NY Fed: Stablecoins Are Not the Future of Payments

Researchers at the Federal Reserve Bank of New York can’t seem to get enough of writing about stablecoins.

Just days after a team from the U.S. central bank branch published a lengthy analysis of frameworks for regulating stablecoin deposits, a separate research group penned a paper laying out reasons why stablecoins aren’t the future of payments.

In the paper published Monday, four researchers argue stablecoins aren’t the best way of transferring money if distributed ledger technology (DLT) becomes integrated into traditional finance. The researchers are economics professor Rod Garratt from the University of California, Santa Barbara, along with Michael Lee and Antoine Martin from the New York Fed’s research and statistics group and Joseph Torregrossa from the legal group.

Liquidity issues

In order for stablecoins to remain, well, stable, they are pegged to an asset considered safe, such as the U.S. dollar. According to the analysts, stablecoins tie up assets unnecessarily.

“Tying up safe and liquid assets in a stablecoin arrangement means they are not available for other uses, such as helping banks satisfy their regulatory requirements to maintain sufficient liquidity,” according to the researchers. The use of stablecoins, they said, could lead to shortages of safe and liquid assets.

Tether, the issuer of USDT, the biggest stablecoin by market cap, is known to be one of the largest commercial paper holders in the United States. According to Tether, there's about $78 billion of USDT in circulation.

Stablecoins that don’t tie up liquidity, such as those that are based on algorithms, are seen as risky and less fungible, according to the analysts.

The researchers cite a paper by Gary B. Gorton and Jeffery Zhang in which they argue stablecoins can be compared to private bank notes issued during the "free banking" era in the U.S. in the mid-18th century.

“Private bank notes were not fungible and individuals handling them needed to consider whether to accept any particular note at face value,” the analysts said, adding that this history of private bank notes suggests that stablecoins might be subject to the same issues.

Tokenized deposits instead of stablecoins

“Recent analysis has emphasized the benefits of maintaining the centrality of banks in the payment system,” according to the research paper. The authors raise the question of why the central bank would use stablecoins if it could issue tokenized deposits.

"While a number of practical details would need to be worked out, the principle behind tokenized deposits is straightforward. Bank depositors would be able to convert their deposits into and out of digital assets – the tokenized deposits – that can circulate on a DLT platform. These tokenized deposits would represent a claim on the depositor’s commercial bank, just as a regular deposit does," wrote the researchers.

Tokenized deposits would also make use of existing payment infrastructures.

“Customers can exchange these deposits for goods or services using well-functioning existing payments infrastructures," the paper noted. "Merchants receiving these funds through deposit-based payment systems do not worry about the source of these funds; they transfer at par.”