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Macro Musings with David Beckworth
Neha Narula, Anders Brownworth, and Daniel Aronoff on Understanding Stablecoins in the GENIUS Era
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- [00:00]
A
Hey Macromusing listeners, this is your host David Beckwourth with some very exciting news. We recently announced that Macro Musings has full length video of each episode. Going forward, the full length videos are posted on our YouTube channel Acromusines. David Beckwourth There is a link to that channel in the show notes and it would mean the world to me if you subscribed and shared it with others. Not only will that channel have full length of videos, but it will also have some fun behind the scenes content. Additionally, the full length video from each episode will also be posted on our X account acromusings, so make sure you are following that account as well. We are so happy to be bringing you even more Macro Bang for your buck. Now on to the show. Welcome to Macro Musings where each week we pull back the curtain and take a closer look at the most important macroeconomic issues of the past, present and future. I am your host, David Beckford, a Senior Research Fellow with the Merkita center at George Mason University, and I'm glad you decided to join us. Our guests today are Daniel Aronoff, Anders Brownsworth and Niha Nerula. Dan, Anders and neha are from MIT's Digital Currency Initiative and published an interesting, timely and important paper titled the Hidden Plumbing of Stable Financial and Technological Risk in the Genius ACT Era. They join us today to discuss it and the future of stablecoins. Welcome to everyone.
- [01:39]
B
Great to be here.
- [01:40]
C
Thank you.
- [01:40]
D
Thank you.
- [01:42]
A
Yeah, let's begin maybe by having each of you share your background, your connection to this policy space. And let's start with you, Neha.
- [01:51]
B
Yeah, so my name is Neha Narula. I am the Director of the Digital Currency Initiative which is based out of the Media Lab at mit. I'm a computer scientist by background. I've been working in the cryptocurrency space for about 10 years now and we work with a lot of central banks. We work with a lot of traditional financial institutions, but we also do a lot of work in open source development, particularly on the Bitcoin network.
- [02:16]
D
I guess I can jump in. So I'm Anders Brownworth and I am an engineer. My background is as a software engineer. I was lucky enough to be an early employee at CIRCLE and had a hand in helping USDC start up from there. Went over to the Federal Reserve where we did additional work on a digital dollar and now I'm over at the Digital Currency Initiative with Neha and Dan.
- [02:41]
C
And I'm Dan Aronoff and I'm in the Economics department at mit, an economist by background, collaborate with the DCI and have become quite involved in the cryptocurrency space and cryptography and economics in general.
- [02:59]
A
Well, thank to all of you again for joining the show. This is such an exciting time to be discussing this issue. So much going on and imagine you guys are super busy responding to inquiries like mine and just doing the work in this policy space. We are recording this February 27th and just this week there's been a lot of news in this policy space. We learned that crypto.com secured a conditional approval from the Office of of the Control over the Currency for a special trust bank charter. So now we have Ripple Circle, Paxos Bridge and Fidelity. They all have these charters that allow them to tap into the banking system and maybe even one day into the Fed's balance sheet. We'll talk about that later. Also we see that Stripe now is in talks to acquire PayPal. And maybe one of the biggest news items from this week, which I'm sure you have talked about, is Facebook or Meta is getting back into the stablecoin space. So as you all recall, 2019 was a pretty interesting year when Libra was introduced and that kind of triggered a lot of excitement among central banks. So they kind of pushed forward with cbdc and it seems like we're coming back full circle now we have the genius act and now we have all these players in this space. So tell us a little bit more about your work and how you're engaging these issues.
- [04:13]
B
Yeah, absolutely. So like I said, I lead a group called the Digital Currency Initiative, which is based out of the media lab at MIT. And we've been doing this for about 10 years now. We just had our 10 year anniversary in 2025 and you know, maybe we could kind of go back to 2015 and remember how things were then. Right. So bitcoin had been around for a while. The network had been running for about six years. I think Ethereum had just launched. I remember the tenor at the time being very blockchain, not bitcoin. People were very excited about the data structure and, you know, about the technology, but they were kind of maybe a little bit less interested in getting into the changes in money and our monetary system. Fast forward 10 years and I think we finally gotten over that and we realized, no, this is about money, this is about finance. Yes, it will have broader implications than just money and finance. It will affect the entire economy, it will affect the entire Internet, but that's really where it's coming from. That's where the change is being driven from. And so everything that's happened since then, I think, has made a lot of sense. You're kind of speaking to repetition, right? So history, maybe it doesn't repeat, but it rhymes is what we're seeing. And so people are trying to do stablecoins again, and they're trying to do them in a slightly different way. And as we bring our regulatory regime, our political regime along with us, as these large institutions sort of come into the future, we're seeing that progress. It's just happening really slowly.
- [05:37]
A
So we're going to get to your paper in just a minute because it addresses some of the challenges that stablecoins still face and hurdles that needs to be cleared to really make them reach their full potential. But just stepping back and based on your experience and looking at stablecoins, is it fair to say the horse is out of the barn? This is something that's going to happen no matter what. There may be challenges along the way, but given the genius act and other developments, this is something we need to embrace as opposed to pretend it's not there or to fight against. What do you think?
- [06:07]
B
Yeah, 100%. I mean, everyone I talk to seems like they are on board with at least a 10x growth in stablecoins coming up. Like the horse is definitely out of the barn. Right? At the same time, it's up to the industry to show the real value and show the real use cases. And I don't know if you want to get into use cases now. We can talk about where stablecoins come from and where they're going. But I do think that now is a really critical time because the industry needs to prove out the use cases, show that there are new use cases that are going to drive that growth. And so that's what we're in the middle of right now. But everyone is very optimistic about this happening. I don't think you can ignore it any longer.
- [06:49]
A
Yeah, it definitely seems to be an important part of the financial landscape, the payment landscape going forward. Let me ask one question before we get into your paper. So I think it's fair to say we've been in a crypto winter. Am I exaggerating? In general, like, most of the crypto assets have been down along with other risk assets, but stablecoins have held their own, right? They've maintained their value. That's what they're designed to do. However, one thing I have noticed is the market cap has kind of peaked for the time being, around 300 billion. So what do you attribute that to? Is it tied to the crypto market itself writ large, or just some other factor driving momentum here?
- [07:30]
D
I would say stablecoins, their first use case was really for traders to get into and out of digital assets, different cryptocurrencies and escape or enter volatility in different places, move money around. That was the first use case for stablecoins. Since then, I mean, there's always been the, you know, the idea that at some point maybe I'm going to buy my cup of coffee with a stablecoin. We're not there, but it's trending sort of towards that direction. So when you look at back in the day when stablecoins were new, it very much tracked crypto prices because there was this whipsawing back and forth that's not so true anymore as stablecoins become much more commonly held. So I don't really have a. I don't know. That's my opinion. You know, I don't exactly know why they've leveled, but I don't think it'll stay where it is.
- [08:20]
A
Well, let me share a story with you. I recently gave a presentation at a conference for bitcoiners, and of course, I was there to talk about stablecoins and I wasn't very, very popular. They didn't like the fact that I was presenting something that to them was not very pure. It wasn't a true, you know, blockchain asset. It was, you know, there's big players, there's choke points, as they've told me. And so they weren't as sympathetic to the idea. But what I was making the case is this is something that has traction, that it's what people want to use for payments. People want a stable medium of exchange. They don't want something that goes up and down like bitcoin and other crypto assets. Now, on the flip side, I made a presentation to a bunch of federal regulators in the banking system and they weren't pleased either. They didn't like the fact what stablecoins may or may not do to their business. Now they have to look over banks and other entities. So it's interesting that we see this movement forward with stablecoins, but there are some parties who aren't as excited about it as maybe as we see it. What do you see there?
- [09:27]
C
Well, to me, it's sort of explicable by the fact that stablecoins are the new entrant. So the incumbents are naturally going to be resistant unless they can find a way to adapt and Profit.
- [09:39]
B
I think there's also something to be said from having both sides be mad at you. It means you're probably doing the right thing. This is something we also have a lot of experience with at the dci, which is, you know, we work with developers who work on the Bitcoin network 24 7. They're developing code, they're working in open source. They consider themselves cypherpunks. And then we turn around and we'll go talk to the BIS or the Federal Reserve or, you know, more traditional financial institutions and bridging those two worlds. You know, some people look at us and they're like, how can you possibly do, how can you believe in both of these things? But I really see it as, you know, sort of pun intended, two sides of the same coin. You know, we want to bring money into the future and that's going to happen. You know, you're not. You can't do that by completely ignoring the currency that 8 billion people across the world are using and the currency systems that 8 billion people across the world are using. You have to work on those and bring those into the future at the same time that you are developing something new and cutting edge and quite different. You know, to see how that works out, you have to place multiple bets and it's all going to move forward together.
- [10:43]
A
Okay, so the horse is out of the barn. We need to embrace and think about stablecoins. And you guys have written a wonderful paper that helps us do that. So listeners, it's time to jump into this amazing paper. It's titled the Hidden Plumbing of Stable Financial and Technological Risk in the Genius Act Era. So why don't you maybe summarize it for us? Kind of give us the executive summary and then we can jump into certain sections and go along from there.
- [11:09]
B
Yeah, so I think I'll give the summary and then Dan and Anders will chime in on more specific parts of it. So first I want to set the context of what we're looking at. So we're looking at dollar based stablecoins under the Genius Act. And so that means something really specific. We're talking about stablecoins that are fully backed by Treasuries or bank accounts. We are not talking about algorithmic stablecoins and we're not talking about cryptocurrencies like Bitcoin or Ethereum. I know a lot of people get very confused about that. But you know, just to really narrow that scope, the goal of a stablecoin is to maintain what we call par value that you can exchange one coin for $1. We're talking about the reliability of being able to do that. And also importantly in this paper, we are not talking about why you might want to use stablecoins. We're not pontificating on the use cases. We're not trying to make a prediction as to how big they're going to get or if they're a good investment. What we are trying to do is very specifically answer the question, if stablecoins become widely used as a payment and settlement instruments, what might go wrong with this guarantee of par? So what are the risks and what regulatory, institutional, operational or technical mechanisms might help prevent destabilizing outcomes? So just to dive into that a little bit, we are saying, assume stablecoins become really big, assume they become widely used in that context, what are the risks that we should be looking at and how might we mitigate those risks? And so we're looking at three important areas. We're looking at the backing assets, so the banking system, the treasury securities markets. We're looking at the technology rails that stablecoins run on, and we're looking at the regulatory frameworks that govern these issuers, these institutions. And so in order to do that, we had to, I think, really dive into how stablecoins work. And so we talk about how to situate them in the hierarchy of money. We talk about how they work practically, how you get one, how you move one, how you redeem one. We have to talk about the actors who are involved and you know, kind of like the physics of stablecoin movement. And we reached, you know, just to summarize, sort of three high level conclusions which we're gonna, we're gonna dive much further into detail, into these conclusions on this call. So first, there's been a lot of focus on what we call asset quality, right? Is the stablecoin fully backed? Is it backed by high quality assets? And the assumption has been Treasuries. Treasuries are great. Treasuries are the highest quality asset. You know, this is sufficient. But asset quality and asset backing alone is not sufficient to guarantee PAR value stability. If redeeming, getting in and out of stablecoins depends on both intermediated markets that are subject to capacity constraints and also blockchain based rails which introduce very different operational risks than our traditional financial rails. And just to be clear, I'm not saying this to say that blockchain based rails are bad or that we shouldn't use them, just that we need to understand that we can't abstract them away and Pretend like they operate exactly like our existing financial system and we can just assume that they're going to have the same risks and roughly stay up the same and work the same. No, they're really fundamentally different. And we'll dive into how they're different in this call. And interestingly enough, those operational and technical risks can actually amplify financial stress. And then third, last high level conclusion of the paper is that the Genius framework is a strong foundation, but it leaves a lot of stuff open and unresolved. We had a nice little blog post about this and the image in the blog post was a picture of Swiss cheese. There's a lot of holes in the Genius act, so there's a lot of unresolved policy dilemmas which a lot of agencies are trying to figure out right now. And we're starting to see them come out with that. I think the OCC just very recently came out with some guidance on yield this week. But also Genius doesn't say anything about redemption mechanics. How strictly we need to maintain PAR value and how we should think about stablecoin issuers operating these rails and whether we should demand anything of them when it comes to how they communicate with their users. So that's high level. Excited to dive in?
- [15:42]
A
Yeah, let's do that. Let's begin by maybe going through the basic mechanics you were talking about of a stablecoin. How does a stablecoin operate? What's the step by step issuance transfer redemption mechanics?
- [15:54]
B
Yeah, so I think there's two parts to this. One is sort of technically how stablecoins move, like the physics of it, what does it mean? What are the messages that are passed through the actors involved. And then there's kind of looking at it from the, the financial side. And so maybe Anders and I will talk about the technical part and then Dan will jump in on the financial part. How bank account balances move and you know, who are the actors involved. So let's say that you have a person who wants to buy a stablecoin, right? And so you got the person, you know, the user, let's call them, and they've got some money in a bank account. Then you've got what we'll call the stablecoin issuer. So in the case of usdc, that is Circle. In the case of usdt, that's tether and so on and so forth. And then you've got the blockchain based network on which the stablecoin operates. And something that people might not realize is that there's many of these so USDC is on over a dozen different blockchains. Right. And so just from, in terms of like, the basic mechanics, and I'm. I'm very much oversimplifying here. When a person buys a stablecoin, what happens is that there's a smart contract that was created by the stablecoin issuer running on a specific blockchain, and the user gets a stablecoin by making a transfer to the stablecoin. Well, usually through an intermediary. But ultimately, once it goes through all those hops, the stablecoin issuer smart contract issues a stablecoin to that user, it creates one. In the smart contract, it does something we call minting. And then, then that user has control of that stablecoin on that blockchain. Through that smart contract, they can transfer that stablecoin, which all happens through the smart contract. And then at some point, they can redeem the stablecoin. And so at that point, the stablecoin issuer and the smart contract will take an action we call burning the stablecoin or removing it from circulation on the blockchain. So that's like the basic overview of how that works. Anders, how did I do? Anything you want to chime in with on the mechanics?
- [17:47]
D
No, you did great. I think the difference here, like Neha definitely said that it's a lot more complicated than this sort of simple overview. There are, you know, obviously a primary market, there's a secondary market for this. If you are just a person walking around buying a stablecoin, you're probably buying it from a, you know, secondary market player. And then this mint operation has already happened, and they're just giving you some of their supply.
- [18:13]
A
Quick question on the mechanics here. So I mentioned earlier, one of the critiques I got from Bitcoin people is there's these choke points. This isn't truly a public ledger or blockchain. Can you speak to that difference?
- [18:26]
B
Yeah, this is super important. So stablecoins, ultimately the type that we're talking about under Genius, there is a stablecoin issuer who has a tremendous amount of control over the stablecoin. So they operate on top of what we call decentralized blockchain networks like Ethereum or Solana. You know, these are the networks that operate the smart contract. And those are decentralized, though. You know, when you start to get into the details, there are different levels of decentralization and there's different risks with all of these different blockchain networks. They're not all the same. You know, we like to Pretend they are, but they're not. They're very different. And so the underlying blockchain might be decentralized, but the blockchain is just accounting. It is storing the ledger of who owns what stablecoin. The stablecoin smart contract is the smart contract that is maintaining that ledger on the blockchain and it is under the control of the stablecoin issuer. And Anders will get into this later, but there's certain like upgrade mechanics. It's very auditable. You can, you know, everyone can see what's happening. The code does constrain the stablecoin issuer in some ways, but they can upgrade contract, just to be clear. And then most importantly, the stablecoin issuer has all of the assets backing that stablecoin off chain. The Treasuries, the bank account balances, whatever other assets are behind that. And maybe they rely on a third party to manage those assets like BlackRock does for Circle or Cantor Fitzgerald does for Tether. But you know, that's all off chain. That's all very centralized. The fundamental backing assets that give the stablecoin its value. That's not decentralized. And so when you are using usdc, right? When you are transacting, in this token, you're going through a smart contract that's ultimately controlled by Circle and you are relying on backing assets that are ultimately controlled by Circle or whoever is custodying those assets for Circle.
- [20:20]
A
So I think this is a big deal when we talk about like know your customer or anti money, anti money laundering laws. Stablecoins do provide a way in for, for governments to have some influence on this issue. Right.
- [20:34]
C
I think the issue there is that at the point of entry and exit there's kyc. In fact, it doesn't require the stablecoin. It shouldn't have to require the stablecoin issuer doing anything. I don't actually know what Genius talks about because the stablecoin issuer at the point of minting and redemption is interacting with bank accounts held at other banks. So the banks are doing the kyc. The issue is that on chain there's no regulation, okay. So that transactions that are taking place in stablecoin world are completely unregulated.
- [21:08]
B
There is some regulation and Genius does sort of indicate that there does need to be some AML and kyc. But I think that exactly where that happens is very much still up for debate and is being formed. Dan, maybe you can talk a little bit about the bank mechanics of how stablecoins move. So you know, from one bank account to another. And specifically I think that there's this very broad misunderstanding that stablecoins somehow move money out of the banking system. When you actually look at the creation and destruction of a stablecoin, that's not exactly what's happening.
- [21:41]
C
That's correct. So that what a stablecoin issuer is doing, one way of conceptualizing it is that it's monetizing treasuries. And a bank deposit does not leave the banking system. In other words, if Alice wants to purchase a newly minted stablecoin, Alice transmits a bank deposit to the stablecoin issuer. And the stablecoin issuer gives Alice a minted stablecoin or assigns her a minted stablecoin. The deposit hasn't left the banking system. And if that stablecoin issuer is then investing in Treasuries, well, it's paying for the treasuries by transmitting its debt bank deposit somewhere else. And fundamentally I think the misconception is rooted in a larger misconception about the relation of bank deposits, the bank lending. There is a popular misconception that your deposit base is the fund for lending. It's exactly the opposite. The bank assets, the asset side of the balance sheet determines what the deposits are, the reserves set by the central bank. You know, that the banks are required to hold is one portion of assets and the other are the loans that the banking system is making. And I think this idea that somehow you will drain deposits from the banking system or even that if there is a drop in demand for deposits because people are using stablecoins for transactions that cannot express itself as a reduction in deposits. It can express itself as a shift in velocity or turnover. In other words, you might have a reduction in the turnover bank deposits and an increase in the turnover of stablecoins, but you aren't draining deposits from the system. And if you go through the steps, you know, you'll see that, that.
- [23:28]
A
Yeah, you did a great job on the paper illustrating this. You have a lot of flowcharts, diagrams, very, very helpful. So I encourage listeners and watchers of the video to go out and check it out. So Dan, the total or aggregate amount of banking deposits does not change, but maybe the banks that actually service those deposits could change. Right. So in other words, you might want to be a bank who is a custodia bank. So maybe it's in bankers interest to make sure they're a part of this activity.
- [23:58]
C
Yes, and the other thing is that I can see that we haven't really gotten into this in the paper. So we shouldn't go too far afield here. But if there was a shift in velocity and transactions from the banking system to stablecoin world, that could have an impact on bank earnings because there'd be less transaction related fees that banks are earning. But it wouldn't fundamentally change in either direction either minting or redeeming.
- [24:24]
A
Well, let me ask this question. It's related to what we're talking about here because this is the critique that comes up is that stablecoins will take business away from the banks. That's what I heard from these regulators. I felt like I was an OK corral shooting all these objections down as they came my way. I wish I'd had your paper beforehand. Would have been very helpful. So Dan, tell us more about this par value, this minting risk idea that you bring up in the paper.
- [24:49]
C
So there's been a focus on, understandably on redemptions, on the reliability of the stablecoin issuer. To be able to convert a stablecoin or to take a stablecoin and issue bank deposit. The stablecoin holder there has not been focus on. But par value requires some adjustment on the other end. That is when there's demand for stablecoins which would put upward pressure on the price of stablecoin. Will the issuer respond by minting stablecoin? And the answer to that question probably is related to the profitability of issuing the stablecoin in a low interest rate environment and particularly treasury rates because that's what the issuers are investing in. You could see a point at which it is unprofitable the issue and therefore there would be an increase in demand without a supply adjustment. And like in both cases, that's kind of the dynamic. Right? It's in either direction. You're looking at whether it's minting or redeeming, there being a demand to convert in one direction. And the question is, and the stablecoin issuer make the supply response. And the only point is that that issue exists on both sides, not just on redemptions.
- [26:08]
A
All right, so an issue for us to continue to think through. Let me move on to technical and operational risk. And Anders, it's great to have you here. I mean you were in the trenches with Circle. You have probably some war wounds from those experiences. So tell us, what are the real technical and operational risks we should be thinking about?
- [26:28]
D
Yeah, well, what we go through in the paper, there's a technical risk matrix and pretty much I think boils down what you need to know. There's kind of a most likely to least likely and a high systemic risk to a low systemic risk. And so the stuff that's kind of in the upper left quadrant of that is probably the most important to talk about. And that would be smart contract logic flaws and bridge failures, things like that. So as we were mentioning, blockchains are they seek to be immutable. So if you write something onto the chain, you would expect that it not be changed. That's a problem. If you're, as NEHA was saying, in order to supply a stablecoin, what you do is you create a smart contract that implements it and then you start using that. And what happens if there's a bug in that smart contract? So there's kind of this decision talking about war wounds. Remember when this happened? It's not a war wound, but remember when this happened at Circle when we were talking about this, should we just put it out there? And so you cannot change it. And if it works, there's confidence. Or should we deploy something that can be upgraded? And everyone has decided to put. All the major stablecoins are all upgradable, but that leaves this possibility that there is a way for bugs to then creep in later in an update and things like that. So the implementation of your smart contract, I mean, obviously there are things you do, you audit that very well, et cetera, you test it heavily. But once you put it out there, you know there are keys that exist that can upgrade that contract. So there is a way for changes to be made, both good and bad. So obviously if there's a problem with that, it's. It would be a systemic problem, it would take over. It could potentially impact that entire stablecoin on that blockchain. So that's, that's why there's many other risks that we go through. How do you bridge between different stablecoins on different implementations of the same stablecoin across different networks and stuff like that as well. So there's sort of a matrix that we pose.
- [28:39]
A
So just to be clear, a solvent stablecoin, one that has assets fully back in it, could fail to operate. If it has some of these technical challenges emerge.
- [28:50]
D
It could. I think the important thing to remember is the money is still in the bank, presumably. Right. If there's simply a technical problem, it's not like the money disappears from the bank, the ledger, or who owns how much of what might have a problem. One of the problems it might have, it could just cease to be live. You can't update it and you know, you can't trade the stablecoin. And that might impact its par value because you can't use it anymore. You can't send it back to the issuer to get a redemption. The issuer can't mint new coin. Right. So that all of these three things, you know, issuance, transfer and burning of the stablecoin or all those things require on chain actions. So yeah.
- [29:37]
A
So let me ask a question that was asked of me by the bankers and this was my. I'll give you my answer. It probably wasn't adequate. You guys are mit. You are the engineers, you are the folks who really know these technical details. But someone brings up this question, what about quantum computing? What if these blockchains get hacked? And my response is, well, look, you got bigger fish to fry because if you can hack a blockchain, you probably can hack your antiquated computer system that runs the bank. So I probably should put things in perspective. But what would be your response to this question that sometimes comes up about quantum computing and being able to hack through the encryption?
- [30:13]
D
Well, I would argue that we don't know whether or not that's practical yet. I think it is not. There are many and like you say, it would be a systemic issue that would impact traditional financial networks and pretty much anything on the Internet. HTTPs. Right. Anything in a secure web browser. So these would be hugely systemic problems, not only focused on the cryptocurrency world. However, there are efforts afoot to address this and to come up with quantum safe cryptography and implement it in all the different blockchains. So it's a known problem and it's something that people are working on.
- [30:57]
C
But there is something to it that, that, you know, that relates to concerns that Anders has raised. One difference would be that if there's a hack, let's say of a commercial bank, you do have legal recourse. There's a legal structure. And Anders, you can talk about this more, but that, that is not necessarily the case with an equivalent.
- [31:16]
B
So I think maybe the thing that I would add to what Anders said is that I think quantum computing and its risks are, are very misunderstood. For example, a lot of people don't even seem to realize we know how to build quantum computer resistant cryptography. This isn't an unknown. We know how to build it, we know how to use it. The issue is that we need to upgrade our existing systems to use it. And another issue is that it doesn't perform as well as our current cryptography from the point of view of it's slower, it's larger, it's a little bit more clunky, right? But we know what it is. You know, NIST is working on standardizing quantum resistant signature schemes and hash functions and things like that. So we have a path forward. The issue is really this upgrade question. And with centralized systems, it's relatively straightforward to upgrade them. Google decides to upgrade Chrome, Microsoft decides to upgrade Windows. They move forward, they roll it out, they tell everybody, you got to upgrade, you got to get on this new version, here's how it's going to work. They can coordinate that much, much harder to coordinate the upgrade of decentralized systems. Easier on some blockchains than others. Most challenging on the most decentralized blockchains like bitcoin. And so I think that's where the concern arises. Also the fact that these blockchains fundamentally rely on cryptography to determine who owns what asset. There's no other way. You know, no one's storing a list of all the bitcoin owners and their ID numbers next to them so that if they lose their private keys, they can figure out how to give them their bitcoins back. That doesn't work. The way that you show that you own bitcoin is you produce a cryptographic signature. And so if the fundamental of that cryptographic signature breaks, then you don't know who owns what bitcoin. And so that's why this is a little bit more challenging. In addition to that, there's what Dan says, which is that if you can't access your bank account or if someone steals it because they break the cryptography behind it, you could probably, you could call Chase, you could get on the phone. The regulators are going to be monitoring this very carefully. They can probably figure out how to make you whole again and how to make things work. There's no one like that for Ethereum, so it's a bit of a different situation. If things actually do break, how do you recover? How do you. Do you have any recourse? And so that's why it's a little bit different than the existing system, but maybe not quite in the ways people traditionally think.
- [33:30]
A
So that is so interesting, and thanks for sharing that. When I was at that bitcoin event, this did come up and there were people there who admitted that, yeah, we could upgrade, but the culture doesn't want to do it because we're bitcoiners and we like, you know, to stick to the original and we're very decentralized. So there are advantages to centralized finance. This is one of them for sure. Let's Go on to one more question related to this technical side, and this is the question of scaling. Right. So right now, as I mentioned earlier, we have just over 300 billion market cap in stablecoins. Well, what happens if we reach these amazing projections of 3 to 4 trillion by the end of the decade? Maybe even more than that over the next few decades? Can stablecoin infrastructure handle this just added capacity?
- [34:18]
B
Yeah. So I think this is something, again, where if you just assume the blockchain works, you might not understand some of the nuance and the detail here. Right. So I think there's two components to this question. So one is, can you just handle a large number of users, a large number of transactions, if they all want to transact on the blockchain? And the simple fact of the matter is that decentralized systems are less efficient than centralized systems. Okay. It just, you know, you can't do as many transactions per second. And so if there's, you know, for example, a run on a stablecoin or something like that, you could end up having a very high backlog of transactions of a lot of people trying to get through. You literally can't fit all of the transactions that people want to make onto the blockchain. That could happen. Blockchains are limited in capacity. So I think that's one component that's important to understand. The other component that's important to understand is the fundamental security of these blockchains and what it's based on. So the idea behind decentralized blockchains is that they are open and they are permissionless, and this is part of the value, this is part of the power. This is why they're interesting that this is why we're all building in the space. Anybody can access them. When anybody can access them, that means that hackers can access them, attackers can access them. Right? And they're built very carefully to try to be secure, even though they are operating in very adversarial environments. The open Internet. Okay? And the way they do that is using cryptography, but also a field that we now call crypto economics. So what does that mean? What that means is that the reason these blockchains are secure, the reason that we have a ledger that we know, you know, there's one ledger, everybody sees the same copy of the ledger, and people only can add to it according to certain rules, is based on crypto economic security. So there's a set of validators or there's a set of miners that are producing the blockchain. And we make certain assumptions about Them, we make assumptions that the majority of them are honest, that they are following the protocol, that a majority of them don't collude, to try to create advantages for themselves. And we design the protocols in such a way to encourage this. One of the mechanisms that does this is called slashing. So in proof of stake blockchains, where most stablecoins run, the idea is that if you misbehave as a validator, then you might get your stake, which is in the native cryptocurrency, slashed. You might actually lose money if there's evidence of your misbehavior. But these protocols are complicated and all the blockchains use different, slightly different protocols, right? And so you have this really interesting, very dynamic set of protocols. They're also updating them constantly. Like Ethereum switched from proof of work to proof of stake a few years ago. That was a very big change, you know, and did so mostly successfully, I want to be clear. But, you know, I think that a lot of people who are building with stablecoins, a lot of traditional financial institutions that are operating on top of these networks maybe aren't as fully aware of what's going on under the hood. Who's making these upgrades? What are the dynamics of the crypto economic algorithms that are powering these protocols? What are the risks? Where are the validators? What are their incentives? And a really interesting thing that I think people might not understand is that the game theory of the crypto economics behind the security of the blockchains changes when you have a very large asset like a stablecoin that is not denominated in the underlying crypto economic token. So if we look at, for example, Ethereum, if you misbehave in the Ethereum protocol, you get slashed in Ether. Your stake is in ether, right? Your stake is not in usdc. And so if the value of USDC becomes very, very large on the Ethereum blockchain such that it dwarfs the market cap of Ethereum, then the balance of incentives changes. And it might be in an attacker's interest to attack the underlying blockchain, incur that slash in Ethereum if they can get a large gain in usdc. So that's an example. Now, it's not as simple as I make it sound, because as we were just talking about, USDC is very centralized. So, you know, Circle still controlling the underlying backing assets. But as we have defi, as we have decentralized exchanges, as we have automated market makers, there are all kinds of attacks that attackers can engage in that might be very Hard to undo. Might be very hard to really prevent an attacker from running away with an advantage.
- [38:53]
A
Wow. So much there on the technical side. You guys will be busy for some time dealing with these technical issues and hopefully industry, I mean this is what industry does, right? It responds to challenges. Hopefully there's enough profit motive there to drive them to solve some of these things. But also folks like you providing solutions. Now let's move on to another issue you bring up in the paper. And this relates to treasury market fragility. And I know Dan, this is kind of like, like your specialty. And this is actually something that came up when I had this presentation with these federal regulators. They were worried about what the implications for the treasury market would be from stablecoins holding a bunch of treasury bills. So maybe walk us through the questions and issues there, Dan.
- [39:34]
C
So the mechanics of redeeming a stablecoin when the stablecoin issuer is holding a Treasury security outright treasury or Repo involves ultimately a liquidation, a sale of a Treasury. And the question the issue is the capacity of the treasury market to process that sale. Right. And this isn't a new issue in general in the treasury markets. The fragility of treasury markets has led to such initiatives as the central clearing mandate, as the recent relaxation of the SLR lower bound, as the introduction of the standing repo facility. So all of those are in place. But if you go Back to the 2020, March 2020 run on the treasury market, the ultimate, the net transaction, the net sales that were processed, that is when you take out the movement through the intermediation chain was around $100 billion. Now this is in a $25 trillion market and that caused a meltdown that's rather fragile. As you mentioned earlier, the capitalization of Stablecoins today is 300 billion. But if the projections made by Citi and by treasury of it being a $2 trillion market, that's both a non trivial percentage of the total treasuries. The 25 trillion is treasuries held by the public, I guess an additional amount not by the Fed, that's a non trivial portion and $100 billion is a very small percent. That would be a minor blip in terms of a Stableco. It's, it's there. And the choke point again nothing new here is the intermediation chain, the capacity of broker dealers to process those transactions either because they're running into their SLR limits. And as an aside, the recent I did sort of did a back of envelope calculation of the increasing capacity that the Recent revision to the SLR rule would provide among the largest five broker dealers, and roughly speaking, it works out as follows, that for each of the bank's affiliates or those broker dealers, it would give them about a trillion dollars additional capacity for assets on their balance sheet. On average they have 10% of their assets in repo. So that's like a $500 billion increase in repo transaction capacity in a $12 trillion market. And a market where that's supporting Treasuries that are increasing, that gives sun relief. I don't think it solves the problem. Another thing that's been addressed is the standing repo facility which gives broker dealers essentially unlimited access to reserves so that they can carry out their transactions. Because surprisingly, in a abundant reserve regime in these crisis points, it is generally that the key broker dealers were short of reserves to process transactions. And that's been solved. But it doesn't solve the balance sheet problem because, well, let me go back to that. It's abundant reserves. But the problem is that as you know, one of the consequences of the abundant reserve regime is the interbank lending market and the whole like trading desk and so on have almost completely closed down. But you can't transfer. The only way you can transfer reserves in the banking system are for those banks that are active in the repo market. And so if all the banks in the repo market are running short of reserves, they have no way of transacting with banks outside of the repo market system that might have excess reserves. So that's solved by the standing repo facility. But a standing repo is a repo borrowing transaction that all goes on the asset side of the balance sheet. So you run into the SLR constraint. In addition to that, the Fed cannot participate in a central clearing platform. So you don't get the benefit. If a broker dealer has repo lending on the other side, they can't net those in the standing repo transaction. But the bottlenecks remain. And that's the issue is all this has to funnel through the treasury market to handle. The other thing is that kind of looking at it, the other side is that a small disruption in the treasury market could trigger a stablecoin run. Stablecoins are a very runnable asset. There's an interesting paper I would refer listeners to by Altissaro, Merling and Nelson, a BIS paper where they compare the stablecoin system to euro money and they talk about the fact that in the euro money market, euro dollar market, there are all sorts of institutions that are built up to absorb pressure of movement in one direction or the other between the dollar system and the Eurodollar system that sort of create frictions or stem the tide of what could otherwise be a run. And they point out that none of that exists among stablecoins now, but it's a very runnable asset. And one of the things we address in the paper is an idea developed by Bank Holmstrom about assets that you basically assume are safe and people don't question, and so they can transact on that basis. And the idea is that bank assets would be like that. And so that when a bank has trouble, if there's just a slight release of information about it, that can cause a panic, as for example, happened with SBB bank in 2023 or, you know, banks in 2008. And the point here is that while the treasury market's stable, while people may not question the US Government's ability to pay, that market's intermediated by banks. And so if there's a slight disruption in intermediation, that could cause concern and a panic. And then that interacts with the stablecoin market, that's a runnable asset that has no natural buffers. And so that can also be an explosive situation. But there's kind of a mouthful there, but that's the picture of it that I have.
- [45:31]
A
Those are legitimate concerns. And of course you guys talk about this in the paper I've talked about on the podcast, I've written about it myself. But the Fed has proposed one possible valve to release pressure, so to speak, and that is the Skinny Fed master account having limited access to the Fed's balance sheet. So, Dan, do you think that would be something that would help or do we need something more than just access to the Fed's balance sheet here?
- [45:58]
C
Well, let's make a differentiation between the Skinny Fed account proposal and full access to the Fed balance sheet. As I understand it, the Skinny Fed proposal would not provide a buffer for a run. It would just facilitate daily transactions and there would be limits so that the stablecoin issuers could, could send and receive reserves. I mean, that probably would help, you know, grease the wheels of commerce in a way on a normal situation. But you would need to have full Fed access. You'd need for the stablecoin issuer to be able to go to the Fed discount window and borrow against its treasury securities to be able to meet redemptions. That would solve the problem, that would make the Fed the insurer, but it would potentially raise other problems. One that applies to the stablecoin issuer itself is that if a stablecoin issuer comes under that kind of, gets that kind of access, one presumes that they would be subject to banking regulations and the costs associated with those regulations. And that would then create a wedge such that. Or that would increase an operating cost of the stablecoin issuer. And it would create a risk that if interest rates, if treasury interest rates fell, let's say below some threshold amount, it could bankrupt the stablecoin issuers. Because remember, the stablecoin issuers do not control their margins under genius. They pay no interest on the stablecoin, but they have only one asset that they can invest in Treasuries in a market. And so they have, they have absolutely no margin control. And that's a differentiation from a bank. That's, that's one risk. The other is that is, is sort of a general observation and something I'm not in a position to like trace out the details, but it clearly it alters the monetary transmission mechanism. Right. If stablecoin issuers have access to Fed balance sheets, it creates another channel of transmission and thereby complicates the conduct of monetary policy. And we don't have any. I don't have any conclusion about what those complications are other than to make the statement it's there and it needs to be studied because it's a slightly different situation than what we have today. When you go and make that move.
- [48:18]
A
Yeah. Well, let me speak to what you just addressed. And that is the business model of stablecoins. And this has come up several times before in other podcasts and other conversations I've had. And you touched on it, that if the yield on their assets were to go down. So imagine we returned to a world with zero lower bound interest rates like we were in the 2010s. Could stablecoins still survive? Could their business model adapt and earn revenue some other way? So can someone speak to that?
- [48:45]
B
Yeah, I think that's definitely possible. And we're just at the beginning of exploring different business models for stablecoins, whether that's transaction fees, minting fees, redemption fees. Stablecoin issuers and the whole cryptocurrency market. They're working to figure out how to provide value to users. And if they can figure out how to provide value to users, then they will figure out how to charge for that value. So it might be the case that we're in a blip right now where most of the ways that stablecoin issuers make profit is through this interest arbitrage. That could change in the future, but they're going to have to figure it out. Out. It's not clear or obvious exactly where that new profit, that new business model is going to come from.
- [49:25]
A
Okay, going back to the technical questions, kind of a big overarching theme. What I'm hearing is this lack of interoperability between these different blockchains, different stablecoins. I mean, do you see hope progress there, that at some point I might have tether, you have circle, and we can somehow interact with each other without having to go through our intermediaries?
- [49:52]
D
I think there are probably technical ways to do that. And there's also a market that is really emerging to be able to supply that liquidity across chains. So I think it's a problem that certainly is a problem, but it's something that's being solved right now.
- [50:07]
B
Yeah, I think one of your previous guests, Austin Campbell, seemed to think that the fungibility between stablecoins was less of an issue than the fungibility between bank accounts. Right. So I just, I completely disagree with that position because in the bank account regime, we have things like FDIC insurance. You know, during the failure of svb, the Fed basically indicated that they'd be willing to backstop the entire banking system. And so there is a lot of apparatus that is, for better or worse, dedicated towards maintaining the illusion that a deposit at one bank is equivalent to a deposit at another bank. Right. And there is absolutely zero of that apparatus at play for stablecoins today, other than the fact that they are mostly backed by Treasuries, US Treasuries, but, you know, they are backed by Treasuries and under different regulatory regimes in completely different jurisdictions, different companies that operate in different ways. And so, you know, even under genius, I do not think it's the case that that level of faith in the fungibility between stablecoins is at 100%. And so all of that is going to have to be developed, all of that. And it is not just a technical issue. It is a regulatory issue, it is an economic issue. There's going to need to be a lot that is created and it will probably have a cost. And so it's going to, you know, will it look exactly like what we have for banks? Probably not. It's going to be interesting to see how that develops. But that's part of what's exciting about this whole space.
- [51:36]
A
Yeah, for sure.
- [51:37]
B
It's kind of giving us the opportunity to invent a new structure and not be stuck with the ways of the past. Right. I mean, if you think about when banking regulation was written in the 1930s. A lot has changed since then. And so it's worth taking a step back and trying to reinvent how we do things from first principles.
- [51:55]
A
Yeah. So you mentioned Austin Campbell podcast. You probably also heard the Dan Arie podcast and he shares your view. Almost identical. You know that there's a lot of work to be done in order to get to the place where we do have that fungibility between different stablecoins. And of course, one of his proposals was to allow stablecoins have access, complete access to Fed master accounts, which would go a long ways. But Dan, as you said, there's added costs, so there's a lot of learning to do. But as I look around the world, for example, the bank of England, they are more open to stablecoins on the balance sheet. The ecb, on the other hand, they're making it almost impossible. You got to go through a bank which is a competitor, which then gives you access to the balance sheet. So there are a lot of different models being explored. So it is exciting to see which one will work the best. It does seem though, like in the US we do have this wonderful opportunity, I dare say advantage, our horse is out of the barn and I think we are, you know, gave it a little slap in the rear and it's, it's out running. So we'll be excited to see what happens. And this is a nice way to maybe segue to my final question here as time is nearing an end, and that is we have the largest dollar based stablecoin outside the US outside the Genius act, right? So, Anders, your former employer, Circle, it's wonderful. It's in the US but there is this beast called tether. Right? So what do you see the implication of this is this. On one hand, you might be worried, right? They're outside the regulatory umbrella of the US government. On the other hand, maybe they'll try some things that we wouldn't try in the U.S. maybe they'll make some mistakes and maybe we'll learn from it. But what do you see this dynamism playing out? Is it a good thing that we got experiments inside and outside the US when it comes to dollar based stablecoins,
- [53:44]
D
I have no crystal ball. Can't tell the future with that disclaimer tether. Maybe at one point some would say that that was a feature that they were not, you know, people are looking for a way to not be observed. Maybe I, you know, since the founding of Circle, it was very much regulatory first, very much build it in the United States, let's do things right and properly. And, you know, that took a long time. That wasn't, you know, immediately clear that that was the right strategy. I think it certainly was in the long run, but that game's not over yet. I understand Tether has a US project that they're spinning up. So I don't know. We'll see. Competition is good, generally for consumers.
- [54:28]
B
Yeah. I also think it's important to note that the tether of 10 years ago is not the tether of today. It is a very different organization. Cantor Fitzgerald is located in the United States. States. And so, you know, I think a lot of people come to Tether with a lot of assumptions about how it used to work. And it's not clear to me that it still works that way. So it's, you know, it's very different. I also think it's really interesting because Tether is very much focused on the extra US and in particular, Latin America, Africa, Asia, you know, all of these environments where payment systems are very different, access to dollars is very different. And there is a real demand for dollars that is not being met by the traditional financial system. And Tether is one of the organizations that is meeting that demand. And so we're seeing it in countries with very high inflation like Turkey, Argentina, Nigeria. There's high usage for stablecoins. And we're seeing. I think this is a really interesting data point that we need to examine more carefully. We need to understand what's happening in these places. And so I'm glad Tether exists so that we can see this demand and we can try to understand it better. I think we need more competition, not less.
- [55:41]
A
Absolutely. Well, our guests today have been Neha, Anders and Dan. Thank you so much for joining us. Their paper is titled the Hidden Plumbing of Stable Financial and Technological Risk in the Genius Act Era. Where can people find you online?
- [55:58]
B
I think we all have X accounts. I'm aha so N as in Nancy E H A. The Website for the DCI is DCI mit edu.
- [56:08]
D
I'm Anders 94 on X A N D E R S 94.
- [56:13]
C
I'm Daniel Aronof.
- [56:16]
A
Well, thanks to each of you for coming on the program and listeners. Be sure to check out their paper.
- [56:20]
B
Thanks.
- [56:21]
D
Thanks much.
- [56:24]
A
Macro Musings is produced by the Mercatus center at George Mason University. Dive deeper into our research@mercatus.org monetarypolicy you can subscribe to the show on Apple Podcasts, Spotify or your favorite podcast app if you like. This podcast, please consider giving us a rating and leaving a review. This helps other thoughtful people like you find the show. Find me on Twitter @DavidBeckworth and follow the show @Macromusings.