Matt Levine, like me, loves discussing stable-coin business models. In a recent opinion column he concludes that there is at least some prima facie evidence that transparency is not rewarded. At least not in the short run.
I have covered this ground in previous posts but at a time when the banking industry is seemingly demonstrating a perennial incapacity to learn from past mistakes, it is worth examining again the lessons to be drawn on the role of information and transparency in banking.
So starting with the basics …
Most of the leading crypto stablecoins have a pretty simple model: You give some stablecoin issuer $1, the issuer keeps the dollar and gives you back a dollar-denominated stablecoin, and the issuer promises to redeem the stablecoin for a dollar when you want. Meanwhile, the issuer has to hang on to the dollar.
Next he dives down a bit into the mechanics of how you might go about this. Matt identifies two basic models …
1.The issuer can try to work nicely with US regulators, get various licenses, and park its money in some combination of Treasury bills, other safe liquid assets, and accounts at regulated US banks.
2. The issuer can be a total mystery! The money is somewhere! Probably! But you'll never find out where.
In practice Matt argues we have two examples of these different strategies …
USDC, the stablecoin of Circle, is probably the leading example of the first option. USDT, the stablecoin of Tether, is probably the leading example of the second option.
Matt, like me, is a traditional finance guy who struggles with the crypto trust model…
Me, I am a guy from traditional finance, and I've always been a bit puzzled that everyone in crypto trusts Tether so completely. You could put your money in a stablecoin that transparently keeps it in regulated banks, or you could put your money in Tether, which is very cagy and sometimes gets up to absolutely wild stuff with the money. Why choose Tether?
But over the recent weekend (11-12 Mar 2023) of banking turmoil USDC's transparent strategy saw USDC depegged while USDT did not. The interesting question here is whether Tether is being rewarded for better portfolio risk management choices or something else was going on.
Matt sums up …
One possible understanding of this situation is that Circle made some bad credit decisions with its portfolio (putting billions of dollars into a rickety US bank), while Tether made excellent credit decisions with its portfolio (putting billions of dollars into whatever it is putting billions of dollars into). And, by extension, the traditional regulated US banking system isn't that safe, and Tether's more complicated exposures are actually better than keeping the money in the bank.
Another possible understanding, though, is that banking requires mystery! My point, in the first section of this column, was that too much transparency can add to the fragility of a bank, that the Fed is providing a valuable service by ignoring banks' mark-to-market losses. Circle does not provide that service. Circle keeps its money in a bank with financial statements, and that bank fails, and Circle dutifully puts out a statement saying "whoops we had $3.3 billion in the failed bank," and people naturally panic and USDC depegs. You have no idea where Tether keeps its money, so you have no idea if anything went wrong. This has generally struck me as bad, but it might have some advantages.
Tony - From the Outside
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