Leaked Biden directives focus on stablecoins? How much the Fed loves stablecoins

On March 9, U.S. Treasury Secretary Janet Yellen issued a statement on Joe Biden’s directive on digital assets. This statement did not have a negative view on cryptocurrencies, so many people believe that this statement has driven market sentiment. The statement was suspected to have been accidentally leaked ahead of time on the official website of the Ministry of Finance and has since been deleted. However, from the remaining traces, we can still see some important points.

In a statement full of official language, Janet Yellen specifically mentioned “stable coins”. She said that the Ministry of Finance will cooperate with multiple departments to study stable coins and make recommendations. Some people think that the United States seems to be launching its own CBDC, but Rhythm does not think so. Last year, in the “Full Text of the Federal Reserve’s Speech on CBDC: A Comprehensive Macro Understanding of Stablecoins, Bitcoin, and CBDC”, the Federal Reserve was not excited about CBDC. , and for stablecoins, they are clearly more interested.

In February of this year, the Federal Reserve released a new report on stablecoins, arguing that stablecoins have the potential for next-generation innovation, and focused on the potential impact of stablecoins on the banking system and credit intermediaries.

The following is the main content of the Federal Reserve’s “Stablecoins: Development Potential and Impact on the Banking System”, which has been translated by BlockBeats for the convenience of readers. Before waiting for an official statement from Janet Yellen, this report provides an early look at some of the Fed’s stance on stablecoins. It is important to note that this is an International Financial Discussion Paper (IFDP), preliminary material distributed to stimulate discussion and critical comments. 


A stablecoin is a digital currency that links its value to an external reference, usually the United States dollar (USD). Stablecoins play a key role in digital markets, and their growth could spur innovation in the wider economy. In the past year, there has been an explosion of USD stablecoins circulating on the public chain. As of September 2021, the total circulating supply is close to $130 billion, an increase of more than 500% from a year ago.

As stablecoins gain traction, a range of issues have been raised, including the stability of their pegs, consumer protection, KYC and compliance, and scalability and efficiency of settlement. We will focus on the potential impact of stablecoins on the banking system and credit intermediaries. While a range of stablecoin-related issues can be addressed through appropriate institutional safeguards, regulations, and technological advancements, the continued growth of stablecoins in circulation will ultimately impact the traditional banking system in important ways.

In this note, we first discuss the basics of stablecoins, their current use cases, and their growth potential. Second, we examine the historical behavior of stablecoins during past cryptocurrencies and broad financial market distress. We found that stablecoins pegged to the U.S. dollar exhibited a safe asset quality, as their price in the secondary market temporarily exceeded the peg price during extreme market distress, incentivizing the issuance of more stablecoins. We also highlighted the “run” risk of certain stablecoins backed by non-cash equivalent risk assets.

Finally, we outline possible scenarios for bank reserves, credit intermediation, and central bank balance sheets if stablecoins gain broader traction. Our research suggests that widespread adoption of asset-backed stablecoins may be supported within a two-tier fractional-reserve banking system without negatively impacting credit intermediation. Under such a framework, stablecoin reserves are held as deposits in commercial banks, and commercial banks perform fractional reserve lending and maturity conversions like traditional bank deposits. We also found that replacing physical cash (paper money) with stablecoins can lead to more credit intermediaries. In contrast, a “narrow” banking framework that requires stablecoin issuers to back their stablecoins with central bank reserves minimizes the risk of stablecoin “runs” but may reduce credit intermediation.

The foundation of stablecoins

Stablecoins are digital currencies recorded on a distributed ledger technology (DLT), usually a blockchain, and tied to a reference value. Most stablecoins in circulation are pegged to the U.S. dollar, but stablecoins can also be pegged to other fiat currencies, baskets of currencies, other cryptocurrencies, or commodities such as gold. Stablecoins serve as a store of value and medium of exchange on DLT, enabling stablecoins to be exchanged or integrated with other digital assets.

Stablecoins differ from traditional digital currency records, such as bank deposit accounts, in two main ways. First, stablecoins are cryptographically secured. This allows users to settle transactions almost instantly, without the need for double-spending or intermediaries that facilitate settlement. On the public chain, this also allows 24 X 7×365 transactions per day. Second, stablecoins are often built on programmable DLT standards and allow for composability of services. In this context, “composability” means that stablecoins can serve as independent building blocks that interoperate with smart contracts (self-executing programmable contracts) to create payments and other financial services. These two key characteristics underpin current stablecoin use cases and support innovation in both financial and non-financial sectors.

The use of stablecoins on public chains such as Ethereum, Binance Smart Chain or Polygon has exploded since 2020. As of September 2021, the circulating supply of the largest U.S. dollar-pegged public stablecoin is nearly $130 billion. The graph shows that the circulating supply of public stablecoins has grown particularly strongly in early 2021, averaging around 30% month-on-month growth in the first five months of the year.

Current stablecoin types

Stablecoins are a nascent, broadly defined technology that may come in many forms. The technology is currently implemented in a specific form, which we describe below and summarize in Table 1. However, please note that stablecoin technology is in its infancy and has a high potential for innovation. The current implementation of stablecoins discussed below, and their current state in the regulatory environment, do not reflect all potential deployments of stablecoin technology.

Leaked Biden directives focus on stablecoins? How much the Fed loves stablecoins

The circulating supply of the top ten dollar-pegged public stablecoins by market capitalization. Data from January 2019 to September 2021. Other categories include Fei, TerraUSD, TrueUSD, Paxos Dollar, Neutrino USD, and HUSD.

Stablecoins backed by public reserves

Most existing stablecoins circulate on public chains such as Ethereum, Binance Smart Chain or Polygon. Of these public stablecoins, most are backed by cash-equivalent reserves such as bank deposits, Treasury bills, and commercial paper. These reserve-backed stablecoins are also known as custodial stablecoins because they are issued by intermediaries that act as custodians of cash-equivalent assets and offer a 1-to-1 redemption of stablecoin liabilities in U.S. dollars or other fiat currencies.

The adequacy and robustness of some public reserve-backed stablecoins has been questioned. In particular, Tether, the stablecoin with the largest circulating supply, agreed to pay $41 million to settle a dispute with the U.S. Commodity Futures Trading Commission, which accused Tether of misrepresenting the adequacy of its U.S. dollar reserves. Other widely used reserve-backed public dollar-pegged stablecoins with varying levels of financial auditing include USD Coin, Binance USD, TrueUSD, and Paxos Dollar.

Public Algorithmic Stablecoins

Some stablecoins use other mechanisms to stabilize their prices, rather than relying on the robustness of the underlying reserves. These stablecoins are often referred to as algorithmic stablecoins. While reserve-backed stablecoins are issued as liabilities on the balance sheets of legally registered companies, algorithmic stablecoins are maintained by a system of smart contracts that run exclusively on public chains. The ability to control these smart contracts is often conferred by owning a governance token, a specialized token used exclusively to vote on changes to protocols or governance parameters. These governance tokens can also serve as direct or indirect claims on future cash flows using stablecoin protocols.

The field of public algorithmic stablecoins is highly innovative and difficult to categorize. However, one can generally think that the design of these stablecoins is based on two mechanisms: (1) a staking mechanism and (2) an algorithmic peg mechanism. Collateralized public stablecoins such as Dai are minted when users deposit volatile cryptocurrencies such as Ethereum into Dai’s smart contract protocol. The user then receives a Dai (USD-pegged) loan with a collateralization ratio of over 100%. If the value of the Ethereum deposit falls below a certain threshold, the loan will be automatically liquidated.

In contrast, algorithmic peg mechanisms use automated smart contracts to secure pegs by buying and selling stablecoins and related governance tokens. However, these pegs can suffer from instability or design flaws that lead to “instability,” as exemplified by the fact that algorithmic stablecoin Fei briefly unpegged after its launch in April 2021.

Institutional or private stablecoins

In addition to reserve-backed stablecoins circulating on public blockchains, traditional financial institutions have also developed reserve-backed stablecoins, also known as “tokenized deposits.” These institutional stablecoins are implemented on permissioned (private) DLT, and they are used by financial institutions and their clients for efficient wholesale transactions. The most well-known institutional stablecoin is JPM Coin. JPMorgan and its clients can use JPM Coin to conduct transactions such as intraday repo settlement and manage internal liquidity.

These private, retained-backed stablecoins are functionally and economically comparable to those offered by some money transmitters. For example, Paypal and Venmo (a subsidiary of Paypal) allow users to make near-instant transfers and payments within their network, and these companies hold balances similar to reserve-backed stablecoins. The key difference is the use of a centralized database instead of permissioned DLT.

Use Cases and Growth Potential for Stablecoins

Strong use cases are driving the current growth of stablecoins in all their forms. We summarize these use cases. The most important current use case for stablecoins is their role in cryptocurrency transactions on public chains. Investors often prefer public stablecoins to trade cryptocurrencies, as this allows for near-instant 24/7/365 transactions without relying on non-DLT payment systems or custodial holdings of fiat currency balances.

Leaked Biden directives focus on stablecoins? How much the Fed loves stablecoins

In addition to being used for crypto transactions, both public and institutional stablecoins are currently used for near-instant 24/7 non-intermediary payments with potentially low fees. This is especially relevant for cross-border transfers, which often take multiple days and require high fees. Companies also use institutional stablecoins to transfer cash between their subsidiaries almost instantaneously, to manage internal liquidity, and to facilitate wholesale transactions in existing financial markets, such as intraday repo transactions. Finally, because public stablecoins are programmable and composable, they are heavily used in decentralized, public blockchain-based marketplaces and services known as decentralized finance or DeFi. The DeFi protocol system allows users to use stablecoins to participate in a variety of cryptocurrency-related markets and services, such as market making, mortgage lending, derivatives, and asset management, directly and with trading parent companies, without the need for traditional intermediaries. As of September 2021, approximately $60 billion in digital assets is pledged (locked) in DeFi protocols.

future growth potential

The defining characteristics, cryptographic security, and programmability of stablecoins support the powerful use cases currently driving the use of existing public and institutional stablecoins. However, these capabilities have the potential to drive innovation beyond current use cases, which are largely limited to cryptocurrency markets, certain peer-to-peer payments, and institutional liquidity management for large banks. Going forward, stablecoin technology is likely to see diverse implementations and drive innovation in multiple growth areas: more inclusive payment and financial systems, tokenized financial markets, and microtransactions that facilitate technological advancements such as Web 3.

A more inclusive payment and financial system

Stablecoins have the potential to spur growth and innovation in payment systems, enabling faster and cheaper payments. Because stablecoins can be used to transfer funds between digital wallets almost instantly peer-to-peer with potentially low fees, stablecoins may lower payment barriers and put pressure on existing payment systems to provide better services. This is especially important for cross-border transfers, which can take days to clear and incur high fees. These costs and delays are a burden for low- and middle-income countries.

Stablecoins may also support a more inclusive financial system through the growth of DeFi, which may require stablecoins as a necessary component. It’s important to point out that DeFi faces serious challenges, including a complex user experience, lack of consumer protections, frequent hacks, protocol dysfunction, and market manipulation. Additionally, almost all DeFi protocols only support the trading or lending of cryptocurrencies or non-fungible tokens (NFTs). If DeFi protocols mature beyond their current state and integrate with wider financial markets to support real-world economic activity, DeFi could encourage a more inclusive financial system that allows investors to directly participate in markets without intermediaries. This growth in DeFi is likely to drive the growth of stablecoin usage.

Tokenized Financial Markets

Furthermore, stablecoins may play a key role in the tokenization of financial markets. This will require converting securities into digital tokens on DLT and using stablecoins for transactions and services. For delivery-versus-pay (DvP) transactions, such as securities purchases, a tokenized marketplace will allow for real-time settlement at very low cost. This improves liquidity, transaction speed and transparency, while reducing counterparty risk, transaction costs and other barriers to market participation. This could be particularly beneficial for certain asset classes, such as real estate, by allowing fractional ownership of tokenized assets and more transparent price discovery. For payment-to-payment (PvP) transactions, such as cross-currency swaps, tokenization will also allow for near-instant execution, as opposed to the market’s current traditional T+2 framework, where payments for swaps are settled by two businesses after the exchange occurs days. Additionally, for both types of transactions, tokenized financial markets will benefit from DLT’s programmability, which can automate security services and regulatory requirements, such as required holding periods. If financial markets are partially or fully tokenized, this could drive further growth in stablecoin usage.

next generation innovation

Finally, stablecoins have the potential to support the next generation of innovation. An example of this innovation is Web 3, which may move from centralized web platforms and data centers to a decentralized web. Under this paradigm, revenue from internet services and social media platforms will shift from advertising to microtransactions, thanks to the emergence of efficient, integrated online payment systems. For example, imagine a search engine or video streaming platform backed by near-instant micropayments in stablecoins, rather than advertising revenue and sales of user data. If this shift in network services materializes, it could fuel further growth in stablecoins.

In summary, the current use of stablecoins is primarily driven by cryptocurrency transactions, limited peer-to-peer payments, and DeFi. Going forward, stablecoins are likely to enable further growth by facilitating more inclusive payment and financial systems, the tokenization of financial markets, and possibly the next generation of innovations such as Web 3.

Hook stability

The stability of stablecoins pegged to their reference value is a core issue. This is not the focus of our paper, but we briefly discuss this important issue here. In this section, we will first outline the current sources of peg instability for stablecoins backed by public reserves and discuss how to address these sources. We will then review how stablecoins can serve as potential safe assets in digital markets and provide evidence that current public reserve-backed stablecoins may already be playing this role in cryptocurrency markets.

Currently, pegged instability in public reserve-backed stablecoins comes in two forms: investor redemption risk for issuers and secondary market price dislocation. The former has to do with the security and robustness of stablecoin reserves. Panic could arise if stablecoin holders lose confidence in the robustness of stablecoin support. A run on stablecoins carries the risk of spillovers to other asset classes as stablecoin reserves are sold or offloaded to meet redemption demand. Additionally, runs on stablecoins could cause further distress by disrupting stablecoin-dependent markets and service smart contracts through interoperability. We believe this type of instability can be addressed with appropriate institutional and/or regulatory guardrails, such as transparent financial audits and adequate requirements for the liquidity and quality of stablecoin reserves. Concerns surrounding redemption risk and the extent to which it can be addressed were recently mentioned in Quarles (2021).

A second form of peg instability for public reserve-backed stablecoins stems from supply and demand imbalances in the secondary market. Because these stablecoins are traded on both centralized and decentralized exchanges, they are vulnerable to demand shocks that could temporarily dislocate their pegs until stablecoin issuers adjust supply. In particular, due to public stablecoins serving as a store of value for public blockchain-based markets, these stablecoins experienced high demand during the crypto market troubles as investors rushed to liquidate their speculative positions into stablecoins. During these events, the price of stablecoins backed by major public reserves tends to appreciate temporarily until the issuer adjusts the supply. As an example, the graph shows the cryptocurrency market crash on March 12, 2020 and May 19, 2021. The first event occurred during a period of general market volatility amid concerns surrounding the spread of Covid-19. The second event occurred during a crypto market downturn associated with massive deleveraging. During both periods, the price of stablecoins backed by major public reserves surged as the prices of speculative cryptocurrencies Bitcoin and Ethereum plummeted by 30% to 50%.

Leaked Biden directives focus on stablecoins? How much the Fed loves stablecoins

For these extreme crypto market distress events, stablecoins appreciate as a digital security asset, while more speculative cryptoassets are temporarily in free fall until stablecoin issuers are able to increase their supply and purchase reserves and/or stablecoin experiences The decline comes from price pressure from arbitrageurs. The behavior of these public stablecoins is unique and unlike prime money market funds, which experienced massive capital outflows during the height of the 2008 global financial crisis and 2020’s COVID-19 pandemic.

These events demonstrate the potential of stablecoins as a digital safe haven during times of market distress. While discussions on the financial stability risks of public reserve-backed stablecoins have largely focused on the redemption risks specific to individual stablecoin reserve forms, our analysis suggests that countercyclical secondary market demand for stablecoins can reduce broader market downturns redemption risk. With appropriate safeguards and regulations, stablecoins have the potential to provide stability comparable to traditional forms of security value.

The potential impact of stablecoins on credit intermediaries

If stablecoins gain widespread adoption across the financial system, they could have a significant impact on the balance sheets of financial institutions. Regulators, market participants and academics are particularly concerned about the potential of stablecoins to disrupt bank-led credit intermediation. In this section, we analyze several possible scenarios for the widespread adoption of reserve-backed stablecoins in the financial system. We focus on reserve-backed stablecoins rather than algorithmic stablecoins, as reserve-backed stablecoins are currently the largest and most closely linked to the existing banking system. Using these scenarios, we highlight how the impact of stablecoin adoption on the provision of credit depends critically on two factors: the source of inflows to stablecoins and the composition of stablecoin reserves.

We summarize our results. We found that in most of the scenarios we considered, credit provisions would likely not be negatively impacted. In fact, replacing physical currency (paper money) with stablecoins may allow for a more bank-led supply of credit. One notable exception, which could lead to massive credit disintermediation, requires stablecoins to be fully backed by central bank reserves, which we call a narrow banking framework. Under this framework, redemption risk is minimized at the cost of greater credit disintermediation (disintermediation).

inflow source

If stablecoins gain widespread adoption, the main inflows are likely to come from three sources: physical currency (paper money), commercial bank deposits, and cash-equivalent securities (or money market funds). First, as a form of digital currency, stablecoins will replace some of the paper money in circulation, especially as the economy becomes more digital. In some of our scenarios, we saw an increase in credit supply as users switched from physical cash to reserve-backed stablecoins. This is because paper money, a direct liability of the central bank, is being replaced by reserve-backed stablecoins that, depending on the reserve framework, can create credit through loans or securities purchases.

Leaked Biden directives focus on stablecoins? How much the Fed loves stablecoins

Second, stablecoins may flow from commercial bank deposits if households and businesses prefer to hold stablecoins rather than commercial banks’ traditional balances. This source of inflow is of great interest to policymakers because of widespread concerns that a flood of alternative deposits could disrupt the supply of credit to commercial banks. We show that the effect of deposit substitution on credit supply can be positive, negative, or neutral, depending on the reserve framework. Finally, stablecoins may see an inflow of cash-equivalent securities (or money market funds). This may have no impact on the supply of credit, as it requires circulating funds back into the banking system, which we will discuss in a later section.

Reserve composition

The impact of widespread adoption of reserve-backed stablecoins on the provision of credit also depends on the composition of stablecoin reserves. We propose three plausible stablecoin reserve frameworks: narrow banking, two-level intermediaries, and securities holdings. As shown above.

Under a narrow banking framework, stablecoins need to be backed by commercial bank deposits, which are fully backed by central bank reserves. Equivalently, it is possible for commercial banks to issue full stablecoins (or tokenized deposits) backed by central bank reserves. A narrow banking approach is roughly equivalent to a retail central bank digital currency, where the digital currency is a liability of the central bank but can be used by households and companies through intermediaries such as commercial banks or fintech companies. The People’s Bank of China has adopted this framework in its state-backed digital currency (known as digital currency and electronic payments), the digital yuan, or e-RMB. The possibility of requiring stablecoins to maintain reserves at central banks is also mentioned in the proposed STABLE Act in the United States.

While a narrow banking framework can guarantee the peg stability of a stablecoin as it is effectively a pass-through central bank digital currency (CBDC), this reserve framework poses the greatest risk of credit disintermediation. A period of financial stress or panic could lead to a massive transfer of conventional commercial bank deposits into narrowly defined bank stablecoins, which could disrupt the supply of credit. While this credit disruption effect can be mitigated by limiting stablecoin holdings and differential reserve interest rates, the overall structure of banks’ narrow approaches to stablecoin reserves could destabilize the banking system. Furthermore, a narrow banking approach could lead to the expansion of central bank balance sheets to accommodate the demand for reserve balances by stablecoin issuers.

These concerns about narrow-bank stablecoins mirror more general concerns about narrow-banking, which the Fed has taken note of. In a recently proposed regulation that would affect narrow banks (officially known as pass-through investment entities, or PTIEs), the Fed expressed “concern that [narrow banks] may disrupt financial intermediation in unforeseen ways and may also have implications for financial stability. Negative Impact” (Regulation D: Reserve Requirements for Depository Institutions, 2019). In addition, the Fed outlined serious concerns about demand for reserve balances, saying “[narrow banks’] demand for reserve balances could become very large. To maintain an ideal monetary policy stance, the Fed may need to expand its balance sheet by expanding its and reserve supply to meet this demand.”

In contrast to a narrow banking framework, under a two-level intermediary framework, stablecoins would be backed by commercial bank deposits for fractional-reserve banking. Likewise, commercial banks are likely to issue stablecoins or offer tokenized deposits for fractional-reserve banking. To be clear, this does not mean that stablecoins are not fully backed. Instead, stablecoin issuers rely on commercial bank deposits as assets, and commercial banks practice fractional-reserve banking using stablecoins and/or stablecoin deposits, meaning that stablecoins are ultimately backed by a combination of loans, assets, and central bank reserves. It affects effectively relabeling a portion of regular deposits as stablecoin deposits. Importantly, for banking intermediation to remain constant, stablecoin deposits must be treated the same as non-stablecoin deposits in terms of required reserve ratios, liquidity coverage ratios, and other regulatory and self-imposed risk limits.

Finally, stablecoin issuers can hold cash-equivalent securities, such as Treasury bills and high-quality commercial paper, rather than depositing funds with commercial banks. These securities can be purchased directly or indirectly through money market funds. This is the main framework currently adopted by issuers of stablecoins backed by public reserves, such as Tether, which Federal Reserve Chairman Jerome Powell recently noted is “like a money market fund.”

Scene construction

In our scenario, we consider the impact of one or more fiat reserve-backed stablecoins gaining widespread adoption in a stylized version of the banking system. The baseline balance sheet of the banking system is shown in the figure. Specifically, we consider households and businesses substituting $10 for paper money, commercial bank deposits, or securities, and then we do accounting to determine how stablecoin adoption affects central banks, commercial banks, and the balance sheets of households and businesses. We analyze how this impact varies depending on the stablecoin’s reserve framework and the source of its inflows.

Leaked Biden directives focus on stablecoins? How much the Fed loves stablecoins

It is important to note that we made several key assumptions when constructing these scenarios. The first is that we don’t know the exact form of the stablecoin being adopted. Our scenario is not intended to analyze, for example, the specific impact of widespread adoption of existing stablecoins such as Tether. We do not distinguish whether the adopted stablecoins are institutional tokenized deposits, stablecoins circulated on public blockchains, or otherwise. Second, we only show illustrative advantage cases. In effect, stablecoins can see inflows from multiple sources and hold multiple assets as reserves. Third, these scenarios do not capture secondary knock-on effects or feedback loops, nor do they address heterogeneous effects within the industry. Finally, we assume that traditional deposits in commercial banks have a 10% required reserve ratio.

To illustrate the complex flows between the various parts of the banking system that support our edge case scenario, we visualize the subset of stablecoin inflows and reserve allocations we discussed in the figure. Specifically, we use a graph to show the inflow of commercial bank deposits (inflow A) and paper money (inflow B) into stablecoins, and the distribution of these funds in the form of commercial bank deposits to reserves (reserve flow A ) and securities (reserve flow A ) B).

Leaked Biden directives focus on stablecoins? How much the Fed loves stablecoins

In the graph, we see how stablecoin inflows and reserve flows are related to each other. Companies and households are replaced by stablecoins from deposits (inflow A) and paper money (inflow B). Stablecoin issuers deposit a portion of these funds into the commercial banking system, hold reserves as commercial bank deposits (reserve flow A), and use these funds to purchase securities as reserves (reserve flow B). These securities purchases also circulate funds back into the banking system, as the seller of the securities ultimately receives the proceeds of the securities sale and deposits it back into the banking system. As shown, these flows affect the central bank, which maintains cash and central bank reserves as liabilities, as well as companies and households that receive loans from commercial banks. While this diagram does not capture the full flow between these entities, it is symbolic of how the widespread adoption of stablecoins can reshuffle the complex financial relationships within the banking system.

Scenario Analysis

Narrow Banking Framework

As mentioned earlier, the narrow banking framework poses the greatest risk to credit provisions, depending on the source of the inflow. In our narrow banking scenario, as shown in the table, we find that physical cash flows into narrow banking stablecoins would have a neutral effect on credit supply, while commercial bank deposits would disrupt credit supply.

Leaked Biden directives focus on stablecoins? How much the Fed loves stablecoins

In Panel A (cash inflow scenario), we see stablecoins replacing cash on household and corporate balance sheets. The inflow of cash leads to an indirect increase in commercial bank balance sheets and commercial bank reserves. The central bank’s balance sheet was restructured, with reserve liabilities replacing cash liabilities. The net effect is an expansion of commercial banks’ balance sheets, but no change in credit provisions. This scenario assumes that banks are not limited by the size of their balance sheets. That is, narrowly defined bank deposits and associated reserve holdings are exempt from leverage calculations. This leverage exemption on central bank reserve holdings has been adopted by regulators in different jurisdictions.

Panel B shows a narrow banking scenario where deposits migrate to stablecoins. Because stablecoin deposits remain entirely on commercial banks’ balance sheets, banks must reduce their asset holdings to accommodate the decline in non-stablecoin deposits. The central bank’s balance sheet would then expand to accommodate increased demand for reserve balances without offsetting the decline in cash liabilities. In this case, we assume that the central bank will meet the increased demand for reserves by purchasing securities. This assumption of central bank easing was raised by the Federal Reserve’s previous ruling on narrow banking, as noted above, in relation to Regulation D: Reserve Requirements for Depository Institutions (2019). However, if the central bank determines the size of its balance sheet, we propose two alternatives in Table A1 of the Appendix. In the first alternative, commercial banks substantially shrink their balance sheets to make up for shortfalls in deposit funding. In the second case, commercial banks make up for lost deposit funds by issuing debt securities. The result is a further reduction in bank-led credit creation.

We are not imagining a scenario in which narrow bank stablecoins flow from securities holdings in large numbers. In this case, the impact on credit provisions is likely to be neutral. Under the same assumptions as above, the net effect on the supply of credit should be minimal for the central bank to meet the increased demand for reserves by purchasing securities (from households). Rather than holding securities directly, the move to stablecoins will allow households to own stablecoins backed by central bank reserves, which are in turn backed by securities. This scenario also assumes that increased narrow bank reserves are not affected by leverage, as discussed earlier.

Two-tier intermediary framework

For the two-level intermediation framework shown in the table below, we find that large inflows into stablecoins will have a neutral to positive effect on credit supply. Panel A shows the exchange of cash for stablecoins. As commercial banks engage in fractional-reserve banking through stablecoin deposits, their balance sheets expand as credit and securities holdings expand, accounting for most of the expansion. The central bank shrank on its net balance sheet, with a slight increase in reserves and a notable reduction in cash liabilities. Households accumulate more assets to finance the expansion in bank loans. The impact on credit provisions is positive. Panel B shows a two-tier intermediation scenario with deposit substitution. Overall balance sheets and asset holdings of commercial banks and central banks were unchanged. The only change is the composition of commercial bank liabilities, as term deposits are converted to stablecoin deposits. As mentioned earlier, this scenario assumes that stablecoin deposits are treated the same as non-stablecoin deposits in terms of statutory reserve ratios, liquidity coverage ratios, and other regulatory and self-imposed risk constraints.

Leaked Biden directives focus on stablecoins? How much the Fed loves stablecoins

securities holding framework

As the table below shows, the impact of widespread adoption of security-backed stablecoins is the least predictable. Many situations are possible. In Panel A, we present a scenario in which securities-backed stablecoins see an inflow of commercial bank deposits. We assume that stablecoin issuers source securities from commercial banks rather than the household and corporate sectors. In this case, as households exchange their deposits for stablecoins, commercial banks make up for lost deposit funds by issuing their own securities. In addition, commercial banks can reduce their portfolio of securities to cover the loss of deposit funds. If banks adjust the asset portion of their balance sheets primarily by changing securities holdings, the size of the bank’s loan portfolio may remain the same. In this case, the central bank’s balance sheet also shrank slightly due to the loss of bank reserves.

Panel B shows a scenario where households exchange their cash-equivalent securities holdings for stablecoins. This would lead to the efficient tokenization of cash-like securities without directly affecting the supply of credit in the banking system. We also consider another scenario (not shown) in which securities-backed stablecoins experience an inflow of deposits from the household and corporate sectors while selling securities to commercial banks. The sellers of securities are the household and corporate sectors, not the commercial banks described in Panel A of Table 7. The net effect on credit provision is neutral, as commercial bank deposit balances held by households and companies that purchase stablecoins are eventually recycled back to banks by transferring them to other households and companies that sell securities to stablecoin issuers system. This restructuring of security holdings is illustrated in Figure 3 by inflow A and reserve inflow B. The end result is a balance sheet change, the same as Panel B.

Leaked Biden directives focus on stablecoins? How much the Fed loves stablecoins

Finally, we do not describe a scenario in which security-backed stablecoins flow in from physical cash. However, this could have a neutral or positive effect on credit creation. If stablecoin issuers use paper money to buy existing securities that are not ultimately deposited in the banking system, this will not affect the supply of credit, as this would constitute a direct exchange of paper money for securities. However, if notes for the purchase of existing securities are deposited in the banking system, or if those notes are used to fund the issuance of new securities, this may increase the supply of credit by increasing commercial bank lending and securities purchases, or by reducing the amount of money to issue securities. Equilibrium cost. All in all, the likely impact is a modest increase in credit supply.


Stablecoins have grown significantly over the past year as digital assets gain wider adoption and the use cases for programmable digital currencies are clarified. This rapid rise has raised concerns about possible negative effects on banking activity and the traditional financial system. In this report, we discuss the current use cases and potential growth of stablecoins, analyze historical events of peg instability, and illustrate different scenarios for the impact of stablecoins on the banking system. As stated in the introduction, this paper does not consider all potential impacts of stablecoins on financial stability, monetary policy, consumer protection, and other important unexplored issues. We focus on balance sheet effects and credit intermediation under a range of reasonable assumptions.

We examine reserve-backed stablecoins and find that the impact of stablecoin adoption on traditional banking and credit provision may vary depending on the source of inflows and the composition of stablecoin reserves. In various scenarios, the two-tier banking system can both support the issuance of stablecoins and maintain traditional forms of credit creation. In contrast, a narrow banking stablecoin framework can bring the greatest stability, but with the potential cost of credit disintermediation. Finally, dollar-pegged stablecoins can act as a safe haven compared to other crypto assets during market distress, if they are deemed to have sufficient collateral.

Posted by:CoinYuppie,Reprinted with attribution to:https://coinyuppie.com/leaked-biden-directives-focus-on-stablecoins-how-much-the-fed-loves-stablecoins/
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