A multi-bank Stablecoin. Good, bad or ugly?

“Let’s get together!” Big US banks and infrastructure providers are apparently looking at a common stablecoin. The story: the original is behind a WSJ paywall (<- but this is a gift link 🎁); Coindesk also put out a summary.  

Why is this an important topic?

Stablecoins have huge, perhaps unstoppable momentum. They are already happening, so any financial services business needs a plan. How should you think about this and what should you think? 

I would start with how to think about any financial asset you have. What do you have a claim on? Although this might sound academic or like legalese, I can assure this question is front and centre of mind and questioning of regulators and central bankers. I heard it all firsthand when we started to set up Fnality which is intended as a new payment system for wholesale banking markets. 

So, let’s unpack this important concept.

What’s new or changing?

At first pass, the potential idea here is that some combination of big banks and financial market infrastructure (FMI) operators issue a joint stablecoin. 

If you own JP Morgan shares you have a claim on a share of the assets whatever number that might be, if you own UK Gilts you have a claim on his majesty’s government for the nominal value of the debt you hold at maturity date. If in 2008 you owned some Lehman capital protected notes, you had a claim on the issuer, one or other Lehman entity; although that protection lasted only as long as the issuer was solvent. If you were an SVB, Silicon Valley Bank, client and when it went under, you had a cash balance beyond the insured limit, you had a general claim on SVB. You were an unsecured creditor and came below others in the pecking order for repaying any money recovered.

With the new world of digital assets, some things change, some stay the same; in things stablecoin, the coin holders collectively have a claim on the issuer. Issuers will wax lyrical in their marketing about how the issue, or liability, is backed by various assets which for the most part they will describe as “High Quality Liquid Assets” aka HQLA. The make-up of the assets underlying Tether has at times been opaque and involved some very specific risks like inter-company loans and using banks in faraway places. The backing for USDC is more transparent. If you own a mutual fund, you will normally have a claim on the assets of the fund, which are ring-fenced from the operating company; this is a bit better than that claim on SVB as all fund holders are equal and you are not behind, employees, pension funds, tax men of various flavours and the social security folk, as well as bondholders. And there are some rules in place about what the funds can buy and how much of it so they avoid them putting all their eggs in one basket or just buying the eggs that are not on the approved asset list for that fund.

In my mind, there are two possible Stablecoin flavours we might see and we need to be very clear with investors and the public on what is on offer in each case:

#1.  Coins issued by a single name or bank. Then we need to be clear on what a coin holder has a claim. That could be against a specific segregated and ring fence to a pool of assets. Sounds like a money market fund. Or it could be a claim on the bank as issuer. In other words really no different than a deposit which is in effect a loan to the bank.

#2. A coin sponsored by several banks or financial institutions. In this case coin holders will not have a claim on the sponsoring banks; in the worst case you would not be able to make a claim against say Citi, JP and Wells Fargo and hope one of them makes you whole. Rather, you would have a claim on a specific, ring fenced pool of assets, bankruptcy remote from the stablecoin operator and from the sponsoring banks. In other words a money market fund. 

To me this is no different from something we used to have in Switzerland where we had Swiss Cantobank issuing funds on behalf of several Cantonal banks.

At this point, we should also remember a product lauch, or rather a failed one, in the digital space from the not so distant past: Libra / Diem from what was then Facebook and is now Meta. The first incarnation was meant to be a multi-currency stablecoin, the second a single-currency USD-denominated one. In both cases, the design was enough to scare regulators; a Big Tech backed structure could very soon be so large that it could be almost too big to fail. Think back to late 2023 and the problems in the UK with the their LDI funds aka Liability Driven Investments. Markets moved, which saw them have to meet margin calls, and their inability to generate intraday liquidity forced them into fire sales of HQLA, driving prices down, which started a vicious circle. Given the recent wildfire-like virtual runs on the bank at SVB and Credit Suisse, I would imagine regulators are very wary of “money-market-like” things which might grow like topsy.

On matters liquidity, there is a very specific risk around stablecoins and even tokenised money market funds; if they become widely held and they could be used as a means of payment, then the good old bank deposit is under threat. My friends at Yodl are working on that angle, but that is a story for another day.

In conclusion

Here’s how I would triage things stablecoin. I’ll include a step on things tokenised deposits (more on this in the last post – click here)

Step #1 – Get ready for tokenised deposits. These things are not a new currency, they are simply a discrete Nostro. In that last post, I said that if you already process FX trades for CLS settlement, that process is the one to build on so you can select the use of the tokenised deposit for speicfic settlements.

Step #2 – Ignore the multi-bank coin thing for now. It is a distraction. Assume that there will be stablecoins and that clients will at least want you to hold them for them and then they will want use them to buy and sell other digital assets, even legacy securities. Work out how you might do that. 

Thanks for reading. Please do let me know what you think of these notes. Feedback via the comments would be great.

Author

Olaf Ransome is a liquidity and financial services expert. He is the founder of 3C Advisory  You can message Olaf directly here.