Econ 101: Bank Deposits and Stable Coins

I have always been fascinated by the details of money and payments and written a lot about it. “Econ-101: Money”  With the introduction in the US of dollar Stable Coins and potentially the retail (bank operated) version that might be established by our central bank (Central Bank Digital Currency) I find it interesting to compare how a payment with a dollar stable coin is executed relative to a payment with a dollar bank deposit.

The totally safe foundation of the dollar are the liabilities of the Federal Reserve Banks (we have twelve of them). These liabilities are currency (Federal Reserve Notes) and deposits banks have with their district Federal Reserve Bank, so called reserve deposits. Here in Washington DC our Fed is the Federal Reserve of Richmond. These two Fed liabilities (C+R) together are referred to as High Powered or Base Money.

As explained in my “Econ 101: Money” blog linked above, when you pay someone for a purchase with a check (or electronic payment order) drawn on your bank, the recipient does not accept an increase in their account at your back because they will almost certainly have their deposits in their own bank and deposits in banks do face the small risk of the bank failing and not being able to honor its deposits. Your payment from your bank deposit will be transferred to your payee’s bank and their deposit account via the debit of your bank’s deposits with the Fed and credit of the payee’s bank’s Fed deposit. When your payment is thus “settled” your obligation has been fulfilled and the seller has no further claim on you. Your bank deposits are ultimately claims on the Fed.

Payment of dollar Central Bank Digital Currency (if the Fed ever creates it) is a different story. Your transfer of your CBDC dollars to the seller is the whole story. Your CBDC (whether issued by your bank or directly by the Fed) is a direct claim on the Fed. Transferring it directly to the seller gives the seller a direct claim on the Fed. Thus, no other transactions are needed to provide the seller will the full certainty of such a claim.

Dollar stable coins issued by different banks or other financial enterprises are more like our VISA cards which are issued by around 15,000 different institutions. Mine is issued by United Airlines. Merchants who accept payment via any of these VISA issuers do so because of their confidence in the VISA network’s commitment to reliably delivering payment to the merchants bank account. It remains to be seen whether all or most stable coin issues achieve the same confidence and thus universal acceptance that the accepting party can redeem them for a dollar deposit to its bank account. Regulations that establish virtual certainty that dollar stable coins are fully and safely banked by liquid dollar assets will be essential. Such backing will enable any recipient of such a stable coin payment to redeem it for a deposit to the recipients own bank account.

A similar issue existed back in the days of currency notes issued by commercial banks. When they were accepted far from the issuing bank, they generally were given a lower (discounted) value. The issuance of National bank notes ended in 1935 when the newly established Federal Reserve System acquired a monopoly on bank note (currency) issue.