The authors believe that stablecoins and bank deposits serve as complements rather than substitutes, and that the rise of stablecoins has not produced large deposit outflows, with bank deposits increasing by over $6 trillion since 2018.
Bitcoin and other crypto tokens fluctuate in price — sometimes wildly — behaving more like speculative securities or options than money. But stablecoins are a different matter, as their name suggests. Are they, as their proponents claim, a truly “internet-native” means of payment — in short, the future of money? Or are they, as critics warn, a mortal threat to financial stability? We think the former.
Following the passage of the GENIUS Act last summer, the US for the first time has a clear regulatory framework for the issuance of stablecoins. The result has been a boom: Fiat-backed stablecoins have surpassed $284 billion in quantity, led by Tether’s USDT and Circle’s USDC. The Treasury Borrowing Advisory Committee’s (TBAC) “Digital Money” presentation, published in April, adopted and popularized Standard Charted Bank’s forecast that total stablecoin market capitalization would reach $2 trillion by the end of 2028. Treasury Secretary Scott Bessent raised the target to $3 trillion at the Treasury Demand Conference on Nov. 12.
Tempo, a stablecoin payments system incubated by Stripe, just completed a $500 million Series A fundraising round, at a $5 billion valuation. This follows the announcement of a host of other stablecoin-focused blockchains. USDT-focused blockchain network Stable raised $28 million at an undisclosed valuation, while competitor Plasma debuted at a valuation greater than $10 billion. Circle, in turn, announced Arc, a USDC-focused network “where programmable money, tokenized assets, economic contracts, and on-chain markets [can] converge.”
Not everyone is happy about the stablecoin bonanza. The banks, in particular, regard stablecoin issuers as upstarts. Efforts last week by the established financial institutions to influence the crypto-market structure bill in Congress, dubbed the CLARITY Act, caused Coinbase and others to pull their support from the proposal, delaying its planned Senate markup in part over “amendments that would kill rewards on stable coins.”
The odd thing is that the banks are, meanwhile, accelerating their own adoption of blockchain technology. JPMorgan Chase & Co., Citigroup Inc. and Bank of America Corp. are exploring in-house stablecoin solutions and tokenized deposits, while the New York Stock Exchange is seeking Securities and Exchange Commission approval for a tokenized stocks and ETF platform.
What is the argument against stablecoins? Atlantic staff writer David Frum recently claimed that stablecoins “are by far the most dangerous form of cryptocurrency,” and that their failure would require an expensive government bailout.
In a 2021 paper, economists Gary Gorton and Jeffrey Zhang argued that “the closest analogy to stablecoins is found in the US Free Banking Era,” that is, before 1863, when anyone could open a bank. Back then, uncertainty about free banks’ assets caused their bank notes to trade at varying discounts, creating obstacles to commerce and sometimes triggering runs.
Nobel laureate Jean Tirole argued recently that, even when a stablecoin’s backing is real, “small doubts about its completeness can spark destabilizing runs.”
But these concerns are at odds with reality under the GENIUS Act (the name of which is a tortured acronym for Guiding and Establishing National Innovation for US Stablecoins). First, the act strictly limits stablecoin backing to cash, deposits and risk-free Treasury securities with maturities of 93 days or less. Unlike 19th-century banks, stablecoin issuers cannot make or hold loans.
Second, stablecoins display extraordinary network effects. Tether and Circle account for more than 92% of fiat-backed stablecoins, and the top 10 issuers for 98%. This is a level of concentration unthinkable in the US banking industry, but one that simplifies regulatory oversight and the use of these two stablecoins in payments and commerce.
More self-interested critics worry that stablecoins might prove too capable a competitor to the banking industry. Although the GENIUS Act forbids stablecoin issuers from paying interest, it allows third parties such as crypto exchanges to pay rewards for holding stablecoins on their platforms.
Banks have quickly and loudly moved to label such stablecoin rewards a trillion-dollar “loophole” that encourages depositors to move their funds from banks into crypto exchanges, thereby raising bank funding costs and reducing credit to the real economy. Following a recent SEC report, TBAC hypothesized that 37% of all bank deposits, or about $6.6 trillion, were “at risk” of flight to interest-bearing stablecoins.
The nonpartisan but pro-bank Bank Policy Institute (BPI) has forecast that if stablecoins paid interest of 3%, stablecoin demand would increase to $4 trillion; paying interest of 3.5% would increase demand to $5.7 trillion. The BPI argues that such unchecked stablecoin growth would crowd out credit to the real economy, and “bank depositors would transform from funders of economic growth to funders of government growth.”
The American Bankers Association (ABA) in turn has argued that a $2 trillion increase in stablecoin issuance would absorb 10% of banks’ deposit base, requiring them to turn to brokered deposits, Federal Home Loan Bank advances, repo, overnight interbank lending or long-term debt. The ABA estimated that banks’ average cost of funds would increase from 2.03% to 2.27%, reducing credit to households and businesses. “Over time,” the ABA warns, “this could slow economic activity and weaken smaller banks that anchor local communities.”
History might seem to support such concerns. Until 1935, American banks could issue bank notes against government bonds. These notes would then circulate as currency, passing from hand to hand. Crucially, bank notes issued by private banks, with just a handful of brief exceptions, did not bear interest (although both the Union and Confederate governments experimented with interest-bearing notes during the Civil War).
Federal Reserve Bank of New York researchers argued in their recent “Historical Perspective on Stablecoins” that “bank deposits had an advantage over national bank notes in that they were able to earn interest.” This led deposits to supplant bank notes, whose share of bank assets declined from 20% in 1869 to 4% two decades later. Were regulators to allow interest-bearing stablecoins, the New York Fed paper concludes, these could similarly replace today’s zero-interest deposits.
Yet the dominance of deposit accounts obscures the important fact that bank notes in circulation increased over time too, albeit more slowly. During the National Banking Era — that is, after the 1863 National Bank Act established federally chartered banks that could issue bank notes against US government bonds, but before the 1913 creation of the Federal Reserve — national bank deposits and national bank notes in circulation grew more or less in tandem, with a correlation coefficient of 0.82. (The exception was a five-year period of financial instability following the Panic of 1884, when bank note circulation decreased before resuming its rise in step with US economic growth.)
This relationship extended past 1913. Deposits and bank notes diverged only in the 1920s — a time of rapid financialization as Americans went on an unprecedented credit spree — lowering the correlation to 0.62.
How are we to explain the seemingly complementary relationship between deposits and bank notes? Naïve economic theory might suggest that funds necessarily flow to where they earn the highest return. But history shows that bank notes and deposits fulfilled different needs — one provided currency and the other one credit — and thus functioned as complements rather than substitutes.
In his classic 1873 study of the British financial system, Lombard Street, Walter Bagehot explained that banks provided circulating currency through bank notes. This was banking’s most “popular kind of business” and bank notes circulated in cities and towns, changing hands in the course of everyday life. Deposits, in contrast, are created primarily through credits. For example, when a bank extends a commercial loan, it doesn’t create currency but instead credits that business’s account. Bank customers are then able to settle payments amongst each other, sometimes over large distances, and safely carry large balances.
These different needs for currency and credit help explain the uneven growth of deposit banking. In 1873, as Bagehot documents, the Banque de France (the French central bank) had the equivalent of 112 million pounds in circulating notes against 15 million in deposits, while German banks had 60 million in circulation against 8 million in deposits. As late as 1913, continental Europe’s balance of deposits and bank notes remained more or less unchanged.
American deposit banking also grew unevenly, even with significant government help. The 1863 National Bank Act imposed a 2% tax on state bank note payments, later raised to 10% in 1865, causing state banks to retire 97% of their notes by 1867 and to expand their deposit business instead.
National bank notes were in turn driven from circulation not by competition from high-interest deposits, but by the Federal Home Loan Bank Act of July 1932, which established a 1935 deadline for the Treasury to redeem all bonds used as bank-note collateral, allowing the Federal Reserve to replace private bank notes with government currency.
This history has important lessons for understanding the risk, if any, that stablecoins pose to bank deposits today.
First, deposits continue to be primarily driven by credit creation, while stablecoins are driven by crypto trading on centralized and decentralized exchanges. Like deposits and bank notes, they serve more as complements, not substitutes. As a result, both deposits and stablecoins have increased and decreased more or less in tandem since 2018 — when Circle’s USDC launched — with a high correlation coefficient of 0.87. Bank deposits have increased by over $6 trillion, while stablecoins have increased by about $280 billion.
Crucially, stablecoin rewards have been available since October 2019, when Coinbase, the largest US crypto exchange, began offering users 1.25% APY for holding USDC on its platform. The US federal funds rate in October 2019 was 1.5%, while the average savings account rate was 0.18%.
If the banks were right about the threat of stablecoins, the latter’s rise should have produced large deposit outflows. Instead, the monetary and fiscal stimulus deployed to counter the Covid-19 lockdowns triggered a quick increase in credit, and a $4.7 trillion increase in deposits over 2020 and 2021.
The impact on stablecoins was similar if a little slower. Risk assets rallied in 2020, and crypto was no exception. Bitcoin rose from $7,000 and past its previous all-time high of $17,000 to a new peak of $63,000, while the “DeFi summer” saw the quick speculative rise and fall of billion-dollar protocols. All this activity required more dollars both on exchanges and on-chain, triggering a boom in stablecoin inflows that totaled more than $130 billion in two years.
Second, economists from University of California at Los Angeles have shown that, contrary to the assumptions of the TBAC, BPI, ABA and Fed, 70% to 80% of bank assets are practically insensitive to deposit rates. Since 2008, banks have bifurcated into “high-rate banks, which offer deposit rates that are near market interest rates, and low-rate banks, which pay low deposit rates that are very insensitive to market rates.”
This is new. In 2006, when “market rates were similar to today’s, the spread between the 75th and 25th percentiles of deposit rates among the top 25 banks was around 70 bps, whereas today it is around 350 bps.” Low-rate banks offer rates of around 0.01%, while high-rate banks like Marcus sometimes offer interest as high as 4.65%.
This bifurcation was not a product of the global financial crisis, despite their temporal coincidence. Rather, it has likely been caused by the advent of online banking. Low-rate bank customers accept rates close to zero in exchange for valuable bank-bundled services, of which a physical location seems to be an important component.
Third, if low-rate bank customers forgo on average 350 basis points of interest in exchange for traditional “offline” services such as brick-and-mortar branches, the argument that they will migrate to 100% online stablecoins to chase yield strains credulity. We are thus inclined to agree with financial historian Barry Eichengreen, who thinks that flows from bank deposits to stablecoins are unlikely because “banks offer a comprehensive range of services beyond mere payment facilitation — including FDIC-backed deposits and preferential mortgage treatment for longstanding customers — that stablecoin issuers cannot easily replicate.”
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No one is surprised when banks and other financial incumbents argue against measures that might promote innovation. But the argument that stablecoins are a source of instability — and interest-bearing ones especially so — is a bad one. The opposite is quite likely to be true — as Bessent understands. That stablecoins are a new source of demand for all those treasuries he has to sell is only one of the benefits of the GENIUS Act.
Niall Ferguson is the Milbank Family Senior Fellow at the Hoover Institution at Stanford University and the author, most recently, of “Doom: The Politics of Catastrophe.” He is a columnist for The Free Press and founder of Greenmantle, an advisory firm; FourWinds Research; Hunting Tower, a venture capital partnership; and the filmmaker Chimerica Media.
Manny Rincon-Cruz is a financial historian of China, co-founder of FourWinds Research and the founder of Buttonwood, a decentralized finance project.
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