The Breakdown - The Race for Stablecoin Transparency

Episode Date: August 28, 2021

On this week’s Weekly Recap, NLW breaks down the recent history of stablecoins and contextualizes recent news from Tether, Circle and Paxos. Could stablecoin providers be positioning themselves to be the rails of an eventual U.S. digital dollar?  Enjoying this content?   SUBSCRIBE to the Podcast Apple:  https://podcasts.apple.com/podcast/id1438693620?at=1000lSDb Spotify: https://open.spotify.com/show/538vuul1PuorUDwgkC8JWF?si=ddSvD-HST2e_E7wgxcjtfQ Google: https://podcasts.google.com/feed/aHR0cHM6Ly9ubHdjcnlwdG8ubGlic3luLmNvbS9yc3M=   Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW “The Breakdown” is written, produced by and features NLW, with editing by Rob Mitchell. Adam B. Levine is our executive producer and our theme music is “Countdown” by Neon Beach. The music you heard today behind our sponsor is “Only in Time” by Abloom. Image credit: MirageC/Moment/Getty Images, modified by CoinDesk.

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by Nidig and produced and distributed by CoinDesk. What's going on, guys? It is Saturday, August 28th, and that means it's time for the weekly recap. And the weekly recap is always sort of a guessing game of what it's going to be. Will it be a roundup of all the news events, or will it be a topic that I just happened to miss. And this week, I actually did a couple of news roundup type episodes, and I didn't

feel like there was the need for that, but there was a topic that I didn't have a chance to dig into, which is something that I'm calling the race for stablecoin transparency. So let's get into that. So stablecoins, stable coins, stable coins. You guys know that I have a historical, overarching pattern sort of perspective. I like to look back at things and ask how a historian or an observer in the future might subdivide specific parts of a timeline or a movement. History doesn't neatly divide itself into clean sequential phases. It's messy and overlapping and mean reverting and punctuated. Still, I do think that we can look back at certain moments

as either heralding something new coming or reflecting a shift that has happened. I tend to think that Facebook's announcement of Libra will be seen as one of those moments. It was June 2019. This was a fairly perfect middle point between the end of the 2017-2018-I-CO boom and the beginning of the 2020 institutional-driven rally in Bitcoin, which, as we know, was followed this year by a surge in NFTs and continued growth in Defi and Layer 1 smart contract chains. There are two trends that I believe Facebook's Libra announcement heralded.

One was internal to crypto and had to do with the growing significance of stable coins to the ecosystem. Today, trading in crypto is absolutely dominated by stablecoin pairs. When you trade some random defy coin, it's almost always against something like Tether or USDC. In 2017, that wasn't the case. Part of the reason that Bitcoin and the ICOs raced upwards together is that to buy into ICOs and to trade ICO tokens on exchanges, you mostly had to buy Bitcoin. Like it or not, demand for ICOs increased demand for BTC.

did exist, but it was nothing like the force that it is now. Fast forward to the Libra announcement. It's clear that the utility of fiat-denominated stablecoins is going to be immense and not just for crypto, which gets us to the second trend that Libra heralded, and indeed helped accelerate. That's the spillover of crypto and digital currencies into the mainstream of political and economic discussions. There probably isn't another company on Earth that could have freaked out as many governments as Facebook did, when it announced that it was going to create a currency that was stable, but not pegged to any single country's fiat, but instead a basket of global currencies. It was a move that, in the minds of central banks, would have instantly challenged the power

of those central banks. The issue, of course, was Facebook's billions of built-in installs for pushing adoption of this new currency. Now, Libra itself, despite occasionally popping up in the news for having changed its name again or something, was effectively still born and strangled in the cradle. It was a massive miscalculation if they thought they were going to get the U.S. to be down with this, especially obvious, I think, in retrospect, was not pegging it to the dollar and not domiciling the company in the U.S. It was also really, really suspect to try to make a banking-the-on-banked argument rather than a scary China will do at first argument. But this is neither here nor there, and we're not here to focus on Libra, except to say that they were a starting gun.

Since June 2019, a bunch of things have happened. Stablecoins have become absolutely embedded at the core of the crypto system. There are $65 billion worth of tether out there and $27 billion worth of USDC to name just the two biggest. Second, stablecoins have been increasingly the site of significant regulatory scrutiny. Under Brian Brooks' office of the comptroller of the currency during the Trump administration, a number of new rules made it much easier for banks and financial institutions to interact with stable coins and stable coin issuers. This raised the ire of a number of congressmen and women

who basically wrote an act to pin stable coins down to having to be issued by banks called the Stable Act. When the new Biden administration came in, it immediately put every one of Brooks rules under review. What's more, new legislation from Congressman Don Byer, this is that comprehensive crypto regulation that looks like it has the Treasury's hands all over it, would give the Treasury Department sole discretion

to approve or veto private states. And of course, this is to say nothing at all of the global attentional shift to CBDCs. This podcast is sponsored by NIDIG, a firm that's making Bitcoin accessible to banking customers on Main Street and Wall Street alike. As part of their mission to bring Bitcoin to the people. Find out more at Nidig.com slash NLW. That's NYDIG forward slash NLW. China responded first and most aggressively to what they perceived as the threat of Libra, and have largely shaped the dialogue and discussion ever since. Europe has also made it

clear that they're headed in the direction of a digital euro, while the U.S. has been more cagey. That said, Powell and his friends at the Fed have said that this is the year that they really start bringing the digital dollar conversation to Congress. In the U.S., there are some fairly pitched battles around CBDCs. There are some who point to China and say we must keep up with what they're doing. There are others who say that any U.S. digital dollar has to be designed in a way that is anti-surveillance to live up to not only our values but our constitutional obligations. Even though we've been talking about it for a couple years, this is a discussion that is absolutely going to grow in the years to come. Now, to me, one of the interesting wrinkles has to do with the way that financial innovation has usually happened in the U.S.

It has tended to not come from the government alone. Shocker, I know. Instead, it's been about the government creating space and context for the private sector to build the rails and then blessing them with the force of law. So if you look at the progress that has been made on CBDCs, China appears to be wildly far in the lead, right? I mean, they've had multiple contest-based trials of increasing size in cities around the country.

They've started rolling out the digital yuan to use in the metro. Way ahead, right? If we assume that the Federal Reserve is going to design their own digital dollar, then yes, China is absolutely ahead. But what if, instead, the Federal Reserve announced that they're going to build on the existing rails of U.S. denominated stable coins, absorbing, for example, the U.S. D.D.C. infrastructure as the start of an official digital dollar network that could plug directly into today's financial system. All of a sudden, the U.S. digital dollar would be light years ahead of China's CBDC. It would have $2.5 billion in settlement activity daily, which is nearly a trillion dollars annually.

What's more, it would be honed to a nascent and highly dynamic ecosystem of applications surrounding it and natively plugging into it. What's more, it would already be plugged back into the traditional financial system through increasing linkages with companies like Visa. In other words, supporting the U.S. domestic stablecoin ecosystem and investing in that as the germ of a larger digital dollar ecosystem would instantly do an end run around the Chinese digital currency. It is one of my most firmly held beliefs that some U.S. politicians will start making this argument

in the next 24 months. I'm not sure that they will actually come to pass, but I just think it's so obvious, and frankly, so in line with the previous relationship that American government and private markets have had and worked to innovate financial services in the past. So that then is my framework for looking at three recent moves, discussions, events, etc., in the stablecoin space. Tether is clearly working to add additional transparency to their asset disclosures. When they first started making reserve attestations, which, if you'll remember, was a requirement of their settlement with the New York Attorney General, they weren't particularly detailed, and they had a big chunk of assets in commercial paper, which is short-term corporate debt

that could have come from absolutely anyone. However, in August, they made their latest attestation and gave more details about the rating of the commercial paper. Briefly, companies like Standard in Pores, Fitch Ratings, and Moody's give grades to the creditworthiness of different for investments in debt, including commercial paper. Tether's August report claims that 93% of their commercial paper is rated A2 or higher, which is an investment grade short-term rating. It also said that the majority were rated by standard in pores, but that Fitch and Moody's were used as well. Now, as always, there are still questions around Tether. Matt Levine on Odd Lots recently lamented that it's just simply out of sync with market norms to not disclose who these firms whose debt

in commercial paper is held. Still, the ratings grade of the debt is, for many, a reason to nominally increased confidence in the backing of USDT. Then there is USDC. In June, Circle announced one of the largest fundraising rounds in history, raising 440 million. In July, the company announced that it was going public via merger with the Concord Acquisition Corp's back at a valuation of $4.5 billion. Around that time, Circle CEO Jeremy Allaire said that the company intended to become one of the most transparent in the world as it set out on a journey effectively of becoming a regulated bank. Part of that was a new commitment to their own reserve attestations, which they delivered on shortly thereafter. There were a couple different takes when Circle made those attestations.

The first was that they were a lot cleaner and better footnoted than tethers. But the other was that there was still a fair bit of commercial paper in corporate bonds and other things that weren't really cash. The issue was that Coinbase, one of the backers of the USDC consortium, still had language on its site that said every USDC was backed by a dollar in a bank. That created some hot water, and Bloomberg revealed more details. Quote, according to Circle, U.S.D.C. coins reserves have not been all cash for more than a year. The reserves were only in cash until March 2020 when the company added short-term U.S. Treasuries to accommodate the coin's rapid growth.

According to a Circle spokesperson, who said the coin's disclosures also changed to reflect that. The coin's reserves moved to a broader portfolio of investments in May 2021, the spokesperson said. Because of this, and with that goal of transparency in mind, earlier this week's Circle updated their stance. Here's what Jeremy Aller had to say about it. USDC reserves update. This morning we announced that effective in September, USDC reserves will be held in 100% cash and short duration U.S. Treasuries. At Circle, we are seeing rapidly growing interest in digital currency by leading global payment networks, internet-scale commerce and digital media companies, and a broad range of

fintechs and other financial institutions. This growth has rightly brought significant federal regulatory attention, as regulators consider the implications of digital currencies growing from $100 billion to potentially supporting trillions of dollars in economic activity in the coming years. Since inception, USDC reserves have been bound by the permissible investment rules under state money transmission regulations, which is how Circle is regulated today. These rules protect consumers and ensure one-to-one dollar liquidity for USDC at all times. We also recently announced our intention to become a full-reserved national bank, operating under the supervision of the Fed, Treasury and OCC, and the FDIC, while continuing to innovate in the application of digital currency

and blockchain-based financial market infrastructure. Given our commitment to maintaining high standards, which in some cases go beyond those required by our regulators, we will, effective in September, hold all U.S.D.C. reserves in cash and short-duration U.S. government treasuries, which will be visible in our September at a station. The national dialogue around dollar-digital currencies is rapidly evolving, and we are encouraged by the work of policymakers and federal agencies to understand the opportunities presented by this breakthrough technology. As industry and government work together on the appropriate future supervisory standards, we are committed to maintaining or exceeding those standards, driving innovation and building reliable, trusted, secure, and

compliant infrastructure for dollars on the internet. So basically, this is just more of that reinforcement that Circle is saying that we are going to be the most regulated, the most up to snuff, the most ahead of regulators institution out there. And that to me puts way more weight on this idea, that they're, if not explicitly positioning themselves to become the de facto digital dollar, at least leaving that possibility open. Still, these guys aren't the only players. Paxos took a shot at the USDC consortium, basically raising their hand and saying, yo, we've always been dollar-backed.

Paxos also just raised $300 million this year at more than a $2 billion valuation, and this week announced that they were changing their token from Pax to USDP to better make it clear that it was a USD stable coin. So ultimately, who wins and who loses with this? Well, the losers are those who are genuinely using stablecoins to try to work outside the system. However, the good news for them is that algorithmic defy stable coins are probably going to fill that niche. It's also a loss for politicians who want to paint in a broad brush how unregulated this industry is. And who wins?

Well, basically everyone else. More transparency, more competition. These are things that make for a dynamic, fast-growing industry. So I think this is a genuinely good phase. Perhaps going back to my historical moments kind of setup, we will look back at the summer of 2021, with everything that happened around the infrastructure bill and every other regulatory thing that's about to happen, as the shift to a very different moment in the history of the formal U.S. economy in its relationship to crypto assets. For now, I hope you're having a great weekend. I appreciate you listening.

And until tomorrow, be safe and take care of each other. Peace.