Why stablecoin failures could happen again
Published in the Financial Times.
“If stablecoins are not that stable,” governor Olaf Sleijpen of the Dutch central bank warns you end up in a situation where the underlying assets need to be sold quickly, which creates financial stability risks (Interview, November 19). Meanwhile the Nobel laureate economist Jean Tirole says it could result in government bailouts (Interview, September 2).
However this is not really a question of “if”, since stablecoins have already had a government bailout in the US.
Circle’s USD stablecoin held more than $3bn in uninsured, at-risk deposits as “reserves” in the failed Silicon Valley Bank. It should have suffered huge and well-deserved losses on this investment but instead it was egregiously bailed out, along with other crypto and venture capital barons, by the US government. The authorities shifted the losses from the wealthy depositors to the Federal Deposit Insurance Corporation, based on an emergency “systemic risk” declaration.
Could this happen again? Absolutely. The root and continuing problem is that stablecoin issuers are not limited to holding short-term Treasury bills, as is often erroneously claimed, but in reality are empowered to invest in at-risk deposits in both domestic and foreign (from the US viewpoint) banks. The so-called Genius Act regulating stablecoins explicitly provides for this.
Are large, uninsured deposits risky? Of course they are. More than 3,000 US-insured depository institutions have failed since 1980, and many more would have failed if not for recurring government bailout programmes, most recently in 2023. The inclusion of non-US banks adds extra risk, because, in addition to their potential failure, their dollar-denominated deposits are foreign currency liabilities to them, and ultimately depend on the Federal Reserve’s willingness to lend dollars to their own central banks.
The Genius Act thus deeply entangles stablecoin and banking risk, and just as happened in the Silicon Valley Bank case, can transmit banking crises into stablecoin crises: a systemic stability problem indeed.