Bank of America CEO Brian Moynihan recently made the news when he cited a Treasury study estimating that USD-pegged stablecoins that offered a yield could lead to a migration of $6 trillion out of conventional banks. Although he has a dog in the fight, Moynihan’s fears are plausible. Ever since the GENIUS Act passed, I have been stressing that it provided protection to the conventional banks by prohibiting stablecoin issuers from paying interest to their customers. Moynihan is now urging Congress to close other mechanisms by which stablecoin holders can be provided a yield.
We can quote from an article by Brian Manga on The Block to appreciate the various forces at work:
Moynihan said stablecoin structures resemble money market mutual funds, with reserves held in short-term instruments such as U.S. Treasurys rather than recycled into bank lending. In that setup, he said, funds sit outside the traditional banking system, shrinking the deposit base banks rely on to support loans to households and businesses.
“If you take out deposits, they’re either not going to be able to loan or they’re going to have to get wholesale funding, and that wholesale funding will come at a cost,” Moynihan said.
Legislative efforts to address these concerns are currently focused on the latest negotiated crypto market structure bill proposal released by Senate Banking Committee Chair Tim Scott on Jan. 9. The draft text includes a provision that prohibits digital asset service providers from paying interest or yield to users for merely holding stablecoins.
Notably, the bill introduces a distinction for activity-based rewards, permitting incentives tied to staking, providing liquidity, or posting collateral, while banning rewards for idle balances sitting in accounts.
The juxtaposition of these two issues—namely, the claim that the proliferation of stablecoins will make loans more expensive and that digital asset service providers could receive rewards for using their stablecoins—is central to what economists call “fractional reserve banking.” It is the lens through which we can make sense of these disputes over stablecoins.
Explainer: Fractional Reserve Banking
Right now, if you walk up to a teller at Bank of America and hand over ten $100 bills to deposit into your checking, the balance on your account will be credited with an extra $1,000. You can walk around town, thinking you have an extra $1,000 “in your account,” enabling you to spend that much more when you swipe your debit card, or to withdraw that much more in cash from an ATM.
However, as is well understood, Bank of America doesn’t leave your original currency deposit sitting in a vault. No, it takes your deposit and “puts it to work,” by making loans to other BofA customers. That’s how the bank makes money, and it’s why it can afford to pay you interest on your checking account balance.
In contrast, under a 100 percent reserve approach, the bank would have to keep your funds in the vault. It wouldn’t be able to pay you interest on your checking balance, and in fact would have to charge you a fee to pay for the infrastructure and personnel necessary to provide you with checking account services (including the system of ATMs across the country).
This model can still work, because banks could still earn a spread on time deposits (as opposed to demand deposits). For example, if you used your original $1,000 in currency to buy a one-year CD issued by Bank of America, you could earn 2.5 percent (according to their website as of this writing). Bank of America could then invest your funds in a separate project where they earn (say) 8.5 percent, netting a 6-point spread.
Many economists, going back to David Hume in the 18th century, have written favorably of a 100 percent reserve banking system (as I summarize in the beginning of this journal article), because they argue that it would promote financial stability. Under 100% reserves, banks can’t “create money” with the mere act of granting a loan. In our CD example, if you hand over $1,000 to BofA to obtain a CD, you don’t have your $1,000 for the year. So when BofA lends it out to someone else, all that has happened is your money was transferred to the other borrower, for the duration of the CD. But if instead you had put your $1,000 in currency into your checking account—if BofA obeyed a 100% reserve rule—then nobody else would be able to spend more money. That money would still be under your control.
But with fractional reserve banking—our current arrangement—when you put your $1,000 into a checking account, you still think you have it. But if BofA lends (say) $900 to somebody else at the same time, now that person thinks he has an extra $900 in his checking account too. So this process genuinely expands the money supply (as measured by M1, M2, etc.) by $900, causes price inflation, and makes bank runs possible. (The Austrian School also blames the business cycle itself on this practice, which is the focus of my journal article on the topic.)
Back to Stablecoins
With that context, we can now see more clearly what is driving the current dispute over stablecoins. The GENIUS Act not only forbade payment stablecoin issuers from paying a yield to their customers, but it also required them to hold 100% reserves (in the form of FDIC-insured bank deposits, T-bills with 91 days or less to maturity, or other instruments equivalent to these) for their outstanding stock of stablecoins. This was a logical connection, intended to promote trust and stability in the stablecoin sector. The ostensible rationale was, if the public is going to start holding USD stablecoins thinking they are “equivalent to electronic dollars,” then legislators wanted safeguards in place to ensure that a “run” on stablecoin issuers wouldn’t cause a financial crisis.
However, even though the GENIUS Act forbid the payment of yield directly from the stablecoin issuer to the user (i.e. the person holding a particular stablecoin), it didn’t prohibit other entities from paying a yield to people for parking their stablecoins with the entity. For example, just now I googled “does USDC pay interest” and this was the result:
USDC does not pay interest directly just by holding it in a private wallet. However, you can earn competitive yields, often ranging from 3% to over 10% APY, by depositing USDC into centralized crypto platforms (e.g., Ledn, Nexo), staking on exchanges like Kraken, or using Coinbase rewards. These rewards are generated through lending activities.
And so we see, even though the GENIUS Act prohibits the stablecoin issuers from acting as fractional-reserve banks, it leaves open the possibility for other platforms to act as them. It would be as if legislation prevented Bank of America from paying interest on checking accounts and maintaining 100% reserves of currency in the vault, but allowed BofA customers to deposit their BofA checking balance into a Wells Fargo account that paid interest because it lent out those same BofA balances to other borrowers.
If the purpose of the legislation is to prevent the instability associated with fractional reserve banking, then it wouldn’t work to allow this type of move for the opening up of checking accounts, with on-demand withdrawal, for the Wells Fargo accounts funded with BofA balances. However, if Wells Fargo could demonstrate that it was only paying interest to clients who locked their BofA funds up for a specified time period, then it would still be consistent with 100% reserve banking.
I hope the analogy is clear. In the current dispute over stablecoin legislation, Moynihan and other critics are correct when they argue that the original intent of the GENIUS Act is circumvented if platforms can simply pay yield directly to customers who park their stablecoins with them. On the other hand, the platforms are also correct when they argue that there is an important distinction between paying interest merely for a deposit, versus paying it for an “activity” such as staking, in which the stablecoins are “deployed” and can’t be double-spent by the original owner.
Conclusion
In wrapping up, I must emphasize the hypocrisy of Moynihan and other defenders of the conventional banks vis-à-vis stablecoins: Fundamentally, what Moynihan is insisting is that the stablecoin sector be denied the privileges currently granted to the banks. He wants Bank of America to be able to pay (paltry) interest on checking accounts, and especially he wants to use his customers deposits to make other loans, in things much riskier than 3-month T-bills. (I.e. Bank of America does not obey the reserve requirements that the GENIUS Act placed on stablecoin issuers.) The reason loans might cost more if deposits migrate to stablecoins, is precisely because the 100% reserve requirement prevents stablecoin issuers from “creating money” the way Bank of American currently can. But that’s a feature, not a bug, of the GENIUS Act framework.
Dr. Robert P. Murphy is the Chief Economist at infineo, bridging together the dependability of Whole Life insurance policies with the benefits of blockchain-based finance.
Twitter: @infineogroup, @BobMurphyEcon
Linkedin: infineo group, Robert Murphy
Youtube: infineo group
To learn more about infineo, please visit the infineo website