of safety, liquidity and value — against their liabilities.