StStablecoins are backed by ‘reserves’? Give us a break.

In a recent op-ed in American Banker, Judith Rinearson argues that stablecoins, cryptocurrencies with valuations tied to a real-world fiat currency, are safe because the state money transmitter requirements that they are subject to require them to be backed “100% by reserves.”

She contrasts the backing of stablecoins with bank deposits, for which the current “reserve requirement” is zero. However, Rinearson conflates vastly different meanings of the term “reserves” and is thus wrong on all counts. Unfortunately, the “stablecoins are backed by reserves” canard is a source of widespread misunderstanding.

It is difficult to decide where to begin.

First, insofar as the public can tell, stablecoins are backed mostly by commercial paper. Commercial paper is a short-term extension of credit to a corporation, essentially the same as a loan. The purchaser of the paper provides the corporation money that the corporation returns later with interest.

The two largest stablecoins in the United States, Tether and USD Coin, which together account for 77% of circulating stablecoins, are both backed primarily by commercial paper — essentially business loans. Furthermore, the commercial paper backing these stablecoins is not all highly rated. So, when you give a stablecoin issuer dollars, they take the dollars and lend them to businesses — in some cases, with poor credit ratings — and earn interest.

Second, if loans — and by that logic, basically anything of value, such as securities — count as “reserves” to those who endorse the safety of stablecoins, then bank deposits are backed by vastly more “reserves” than stablecoins. Banks are required by law to have more assets than liabilities, and deposits are the most senior part of those liabilities. As of the end of the first quarter of 2021, according to the Federal Reserve Bank of New York, U.S. bank holding companies had deposits of $17 trillion and assets, composed primarily of loans and securities, of $26 trillion. So, bank deposits are backed by 165% reserves!

Of course, in banking parlance, that’s not what anybody suggests by reserves. “Reserves” are totally safe and liquid properties with recognized worth. Under this idea of reserves, Tether and USDC in fact have low levels of reserves compared to banks. As of September, according to an auditor’s report, 28% of Tether’s properties were Treasury expenses, which would certify, and 10% were “cash and bank deposits.” But most likely the large bulk of those deposits are above the Federal Deposit Insurance Corp. insurance coverage limitation and are therefore uninsured, so they are not riskless.

Moreover, under the heading of bank deposits, Tether likewise consists of term deposits and fiduciary deposits. Term deposits are plainly not offered to fulfill instant redemptions. According to the FDIC, fiduciary deposits are “deposit accounts established by a person or entity for the benefit of one or more other parties,” and it is unclear how rapidly those deposits might be withdrawn.

As for USDC, according to its auditor, the properties backing USD Coin are 100% “cash & cash equivalents” since Oct. 29, which sounds great up until you check out the footnotes. “Cash equivalents” consists of industrial paper with maturities of less than 90 days, which would record most industrial paper. So, for all we understand, USD Coin is backed 100% by industrial paper and holds no properties that might be thought about safe enough to certify as “reserves” in any sensible sense.

The bulk of the properties of lots of stablecoin providers are not totally safe and liquid properties with recognized worth. Thus, the representation by lots of stablecoin providers that they are safe due to the fact that they are backed by “reserves” does not total up to far more than stating that stablecoin providers hold properties — of differing degrees of security, liquidity and worth — versus their liabilities.


A news media journalist always on the go, I've been published in major publications including VICE, The Atlantic, and TIME.

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