The case against stablecoins

0:06Rob Armstrong: Pushkin. There's a lot going on. The news flow from Iran, the Middle East and the Gulf is relentless, but we mustn't take our eye or ear off other stuff. One of the other things bubbling up now is stable coins, crypto flavoured kinder dollars that live in the virtual world. Donald Trump took a break from Iran earlier this week to lash out at banks, which have been pushing back efforts to draw stablecoin operators into the heart of the financial system. That is unacceptable, he said. We are not going to allow it. In other words, let the crypto in. Now, listeners, do yourself a favour and make a note of this, because maybe not today, maybe not tomorrow, but one day, The impact of giving crypto a seat at the highest tables in finance will bite.

0:57Rob Armstrong: Today on the show, we'll tell you why. This is Unhedged, the markets and finance podcast from the Financial Times and Pushkin. I'm Katie Martin, a markets columnist in beautiful, sunny springtime London. And I'm joined, as usual, by the bald eagle himself, Robert Armstrong, off of the Unhedged newsletter in New York. Rob, say hello or give us a squawk.

1:19Katie Martin: Hello. Hello. Both.

1:23Rob Armstrong: But also, we've got an actual brain box in the London studio with me to unpack what's going on. Brendan Greeley of Princeton University, a proper expert on banks, banking, economic history and money. Brendan, welcome back.

1:38Brendan Greeley: I'm a financial historian and I'm here to help.

1:42Rob Armstrong: So listeners, there's me and then there's two rich baritone American voices here today. If you get confused, the one who knows what he's talking about is Brendan. So, Brendan, I'm going to put words in your mouth here.

1:55Brendan Greeley: I'm waiting.

1:56Rob Armstrong: And say that you don't like crypto very much. I just don't think it's that novel.

2:01Brendan Greeley: I just don't think it's special. So I have students and half of them want to go into finance. And they agonize, do I want to go into DeFi or TradFi? And I have this talk that I give them.

2:15Rob Armstrong: So DeFi is like the crypto world, basically.

2:17Brendan Greeley: Crypto world or TradFi, which is, you know, I guess all of the rest of history.

2:21Rob Armstrong: Yeah.

2:21Brendan Greeley: And I have this talk I give them where I'm like, my dude, you're going into Fi. It's all the same thing.

2:27Rob Armstrong: It's all the same Fi.

2:28Brendan Greeley: So the way I think of crypto is that it's a big fancy word that applies to a lot of different things and a lot of different technology. And I think of crypto as finance as if the past never happened. Everything we're going to talk about today and everything that we talk about under this wide umbrella of crypto has an analog that we already know, that we already understand, that we already regulate.

2:50Rob Armstrong: But that we've conveniently memory hold or completely forgotten.

2:54Brendan Greeley: Yeah, that's exactly it.

2:55Rob Armstrong: So the crypto universe, to the extent that we're going to talk about it today, splits up into two areas. There's crypto, right? So there's tokens, effectively, like Bitcoin or Dogecoin or Melania coin or whatever you like. They're all fundamentally the same thing. They just have different values attached to them. People always say to me, oh, I don't understand crypto. Surely it's just like a bit of, you know, it's just a token and it goes up if people buy it and it goes down if they don't. And I'm like, no, you definitely do understand crypto. That's all there is to it. And then the stable coins, which they're designed to be like a dollar that lives in the crypto ecosystem.

3:31Rob Armstrong: So you buy one of these tokens, effectively, one of these coins, and it's backed by a dollar that's held by somebody else. So a couple of important things have happened this week. So Bitcoin itself got a bit of a boost earlier this week. It went up to about$72 ,000. For me, that's$72 ,000 above fair value, but whatever. And that's because Trump wrote on his social media platform, Truth Social, that, and I quote, The Genius Act is being threatened and undermined by the banks. And that's unacceptable. We're not going to allow it. Right. What is the Genius Act? What is he talking about?

4:11Brendan Greeley: So the Genius Act has already been passed. What he means is the progress that was made under this piece of legislation that's already been made law is being threatened. So what it did was define for U.S. regulators, U.S. bankers, what a stable coin is. It basically said we're going to allow them and they're going to be regulated at the state level. That means a lot in the United States. It's actually very difficult for audiences abroad to figure out like how the American banking regulatory model works because it's so complicated. But broadly, there are two different ways to regulate banks at the federal level and at the state level.

4:47Brendan Greeley: And so very crucially, not just crucially, very crucially, the Genius Act took stablecoin regulation and it put it at the state level. You get a state charter to be a stablecoin provider. Then it said you absolutely have to have 100 % reserve if I give you a deposit of my fiat dollar and you're a stablecoin provider.

5:11Rob Armstrong: So fiat dollar, for normal people, that's just like a normal dollar.

5:13Brendan Greeley: It's not a small Italian dollar. With wheels. A Federal Reserve dollar. You have to hold 100 % of that dollar in reserves, liquid high quality assets.

5:26Rob Armstrong: So if I give my dollar to a stablecoin operator like Tether or Circle, they have to go out and buy a dollar's worth of something to be there on their books for as long as I have that dollar with them.

5:38Brendan Greeley: Yeah. So Rob and I had this conversation when the act was passed. We were looking at the law and trying to figure out, like, what's the profit in being a stablecoin provider if, in fact, you have to hold 100 % of the dollars that are given you in some kind of liquid asset? That doesn't seem like there's a very high return there. I think there are a couple of answers. One of them is it looks like that you can also hold repo where the returns are a little higher. What that means is a repo is just a repurchase agreement. It's an agreement to buy something briefly overnight and then sell it back tomorrow.

6:11Rob Armstrong: Yeah, like really short-term stuff. So you can do some funny stuff with the money. But even if you don't do the funny stuff with the money, even if you just put it in short-term government debt securities, I, as somebody who holds a tether or a circle token, I earn nothing from that. The operators take all of the interest payments.

6:31Brendan Greeley: That's right.

6:32Rob Armstrong: Happy days.

6:33Brendan Greeley: Isn't that, I mean, we do that already. That's called banking, Katie. This is my frustration with stable coins. They're just banks. Every time I have a conversation with a crypto dude, they're like, no, no, it absolutely clears at par with a dollar. Like, congratulations, my dude. That's a bank. Banking is you take in a deposit and then you promise to return that deposit because you're holding on to some liquid investment that's going to give you a small return. That's banking.

7:00Rob Armstrong: So, Rob, over there on your side of the Atlantic, stable coins are great. Crypto is great. is this sort of portrayed over there as like a huge wave of innovation and I don't know democratizing finance or like what like why is it such a big deal I think the excitement

7:19Katie Martin: around crypto in America can be summed up in four words which are I just got rich so anybody you talk to anybody you talk to in America who's excited about this technology is excited about it because they've either earned money on Bitcoin or similar things, or they're starting a business they're going to sell to somebody and make a lot of money. It's a speculative frenzy, Katie, as far as I can tell.

7:47Rob Armstrong: Yeah. And so, Brendan, as you say, Genius Act has been passed, which means that stable coins are a thing, as you say, regulated on a state level. What is the opposition that's coming from the banks, and does it make sense?

7:59Brendan Greeley: So they want another run at it. So the new piece of legislation we're talking about is called the Clarity Act, which, I mean, anybody who's covered any industry knows that when the industry says we need regulatory clarity, what they actually mean is it is clear that we do not like the current regulation.

8:14Rob Armstrong: Yes. Yeah.

8:19Brendan Greeley: So what they don't like is in the Genius Act, which is now law, you cannot pay interest on a stable coin deposit. They want another crack at that. They want to be able to offer some kind of a reward. It looks like maybe what will happen is you'll have a stable coin, you'll hold it with a company, and the company will offer you rewards in the form of other tokens. Can we take a step back, Brendan, just briefly?

8:44Katie Martin: And what was the idea behind the original prohibition on paying interest on a stable coin deposit? it. Was that to discourage the stablecoin managers from taking too much risk?

9:02Brendan Greeley: I think yes, because if you're paying interest, then you got to go out and buy something risky to make a profit. I think more importantly, the banks hated it.

9:10Rob Armstrong: Because they compete with banks. Yeah.

9:13Brendan Greeley: So the problem with this conversation in general, not the conversation I'm having with you two lovely people, but the conversation in general is the banks aren't the good guys. We just know how banks work. When we look at stable coins in banks, there is a long 200-year history of Americans figuring out how do we keep banks from blowing up? And when they do blow up, how do we keep them from blowing up people's dollars that they use for normal daily transactions, right? This is crisis after crisis after crisis, regulatory response after regulatory response. We've built up this framework. So now we have this framework.

9:44Brendan Greeley: So at the very least, we know how banks work. We know roughly how to control them. And we've been fighting that fight.

9:49Rob Armstrong: And normal people don't need to think about dollars.

9:52Brendan Greeley: Yeah. So, you know, in the 1920s, if you – this was before federal deposit insurance. When you look at bank advertisements, they would advertise their assets. You had to know as a consumer who was keeping your money with a bank how stable the money was because you had to know how the assets the bank was holding to make sure that your money had meaning. That stopped after deposit insurance. Again, 1932, another crisis. A lot of banks in America closed their doors. People didn't have access to their deposits. We opened the banks back up by figuring out how to buy those assets and give them Federal Reserve dollars.

10:26Brendan Greeley: And we very quickly in America passed a National Deposit Insurance Act where every bank now pays an insurance premium every year to make sure that if their books blow up, that their dollars continue to have meaning. So stable coins basically offer exactly what a bank has always offered, except without any of that regulatory apparatus that we've been slowly building up for two centuries.

10:49Katie Martin: So how does the stable coin blow up in the style of a bank? If they are following the rules of the Genius Act, they have to own pretty basic stuff backing up the deposits, right? It's like short-term treasuries and dollars, isn't it? So, I mean, if they follow that rule, how can they blow up? How do we know they're following the rule? We don't have to, in this age though, Brendan, I'm going to push you. In this age, you don't need some fellow in a stiff collar wearing Pince Nez going into the vault of the crypto coin. Yeah, we do. But don't -

11:31Brendan Greeley: A hundred percent. Can't you do it electronically? Right? I mean - It's like. Well, yeah, but what are the, so all of the problem with a stable coin is when we talk about crypto, it sounds super whiz bang like all of this stuff is on the internet and you can see it. But a stable coin, it's a company with a fiduciary responsibility to make sure that its tokens have value in the exact same way that a bank is. You can't see what they buy. We don't know what they're holding. They tell us, but there's no, the regulation isn't that intrusive. And so the reason you need bank regulators, right, you can't just have laws.

12:03Brendan Greeley: You need regulators and you need regular periods where they can go in and they are given complete access to the bank's books because, you know, banks, they kind of fudge it a little bit if they're allowed to. That's a natural instinct.

12:16Rob Armstrong: So broadly speaking, the way this whole debate is developing in the UK at the moment is that the Bank of England, Andrew Bailey at the Bank of England, governor of the Bank of England, has said, OK, people want to launch sterling stablecoins. They have to be two things. First of all, they have to be stable. So they have to be properly backed and we have to be able to check whenever we like that the backing is all there. And second of all, they have to be coins, which effectively means not physical coins, but you have to be regulated right up the wazoo in exactly the same way as banks are. We have to be up in your stuff day and night.

12:52Rob Armstrong: We want to know who's in charge of what. We want to know what your processes are. You know, there's rules that come with operating like a bank.

13:01Brendan Greeley: So this is the challenge and this is why we have to make this America's weird banking system clear to a non-American audience. You have state regulation and you have federal regulation. And my fear right now, if we're going to lay down a marker today and say this is all going to blow up and we're going to be on the hook for it. My fear right now is what we did with the Genius Act is that we took stablecoin regulation and we gave it back to the states. We are at the status quo of the early 19th century in America.

13:26Rob Armstrong: Back to the future.

13:27Brendan Greeley: And Katie's absolutely right. What you need if you want to have stable, stable coins is that you need to be all up in their business. States are going to be competing to see how far up the wazoo you go as a regulator. Or how not far. Exactly. It's going to be a race the other direction. It is going to be a race down the wazoo, if you will.

13:47Rob Armstrong: I'm really sorry I'm all wazooed into this. I'll be honest.

13:49Brendan Greeley: But yes, it'll be, let's wipe the metaphor slate clean. It will be a race to the bottom. and you will have certain states that will become, we're going to have a Delaware of stable coins and certain states, it looks like Wyoming is already one of them, but states will compete for the privilege of being able to say, come open your stable coin here. We're not going to be that intrusive. You can just give us a pinky promise once a year and we're good.

14:12Rob Armstrong: Come to Texas, home of the wazoo coin. And then stop it with that, Katie.

14:19Katie Martin: And then the problem is, again, I'm just making sure I'm envisioning this apocalyptic scenario correctly. The problem is that the stable coin, do we call them operators, managers? I mean, whatever they are. Companies. Providers. Providers. These providers, they invest in something besides dollars and short-term treasuries and other very safe things.

14:46Brendan Greeley: Yeah, that's the worry. So the problem is you can give people all the legal reassurances you want, that what they hold is not an actual dollar and that it's actually a speculative instrument. But if people come to think that what they hold is a dollar, if that dollar blows up and the balance sheet of the stablecoin provider is not what they promise it is, and that dollar suddenly doesn't have value, people get angry. And we see this again and again. Private bank notes in the 19th century, private bank deposits in the late 19th century and early 20th century, money market funds in 2008. You know, one of the many crises that happened, we all remember this, was when a money market fund slipped below par when it broke the buck.

15:27Brendan Greeley: All of a sudden, a dollar was not a dollar. People got used to the idea that if you hold this thing, no matter what the lawyers tell you, you feel like it's a dollar and you make it the government's responsibility to make you whole if it suddenly is not a dollar. And that is where we're headed with stablecoin.

15:41Rob Armstrong: So you actually don't even have to go back as far as 08 to see an example of this. 2023, Silicon Valley Bank blew up. There was a bunch of regional banks in the US that went belly up. When SVB died, it turned out that Circle, one of the stablecoin operators, had, count them, three billion US dollars on deposit at SVB. And so suddenly they were like, oh, we're going to be needing a federal bailout here because otherwise we're stuffed. So there are vulnerabilities in stable coins. But I just want to pivot really quickly onto the other piece of important crypto news that came out this week. Kraken, a crypto exchange.

16:24Rob Armstrong: I don't like using the word exchange, but it's a place where you can buy cryptos. It's called Kraken. It said it had been granted access to the Federal Reserve's core payment system. It's going to be able to connect directly into payments infrastructure, including the central bank's Fedwire service. I'm reading from the FT here. The Fed's decision to grant Kraken access to its payments network brings the digital assets group in line with major banks and credit unions. Brendan Greeley, briefly, what can go wrong? And you don't have much time.

17:00Brendan Greeley: So what we're already seeing is, I guess, what you could charitably call experimentation at the state level. So I worry about the race to the bottom. An optimist would see that as experimentation.

17:11Rob Armstrong: Innovation. Innovation and a good thing.

17:14Brendan Greeley: You know, Wyoming has positioned itself as a state that's going to be friendly to crypto in a lot of different ways. And they granted a state-level charter to Kraken under a brand new institutional charter that they just created in 2019, which is a special purpose depository institution. Katie Martin, how do you feel when I say the word special purpose in finance?

17:40Rob Armstrong: A little bit sick.

17:42Katie Martin: I have the overwhelming urge to complete your sentence with the word entity.

17:48Rob Armstrong: Vehicle. For listeners who aren't familiar, special purpose vehicles went very badly wrong 07, 08, were a big part of the, I'm going to say, shit show that came afterwards. So people who've been around in markets quite a lot just do not like to hear the words special and purpose together very often.

18:10Brendan Greeley: And so what that means is the special purpose depository institution charter in Wyoming allows you to, as an exchange, actually hold on to people's deposits and make transfers to other banks through the Federal Reserve's balance sheet in the way that banks make transfers to each other through the Federal Reserve's balance sheet. I suspect the Fed is doing this because there's a lot of demand for this and it's coming. And Kraken is smaller than some of the other exchanges. It exists. Wyoming exists. It's actually in Wyoming. So in a way that they can grasp, I'd rather this stuff be regulated at the federal level.

18:48Brendan Greeley: But at the very least, like, there is a legislature and law in Wyoming. And I think that they're trying an experiment in a small way to see how this works. Because they suspect that this is coming.

18:58Katie Martin: What does access to these Fed payment rails do for Kraken? What can it do now that it couldn't do before?

19:05Brendan Greeley: So I'm having trouble. This is one of those things where they're promising things in a press release, and it's hard to figure out what they actually mean by the press release. One of the things that alarms me the most is they want you to be able to get out your crypto earnings through a debit card in Federal Reserve cash somewhere. So this is the thing is like, and it feels like I'm out over my skis right now only because we're guessing what's going on actually on the payment rails based on what Kraken is promising. But what they're saying is you can transfer what you have at Kraken in dollars, some sort of stable coin, to another bank.

19:47Brendan Greeley: If Kraken is a bank, you can transfer it to, you can make payments with it.

19:51Rob Armstrong: Does that mean you can have a debit card and pay for your groceries effectively kind of with crypto?

19:57Brendan Greeley: Yes. And yes, maybe. When they say debit card, that's what I suspect they're getting after. But what I think this actually means for those of us who think about balance sheets is it's going to be very easy on Kraken to move wealth back and forth between what you just earned in crypto and you cash it out and then it becomes actual dollars and you hold that in your Kraken account and then you can use that to pay for things. So it's basically a base account that is then used to invest in other less valuable, even less reliable coins that are on Kraken's exchange.

20:33Rob Armstrong: Really quickly, Brendan, what is the time frame for how long it takes for this to go wrong and cause a problem? Is it going to become a problem during the Trump administration or will this be something that bites the next president in the neck?

20:47Brendan Greeley: I think this is going to be the next president's problem. I think that's the problem with financial deregulation. In America, everybody blames George W. Bush for the financial crisis. God knows there are many things to blame George W. Bush for. But that one, that one's on Clinton and the Clinton treasury and their rush to deregulate in the late 90s the finance industry. So the problem with easing up on regulation and oversight, it's not just regulation. It's not just the law. It's how often you check the wazoo to see what's in there.

21:22Brendan Greeley: And in a lot of ways, the Trump administration has signaled that law kind of doesn't matter right now in finance. Even if you do nominally break the law, you're not going to get punished for it. They're not checking you out. They're not building a case. You can do no wrong. So the problem is it does take a while. We don't – I can tell you this thing is going to blow up. I can't tell you when. I can't tell you what crappy asset some stablecoin provider is going to be quietly buying. I can't tell you how that stablecoin is going to have burrowed its way into other parts of the financial system as a payment medium.

21:54Brendan Greeley: We just don't know. But we'll find out. And when we do, I think we all agree, or at least Katie and I agree, the United States government will have to make every holder of a stablecoin whole. That's step one. And then we'll have to do all the regulation that we didn't do this time around.

22:08Katie Martin: And the reason you're so certain, again, just trying to make your apocalypse clear to the listener, the reason you're so certain this goes wrong is that the desire of providers of banking services to put bad stuff on the asset side of their balance sheet, in other words, the side of the balance sheet on the other side from the deposits or the crypto coins or whatever else, The desire to put bad stuff on the asset side of the balance sheet is like a human universal that is eternal and always happens. That's the thesis here.

22:46Brendan Greeley: Yes, absolutely. It is a human and sometimes laudable instinct to want to take huge risks on the balance sheet. And I think it's up to us as democracies to make sure that we take that human and sometimes laudable instinct and check up on it regularly to make sure that people are taking acceptable risks that aren't going to blow up money for the rest of us.

23:06Rob Armstrong: Brendan, I'm going to read back to you a line that you put in a column last year for the FT about crypto saying, you're just a dad worried standing in front of another dad who is not. Now you've made all of our listeners worried as well. So congratulations. You're welcome. On that achievement, we're going to break and come back in just one second with Long Short.

23:34Rob Armstrong: It is time for Long Short, that part of the show where we go long, a thing we love, or short, a thing we hate. Brendan Greeley, what are you saying?

23:42Brendan Greeley: I am long made Stone United, the football team in Kent County in England.

23:47Rob Armstrong: Amazing.

23:48Brendan Greeley: I spent this week in the Kent County archives looking at the 17th century banking papers of John Banks. Those archives happen to be right next to the stadium for Maidstone United, the football team. I went, I watched, I stood right next to the field. That stadium is absolutely perfect. There's a pub in the stadium. And there's also a place in the woods near the stadium where you can not have to pay the entrance fee and stand in the woods and drink. And I saw a guy doing exactly that. Everything was perfect about this football game that I watched.

24:19Rob Armstrong: Good times in provincial England.

24:22Brendan Greeley: Go you stones.

24:25Rob Armstrong: Rob, what are you saying?

24:27Katie Martin: I'm sure T.S. Eliot. You know why? No, I don't. He's the guy. Isn't he the guy who said that April is the cruelest month? That was T.S. Eliot. That was T.S. Eliot. Cruelest month. Well, anyway, it's not. March is the cruelest month. March is the worst. It's still winter, but you're kind of thinking that it's supposed to be spring. It's just 30 days of torture. So you're short March. March, the whole month.

24:55Rob Armstrong: Okay, fine. I am long the people who are hurrying back to Dubai to avoid incurring large tax bills by spending too long outside the Emirates. So there are lots of people trying to get out of Dubai because of the conflict going on in the whole region. There have been explosions in Dubai, over this whole thing with Iran. But at the same time, there are a bunch of people who are trying to get back there. So they're not in the UK, for example, for too long, and they don't end up getting taxed over here.

25:25Katie Martin: I just think there's never been a better way to show to people who you really are.

25:33Rob Armstrong: And yeah, no notes. Perfect. So, listeners, we are going to be back in your ears on Tuesday. Please listen up then. Unhedged is produced by Jake Harper and edited by Brian Erstad. Our executive producer is Jacob Goldstein. We had additional help from Topher Forhez. Cheryl Brumley is the FT's global head of audio. Special thanks to Laura Clark, Alistair Mackey, Greta Cohn and Natalie Sadler. FT Premium subscribers can get the Unhedged newsletter for free and a 30-day free trial is available to everyone else. Just go to ft.com slash unhedged offer. I'm Katie Martin. Thanks for listening.