TEN STABLECOIN PREDICTIONS AND THEIR MONETARY POLICY IMPLICATIONS.

• Author: Long, Caitlin

Thank you to the Cato Institute for your kind invitation for me to address you today. I'd like to make clear that these remarks are mine personally and not those of Avanti or any other group with which I'm affiliated.

Jim Dorn hooked me for this way back on February 11, 2020, when the world was a very different place. COVID-19 was already ravaging the world, but back then most hadn't predicted the regime-shifting impact it would have on physical cash and the face-to-face processes involved in banking. End-to-end digital ways of transacting have suddenly replaced long-entrenched analog ways of doing things. And one place where that regime shift had a massive impact relative to its pre-COVID status is the U.S. dollar stablecoin market.

Stablecoins are financial obligations issued on a blockchain. They are generally fully collateralized with either fiat currency deposits at a bank, or with short-term government bonds held at a custodian. They're issued only by nonbanks, although FINMA in Switzerland does allow Swiss banks to issue Swiss franc-denominated stablecoins. Usually stablecoins do not pay interest, and they are designed to trade at par with the fiat currency. Because they are issued on a blockchain, they usually settle in minutes, with irreversibility, and--critically--they are "programmable," which means users can build their own software applications to interact with them.

The value of U.S. dollar stablecoins outstanding on the day Jim contacted me was $5.6 billion. Today, it is $22.1 billion. How prescient of Cato!

But the real story is that annualized stablecoin trading volume is $16 trillion by one measure (Coinmarketcap.com), which is huge compared to the U.S. B2B payment volume of $25 trillion (Mastercard 2018). How does $16 trillion of trading volume happen when a base of only $22 billion of the underlying is outstanding? Answer: velocity. One stablecoin is turning over at a reported rate of 914x per year right now. Another is at 158x, and another is at 70x. By looking at publicly available blockchain data, it's easy to confirm that the average velocity of U.S. dollar stablecoins is at 109x--again, this is verified data. These are eye-popping velocities relative to the velocity of traditional forms of U.S. dollars. Something interesting is happening here.

But what does it mean for monetary policy? Remember, in the United States, stablecoin issuers are in all cases nonbanks. But stablecoins do impact the traditional financial system in two ways. First, they are an important new source of demand for T-bills and other Level 1 high-quality liquid assets (HQLAs)--the very same, scarce high-quality liquid assets that traditional banks need for meeting their capital and liquidity coverage ratio requirements, and which also are so critical to monetary policy transmission channels such as the repo and other pledged collateral markets. Second, stablecoins can touch traditional banks directly, as banks may hold the cash collateral backing the stablecoin obligations of nonbank issuers. Indeed, the OCC in September explicitly acknowledged that U.S. national banks may do this.

Ten Predictions

With that as background, here are my 10 stablecoin predictions and their monetary policy implications.

Prediction 1

U.S. dollar stablecoins outstanding will quadruple again to more than $100 billion by year-end 2021.

Prediction 2

U. S. dollar stablecoin velocity will continue at "shock and awe" levels relative to the velocity of traditional forms of U. S. dollars. Again, high velocity is the real story about stablecoins. What is causing that, and is it sustainable? The key characteristics of stablecoins are fast settlement; settlement finality; traceability on a blockchain; public, open-source protocols; and, probably most importantly, programmability--in other words, faster, better, cheaper technology. These are all desirable characteristics to many users, ranging from digital asset traders to everyday businesses. Among the everyday businesses that are using stablecoins, according to the CEO of one stablecoin issuer, are "e-commerce marketplaces, advertising networks, luxury goods producers, recruiting platforms, digital content markets, peer-to-peer lending platforms, payment companies, software firms, professional services firms, rewards businesses, mobile banking providers and other internet companies" (De 2020).

It's worth stepping back to discuss the origin of stablecoins. They were invented to solve real problems. Trades in digital assets settle in minutes and with finality--that is, once a bitcoin is sent, it's gone and it can't be reversed. But U.S. dollar payment systems don't work that way. For example, ACH payments can take days to settle and can be clawed back by the sender. This is a real risk issue for intermediaries in digital assets. If, for example, a customer purchases bitcoin with an ACH transfer, takes delivery of the bitcoin, and then claws back its ACH transfer, the intermediary is out both sides of the trade. This is a huge risk. If the U.S. dollar leg is in the form of a stablecoin, though, the risk is minimal or potentially even zero. The problem for institutional digital asset traders who typically don't pay with ACH is slightly different but it's still there--they can't settle both the digital asset and U.S. dollar legs of their trades simultaneously, 24/7/365, with finality. This means counterparty risk abounds because one side is carrying the unsettled trade while waiting for the dollar leg to post with finality (FX traders may recognize this as "Herstatt risk"). So, stablecoins go a long way toward solving fundamental risk issues in digital assets, and therefore it's no surprise that the digital asset industry invented a new way to settle the U.S. dollar legs of their trades.

In sum, high stablecoin velocity is no accident because stablecoins really are a faster, cheaper, better, auditable--and programmable--way to move U.S. dollars. Indeed, a FEDS Notes piece written in August 2020 by Wong and Maniff explores the concept of...