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🌐Banks concerned USDC stablecoin will become ‘backdoor CBDC’ 🌐with BlackRock help🌐
January 06, 2023
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The Bank Policy Institute is worried that the BlackRock fund used for the USDC stablecoin reserves may access quasi Federal Reserve deposits

Highlights:Ā 

  • Bank think tank worries some USDC reserves may be parked at the Federal Reserve
  • BlackRock now manages the majority of USDC stablecoin reserves through a money market fund
  • Reports claim BlackRock is applying to use Federal Reserve reverse repos (RRPs)
  • The cashflows of RRPs are similar to depositing money at the Federal Reserve

TheĀ Bank Policy Institute, a bank-supported think tank, published a blog post raising concerns that a proportion of theĀ USDC stablecoinĀ reserves could be parked at the Federal Reserve, despite theĀ stablecoinĀ issuer not having a central bank account. If this were allowed, in times of uncertainty when there’s a flight to quality, this could result in bank runs diverting cash into the USDC stablecoin, which might be perceived as being as good as a central bank digital currency (CBDC).Ā 

SinceĀ November, BlackRockĀ has been managing a large portion of the reserve assets of the USDC stablecoin on behalf of theĀ stablecoin issuer, Circle. BlackRock created a bespoke money market fund, theĀ Circle Reserve Fund, which invests in U.S. short-dated Treasuries. It currently manages around two thirds of the assets of the $44 billion stablecoin, which keeps 80% of its reserves in Treasuries.

A December research note from Barclays highlighted that money market funds can use the Federal Reserve reverse repo (RRP) facility.

This involves the fund buying Treasuries from the Federal Reserve, which are resold to the Fed at a future date at a slightly higher price. The net effect of the cash flows, with the transfer of money to the Fed, is not dissimilar to depositing the USDC reserve cash at the Federal Reserve. The BPI called it a ā€˜backdoor CBDC’.

The BPI claims that BlackRock has applied for the RRP facility. It further asserted that the 20% of USDC reserves currently held at banks could be shifted to the RRP program. We’ve contacted Circle and BlackRock to confirm but didn’t receive a response in time for publication.Ā 

The RRP route is potentially better than a synthetic CBDC. The latter involves a CBDC that is backed by a stablecoin issuer’s cash held at the central bank. This reduces counterparty risk because there’s no bank risk. However, the account still belongs to a private entity which means there is some risk, whereas the counterparty of the RRP is the Federal Reserve itself.

BlackRock and USDC for capital market transactions

BlackRock invested in CircleĀ in April as part of a $400 million funding round. At the time, the asset manager said it was interested in using USDC for capital market transactions. But stablecoins are not viewed as a risk-free settlement asset. So the RRP would considerably improve USDC’s risk profile.

There’s generally a strong preference for using central bank money for securities transactions. Fnality is backed byĀ 17 global institutionsĀ and is effectively creating a synthetic CBDC designed for capital market transactions. Some bankers not involved in the project see that as aĀ good interim stepĀ but would still prefer to use a CBDC.

Why the Federal Reserve might refuse RRP access

Looking at the applicationĀ process for the RRP, for starters, the Circle Reserve Fund would need to be operating for a year, so it won’t happen before November 2023.Ā 

A major hurdle for the Circle Reserve Fund could be compliance. The RRPĀ application formĀ asks about the proportion of shareholders in high risk sectors from an AML perspective. Given Circle is the sole shareholder and its involvement in the cryptocurrency and DeFi sectors, that would be 100%.

Is the RRP a temporary tool?

The BPI argues that the RRP was intended to be a temporary tool introduced in 2013. Between 2018 and May 2021 it was used occasionally with tiny balances. The current balance is $2.2 trillion. The spread between the interest rates on reserve balances and the overnight RRP rate is just 10 basis points (0.1%) and used to be 25 basis points. The BPI wants the spread to be reverted. ā€œThe Fed should not only deny Circle’s money fund access to the ON RRP facility, it should take steps to hasten the winding down of the facility as an attractive nuisance.ā€

A perspective beyond banks

Clearly, the BPI’s perspective is biased towards banks, although its concerns are not without foundation. If one accepts that stablecoins can provide utility, then there should be a desire to make stablecoins safer and more resilient. The RRP is one potential avenue to protect stablecoin reserves.

However, a key issue with stablecoins is the network effect. In other words, without intervention, there are likely to be only a handful of widely used stablecoins, or even perhaps a monopoly. While monopolies are highly desirable for the company, they are often suboptimal for the ecosystem. And for stablecoins, a monopoly or oligopoly introduces significant financial stability risks.

To encourage competition, the central bank might cap the figure that can be supported via RRP. Start low, say at $5 billion, and increase the cap as stablecoin adoption expands. If stablecoin issuers are forced to publicize the figure, then rational stablecoin users should migrate to stablecoins with a higher proportion of reserves ā€˜guaranteed’.

However, to date,Ā cryptoĀ stablecoin users have not behaved rationally, as evidenced by the adoption of market leaderĀ Tether. If the proportion ofĀ mainstreamĀ stablecoin usage increases, perhaps that may change.

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GENIUS Act lets State banks conduct some business nationwide. Regulators object

The Senate passed the GENIUS Act for stablecoins last week, but significant work remains before it becomes law. The House has a different bill, the STABLE Act, with notable differences that must be reconciled. State banking regulators have raised strong objections to a provision in the GENIUS Act that would allow state banks to operate nationwide without authorization from host states or a federal regulator.

The controversial clause permits a state bank with a regulated stablecoin subsidiary to provide money transmitter and custodial services in any other state. While host states can impose consumer protection laws, they cannot require the usual authorization and oversight typically needed for out-of-state banking operations.

The Conference of State Bank Supervisors welcomed some changes in the GENIUS Act but remains adamantly opposed to this particular provision. In a statement, CSBS said:

ā€œCritical changes must be made during House consideration of the legislation to prevent unintended consequences and further mitigate financial stability risks. CSBS remains concerned with the dramatic and unsupported expansion of the authority of uninsured banks to conduct money transmission or custody activities nationwide without the approval or oversight of host state supervisors (Sec. 16(d)).ā€

The National Conference of State Legislatures expressed similar concerns in early June, stating:

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Evolution of nationwide authorization

Section 16 addresses several issues beyond stablecoins, including preventing a recurrence of the SEC’s SAB 121, which forced crypto assets held in custody onto balance sheets. However, the nationwide authorization subsection was added after the legislation cleared the Senate Banking Committee, with two significant modifications since then.

Originally, the provision applied only to special bank charters like Wyoming’s Special Purpose Depository Institutions or Connecticut’s Innovation Banks. Examples include crypto-focused Custodia Bank and crypto exchange Kraken in Wyoming, plus traditional finance player Fnality US in Connecticut. Recently the scope was expanded to cover most state chartered banks with stablecoin subsidiaries, possibly due to concerns about competitive advantages.

Simultaneously, the clause was substantially tightened. The initial version allowed state chartered banks to provide money transmission and custody services nationwide for any type of asset, which would include cryptocurrencies. Now these activities can only be conducted by the stablecoin subsidiary, and while Section 16(d) doesn’t explicitly limit services to stablecoins, the GENIUS Act currently restricts issuers to stablecoin related activities.

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The controversy over Section 16(d) reflects concerns about creating a regulatory gap that allows banks to operate interstate without the oversight typically required from either federal or state authorities. As the two Congressional chambers work toward reconciliation, lawmakers must decide whether stablecoin legislation should include provisions that effectively reduce traditional banking oversight requirements.

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šŸ’³ PayPal:Ā 
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Dubai regulator VARA classifies RWA issuance as licensed activity
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Come to Dubai.

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Ā 

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If you find value in my content, consider showing your support via:

šŸ’³ PayPal:Ā 
1) Simply scan the QR code below šŸ“²
2) or visit https://www.paypal.me/thedinarian

šŸ”— Crypto – Support via Coinbase Wallet to: [email protected]

Or Buy me a coffee: https://buymeacoffee.com/thedinarian

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Ā 

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