Brendan Malone: Stablecoins are safer than bank deposits

Former Federal Reserve policy analyst Brendan Malone, on behalf of Paradigm, released a policy paper stating that stablecoins present a lower risk compared to bank deposits. The paper highlights that stablecoins should not be equated with traditional bank deposits or money market funds. Instead, they offer distinct advantages in terms of risk exposure.

The document delves into the potential risks stablecoins pose to the financial system, especially concerning legislative proposals in the United States that may incorporate crypto payment instruments into existing banking and securities frameworks. Malone argues that stablecoins’ risks are different from those of bank deposits, mainly due to their unique design and underlying assets.

Stablecoins are a type of cryptocurrency designed to maintain a stable value relative to a specific asset, usually a fiat currency like the U.S. dollar. In contrast, money market funds are mutual funds that invest in low-risk, short-term assets and cash equivalents.

According to Malone, banks face risks associated with maturity transformation when they accept short-term deposits and use those funds to offer long-term loans. This creates an ongoing risk for banks that necessitates continuous risk management. He cites the example of Silicon Valley Bank’s collapse due to such risks.

However, stablecoins pegged to a fiat currency are less prone to these risks because their reserve assets typically consist of short-dated Treasuries and are kept separate from the issuer’s assets. This reduces the likelihood of a duration mismatch between short-term liabilities and long-term, or risky, assets.

Furthermore, stablecoins are primarily used for payment transactions based on their peg to the U.S. dollar, rather than as investment options or cash management vehicles. Holders of stablecoins do not receive any return based on the reserves; instead, the stablecoins are treated as equivalent to cash.

The policy paper emphasizes that regulating stablecoins under existing frameworks without considering their unique characteristics could lead to overly strict oversight, potentially limiting competition and strengthening the market dominance of a few major players. To strike the right balance, the legislation should address the specific risks associated with stablecoins while still fostering innovation in the sector.

It’s worth noting that since 2022, multiple digital asset bills have been introduced in the U.S. Congress, covering various aspects, including stablecoins and regulatory jurisdiction. Some of these bills aim to regulate stablecoins, such as the Stablecoin TRUST Act and the Stablecoin Innovation and Protection Act.