Are stablecoins safer than bank deposits?
There are serious concerns as interest rates rise globally, given that governments have kept interest rates extraordinarily low and even encouraged (or some argue, forced) so-called banks to make decisions which are now coming back to haunt them. The latest casualty in the US is Silicon Valley Bank (SVB) which has become the second biggest bank ever to fail in America. SVB saw its deposits rise from $62billion in 2018, to over $190billion in 2021 and, in an effort to generate better returns than the 0.25% returns offered by the FED, SVB proceeded to acquire 10 year-dated commercial mortgage debt instruments offering 1.5%. The issue has been that these 10-year bonds, if cashed in early, would crystallise huge losses.
SVB had been a ‘darling’ of Silicon Valley in helping tech firms, but once there became a whiff of trouble then depositors withdrew their cash and forced SVB to start encashing its longer-term bonds to meet short term cash demands. However, this rush by depositors has not merely been restricted to SVB; as the Federal Reserve has increased interest rates, savers have searched out higher returns. According to Federal Deposit Insurance Corp. data, the impact from this has been that, in 2022, commercial bank deposits fell for first time since 1948 as net withdrawals rose to $278 billion. In turn, the money being withdrawn from banks has led to certificates of deposits (CDs) expanding to be worth $1.7 trillion in the US. Meanwhile, money market funds now exceed $3trillion and with almost $5trillion now being held outside of the banks this therefore represents almost 25% of the cash in circulation in the US. Often referred to as M1 this is the amount to cash available in the economy, comprising cash held in current and deposit accounts (i.e., money that is in cash or can be quickly converted into cash). The value of cash in US as the chart below indicates, has expanded massively from $5trillion in 2020 to, over $20 trillion in 2022.
Cash explosion as FED floods the US with cash
The trouble is, how long will depositors accept 0.5% and leave their cash in a bank when they can earn 4% by buying in a money market fund or a CD? The more people who wake up to this and the more deposits that are withdrawn from banks, not only does this cause a challenge to repay people their money but it leaves less money for banks to lend to other businesses. Obtaining a loan becomes harder which, in turn, puts pressure on the economy and is likely to force banks to charge higher interest rates to compensate for the higher risks due to worsening economic back drop. Some would describe this as a perfect storm, so highlighting fundamental challenges of our fractional banking system. It is not simply banks facing challenging times ahead; listed companies globally have borrowed massive sums of capital and more often than not have bought back their shares as a way to increase/raise earnings per share (EPS) Historically, company executives share option schemes have been predicated on growing EPS as an incentive to grow earnings. However, there is another way to grow EPS and that is to reduce the number of shares e.g., share buy backs. As reported by Investing.com: “Over the past five years, according to S&P Dow Jones Indices, big U.S. companies have spent $3.9 trillion repurchasing their own stock.” Rather disturbingly a new study, Share Repurchases on Trial, which looked at the impact of share buy backs between 1980 to 2020, found: “In the year of a repurchase, companies that did large or frequent buybacks had slightly lower - not higher -returns. Over longer periods, their returns were indistinguishable”. Publicly-quoted companies have ‘binged’ on low interest rates and borrowed so much that now there are no debt-free companies listed on the S&P500. Below shows the seven companies listed on the S&P 500 that have the least debt.
7 firms listed on S&P500 borrowings of less than $100m
Source: Retire before DAD
All well and good, but how many companies will go bankrupt against a backdrop of higher interest rates? And, make no mistake, interest rates are headed even higher. In the Monetary Policy Report before Congress last Tuesday and Wednesday, Jerome H. Powell, the Fed chair, made it clear that the central bank not only intends to keep raising interest rates, “but will increase them even more than previously anticipated if it deems that necessary to squelch inflation.” So, this leads us back to the title of this article: “Are stablecoins safer than bank deposits?” When you put your cash into a bank, you become a creditor to the bank so if there is a run on the bank and dispositors should be so bold and ask for their cash back in an extreme situation, then depositors have to fall in with other creditors and hope they get their money back.
Now, most people who deposit cash in a bank are protected in the UK by the financial services compensation scheme, being guaranteed to get £85,000 of their money back should the bank go bust. Meanwhile in the US, depositors are protected by the Federal Deposit Insurance Corporation (FDIC), which means that the first $250,000 of their money is secure. But, if you have more than £85,000 in the UK or $250,00 in the US, other than spreading your money across a variety of banks you are risking your capital and could be vulnerable in the same way that Lehman Bank customers were (and now Silicon Valley Bank depositors are beginning to realise they are too). However, instead of depositing money with a bank you could hold a stablecoin, provided it is 100% back by a fiat currency and, arguably, this would be much safer. In effect, banks could issue their own stablecoin and then offer treasury management services (holding $ or € or £), and not lend money to other clients. The downside though, is that this does not generate great returns for the bank, but it does offer their clients a safer, less risky alternative to a good old fashion bank account.
As the Ychart image above demonstrates, there has been a huge expansion in the money supply in the US. This, along with interest rates having been artificially kept low for years via central banks quantative easing policies, means there has to be consequences. Could we see institutions flocking to buy stablecoins as a lower risk alternative to bank deposits? Or, could we even see regulators classing stablecoins as lower risk assets than a bank account because, after all, courtesy of blockchains bringing greater transparency, owners of stablecoins can have access to know where their money actually is.
So, the FED, ECB and Bank of England - are you listening?
Johnny. Something is missing here. Any bank can issue a so called stablecoin. And they can say it is backed by cash, but that still leaves coinholders as unsecured creditors. If there is a bankruptcy all creditors have a claim on the sum of all the assets.
To truly be able to say the stablecoin is asset backed the issuer would have to do at least one of two things: make the vehicle holding the asset bankruptcy remote from the issuer. And, ideally the underlying cash would need to be held with a central bank.
The nuance matters.