Regulators’ Stablecoin Warnings Open Door for Digital Dollar, Tokenized Deposits

Warnings on stablecoins from a trio of regulators may cause banks to seek digital alternatives instead.

And digital dollars (aka CBDCs) and tokenized deposits issued by traditional banks may be among those options.

The Federal Reserve, the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency released a joint statement on Tuesday (Jan. 3) that signaled that there would be a much tighter regulatory gaze on the cryptocurrency sphere.

In their “Joint Statement on Crypto-Asset Risks to Banking Organizations,” the regulators stated that there’s real risk tied to cryptos:

“It is important that risks related to the crypto-asset sector that cannot be mitigated or controlled do not migrate to the banking system,” they said, and added that” issuing or holding as principal crypto-assets that are issued, stored, or transferred on an open, public, and/or decentralized network, or similar system is likely to be inconsistent with safe and sound banking practices.”

In other words, holding digital creations on bank balance sheets does not have a place within traditional finance. The language that is specific to stablecoins states that there is a “susceptibility of stablecoins to run risk, creating potential deposit outflows for banking organizations that hold stablecoin reserves.”

Promise of Stability Goes Unrealized

We’ve noted in this space in recent weeks that stablecoins have, as their model at least promises, stability that cryptos such as bitcoin do not have. They are “pegged” to a backstop of traditional financial instruments, often commercial debt and government debt in addition to dollars. But from time to time, illiquidity in any of those “backstop” holdings has wound up “depegging” the digital offerings, causing them to “break the buck.” And the threat of bank runs, as mentioned above by the regulators, would likely cause a sustained depegging, which in turn could conceivably hurt banks’ balance sheets and consumer/clients’ trust in the banks themselves. There may be little incentive for the banks to hold stablecoins created by others.

The authority is there to create stablecoins, as determined by the OCC (re-affirmed by a whitepaper last year from The Clearing House).

Thus, for the banks, the answer may lie in pivoting away from stablecoins created by outside parties, in effect privately issued money, and towards CBDCs, which act as legal tender and would be a central bank liability.

The technical rails are there, so to speak, as determined by the Federal Reserve Bank of Boston and the Digital Currency Initiative at the Massachusetts Institute of Technology (MIT). The first phase of their joint efforts has given rise to an open-source transaction processor capable of supporting a high-performance CBDC. Called OpenCBDC, the processor settled between 170,000 and 1.7 million transactions per second and brought nearly all (99%) of transactions to completion in under five seconds.

There’s also room for tokenized deposits — bank-to-bank transfers — to gain ground as regulators keep sounding the alarm on stablecoins issued from firms operating outside the rules and regulations that govern federally regulated banks. Rob Hunter, deputy general counsel and director of regulatory and legislative affairs at The Clearing House (TCH), told Karen Webster those tokenized offerings would essentially use technology (such as blockchain) to take deposits and transfer value between accounts. Without, we’d hasten to add, the risks and volatility that have been the unwelcome hallmarks of cryptos in the last few months and years.