The Breakdown - The Stablecoin Free Banking Debate—What History Really Says

Starting point is 00:00:04 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. What's going on, guys? It is Sunday, August 3rd, and that means it's time for Long Read Sunday. Before we get into that, however, if you're enjoying the breakdown, please go subscribe to it, give it a rating, give it a review, or if you want to dive deeper into the conversation, come join us on the Breakers Discord. You can find a link in the show notes or go to bit.ly slash breakdown pod. All right, friends, we have a few rules here. on this show. One of them is when Nick Carter writes something, we find a way to read it, sort of, or at least reference it. Nick is not only a great writer, he is a very thorough

Starting point is 00:00:49 writer, and what he gifted us this week was a piece that he called the last word on stable coins and free banking. Subtitle, if you're going to compare the two, at least get the history right. Nick's inspiration for this was how frequently these past periods of banking are compared to stable coins and used as justification for while stable coins are problematic, except a story isn't quite as clear as people make it. Now, Nick's version of this, which I will, of course, include in the show notes in which you should absolutely go take the time to read, is 27 pages long. It's basically a short book. I had a few different thoughts on how to do a summary version for you. The first was to use Notebook L.M's audio overviews, but one, I think some of the

Starting point is 00:01:29 novelty has faded off of that. And two, when I did put it in, it was 53 minutes, so not exactly exactly shorter. So what I did instead was I shared the entire piece with Claude and had it rewrite it as a roughly 2,000 word essay instead. The piece it came back with was titled The Misunderstood History of Free Banking and Why It Matters for Stable Coins, and I think it does a pretty good job of giving you the basic ideas of this piece, although again, as I said, to get the full impact, you really have to go read Nix. So what we're going to do is we're going to turn it over to the Eleven Labs version of myself, to read not Nick's original tome, but Claude's shortened down version of it. Big thanks to Nick for his piece and always taking the time to write these sort of things,

Starting point is 00:02:08 and thanks to you guys for listening. Again, I hope you enjoy this piece, the misunderstood history of free banking and why it matters for stable coins. Picture this. You walk into a coffee shop in 1850s America and pull out a banknote to pay. The barista squints at it suspiciously, pulls out a thick reference book and tells you they'll only accept it at a 15% discount because it's from a bank three states away. Sound like a nightmare? This was actually daily life during America's free banking era. And it's the cautionary tale that central bankers love to invoke when discussing modern stable coins. But here's the thing. They're telling the wrong story. Every time a Federal Reserve official or European Central Bank executive discusses stable coins, those

Starting point is 00:02:48 digital tokens pegged to traditional currencies like the dollar, they almost inevitably reach for the same historical parallel. We've seen this movie before, they'll say, shaking their heads knowingly. Private money issuance led to chaos in 19th century America. Do we really want to repeat those mistakes? This comparison has become so ingrained in central banking circles that it's practically gospel. Senator Elizabeth Warren regularly invokes the specter of Wildcat banks that supposedly ran rampant during the free banking era, issuing worthless notes before disappearing into the frontier. The bank for international settlements warns that stable coins, like their historical predecessors, violate the sacred no-questions-asked principle of money, the idea that currency should be accepted at face value

Starting point is 00:03:32 without the recipient needing to investigate the issuer's creditworthiness. The real story of free banking. But what if I told you that this narrative is at best incomplete and at worst deliberately misleading? What if the actual history of free banking, when examined honestly, actually vindicates, rather than condemns the modern stablecoin experiment. To understand why, we need to travel back to a time when the very idea of who could issue money was up for grabs. In the early 19th century, several countries experimented with what economists call free banking, systems where private banks could issue their own currency notes with minimal government oversight.

Starting point is 00:04:11 The results varied dramatically depending on where you look. In Scotland, from 1716 to 1845, free banking was a remarkable success story. story. Scottish banks operated with minimal regulation, issuing their own notes backed by gold reserves. The system was self-regulating through competitive market forces. If a bank started printing too many notes relative to its reserves, competitors would accumulate those notes and present them for redemption all at once, effectively launching a bank run that would drain the reckless bank's gold reserves. This threat kept everyone honest. The Scottish system produced incredibly stable money. Bank failures were rare, only one major bank collapsed in over a century, inflation was minimal,

Starting point is 00:04:53 and Scottish banknotes traded at par value throughout the country. Banks formed voluntary clearinghouses to settle accounts with each other, creating a sophisticated financial network without any central authority dictating terms. Canada tells a similar story. From 1817 to 1890, Canadian banks privately issued currency with minimal government interference. The result? Near zero inflation. Only 12 bank failures over seven decades, with half causing no losses to note holders and no systemic banking crises. Canadian banknotes circulated at face value across the country's vast territory, despite the era's primitive communication and transportation infrastructure. Today's episode of The Breakdown is brought to you exclusively by Grayscale.

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Starting point is 00:06:17 share of the future. America's not so free banking. So why do central bankers focus exclusively on the American experience, which was admittedly more chaotic? Because it fits their narrative, but only if you ignore the crucial details of why American free banking struggled. The American version of free banking, roughly 1837 to 1863, was free in name only. States imposed crippling restrictions that doomed the system from the start.

Starting point is 00:06:46 Most critically, banks were prohibited from opening branches. They could only operate from a single location. Imagine trying to run Starbucks but being legally forbidden from opening more than one store. This unit banking restriction meant banks couldn't diversify geographically, making them extremely vulnerable to local economic shocks. States also forced banks to buy state government bonds as collateral for issuing notes. When the Civil War approached and Southern state bonds plummeted in value, the banks holding them were wiped out through no fault of their own. It would be like forcing modern banks to hold

Starting point is 00:07:20 only Greek government bonds during the 2010 debt crisis. Without branch networks, American banks couldn't build the relationships necessary to form clearinghouses like their Scottish and Canadian counterparts. Notes from distant banks traded at discounts not because the banks were unsound, but because physically redeeming them for gold was expensive and inconvenient. Specialized publications emerged to track the discount rates for hundreds of different banknotes in each city, the 19th century equivalent of checking exchange rates, except you needed to do it for domestic currency. The infamous Wildcat banks, fraudulent institutions that issued notes with no intention of redeeming them, were largely confined to a handful of states with particularly poor regulatory frameworks.

Starting point is 00:08:04 Modern research suggests these wildcats were responsible for. for a tiny fraction of bank failures. Most failures resulted from the structural problems created by misguided state regulations, not from the concept of private note issuance itself. Enter the stable coin. Fast forward to today, and we have stable coins, digital tokens issued by private companies, backed by reserves of traditional assets, and designed to maintain a stable value relative to currencies like the U.S. dollar. Central bankers immediately spotted the parallel to free banking and started issuing dire warnings. But they're missing crucial differences that make modern stable coins far more robust than 19th century banknotes. First, the geographic limitations

Starting point is 00:08:46 that crippled American free banking are irrelevant in the digital age. Stablecoins are globally accessible from day one. Tether, the largest stable coin, trades against virtually every currency on earth across hundreds of exchanges. There's no equivalent to the banknote that trades at a discount because you're too far from the issuing bank, distance is meaningless on the internet. Second, modern stablecoins benefit from real-time, transparent markets that continuously price risk. In the 1850s, information about a bank's condition might take weeks to spread. Today, if traders suspect a stable coin issuer is in trouble, that information is instantly reflected in the token's price across global markets.

Starting point is 00:09:26 The same mechanisms that keep foreign exchange rates in line, arbitrageurs who profit from price discrepancies work around the clock to maintain stablecoin pegs. Third, and perhaps most importantly, modern stablecoin regulation, particularly in the United States after recent legislation, addresses the specific failures of free banking. Major stablecoin issuers must back their tokens 100% with high-quality liquid assets, mainly cash and short-term U.S. Treasury securities. They can't make loans like 19th century banks did, eliminating the risk of bad debts bringing down the system. They must provide regular audits and attestations, they face strict requirements for honoring redemptions. The Power of Market Discipline

Starting point is 00:10:07 What's particularly striking is how modern stablecoins have recreated some of the best features of successful free banking systems through market mechanisms rather than regulation. Just as Scottish banks kept each other in check through competitive note redemption, today's stablecoin ecosystem includes sophisticated traders who constantly probe for weakness. If a stable coin trades even slightly below its $1 peg, arbitragee swoop in to buy it and redeem it for face value, pocketing the difference. This creates immense pressure on issuers to maintain proper reserves. The decentralized finance, defy ecosystem, has created the modern equivalent of 19th century

Starting point is 00:10:45 clearinghouses, automated protocols where different stable coins trade against each other with transparent pricing. Any sign of weakness in a particular stable coin is immediately visible to the entire market. It's like the Scottish note exchange system, but operating 24-7 at the speed of light. Learning the right lessons. The real lesson from free banking history isn't that private money issuance is inherently doomed. It's that the regulatory framework matters enormously. Scottish and Canadian free banking succeeded because banks could branch freely,

Starting point is 00:11:17 diversify their risks, and build cooperative institutions. American free banking struggled because misguided state regulations prevented these stabilizing mechanisms from developing. Modern stablecoins have solved the technical problems that made 19th century private currencies cumbersome, the high costs of verification, redemption, and information transmission. What remains is getting the regulatory framework right, which recent U.S. legislation has largely accomplished

Starting point is 00:11:43 by requiring full reserve backing and regular attestations while avoiding the geographic restrictions and forced bond purchases that doomed American free banking. Central bankers who invoke free banking, banking to attack stablecoins are cherry-picking history, focusing on American failures while ignoring Scottish and Canadian successes. They're comparing the worst of the past with the present, while ignoring how technology and proper regulation have addressed historical problems. The irony is that stablecoins may actually represent the vindication of free banking principles rather than

Starting point is 00:12:15 their repudiation. By combining the competitive discipline of Scottish banking, the technological capabilities of the Internet age and regulatory frameworks that learned from past mistakes, stable coins are proving that private currency issuance can work, just as it did in Scotland two centuries ago. The next time someone tells you stable coins are just wildcat banking for the digital age, remind them that Scottish free banking was one of the most stable monetary systems in history. The problem was never private money issuance itself. It was bad regulation that prevented market mechanisms from working. Get the rules right, and private currencies can be as stable as any government-issued money. That's not speculation. It's historical fact.

Starting point is 00:12:57 All right, guys, back to Real Me. Hope you enjoyed that. Until next time, be safe and take care of each other. Peace.

The Breakdown - The Stablecoin Free Banking Debate—What History Really Says

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