Stablecoin growth has grasped the Fed’s attention: Avanti Bank & Trust CEO
Yahoo Finance Video
Caitlin Long, Avanti Bank & Trust Founder & CEO, joins Yahoo Finance live to discuss how the crypto market is faring amid the pandemic.
Video Transcript
ZACK GUZMAN: Well, it started with a whisper at the Fed, just one mention of stablecoins. But it's grown into a bit more of a serious warning when it comes to at least looking into potential systemic risks being posed by cryptocurrencies, particularly the explosion of stablecoins. And as a quick refresher, there may be good reason to pay attention to them. Stablecoins are a special type of cryptocurrency that try to maintain the price of one US dollar. In that sense, they're not that much different than a money market fund, which also balances out to keep shares at $1.
But they are a bit different in that they aren't regulated in what they can hold. To keep prices at $1, the largest stablecoin, for example, Tether, which, in its early days, purported to be backed 1 to 1 by US dollars, earlier this year, revealed that it only was back by about 3% in cash holdings. Most of its cash equivalents were held in short-term debt in the form of commercial paper. But it even held corporate bonds and precious metals, something that a normal money market fund would normally not be allowed to hold.
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And there is, of course, precedent for why the Fed would be worried here, they had to step in to effectively bail out money market funds during the '08 financial crisis when they got hit with massive withdrawals and the panic that ensued there. It almost crashed the whole system. And take a listen to what Boston Fed President Eric Rosengren said on Yahoo Finance last week, as he was connecting the dots in that space.
ERIC ROSENGREN: I do worry that the stablecoin market that is currently pretty much unregulated as it grows and becomes a more important sector of our economy, that we need to take seriously what happens if people run from these type of instruments very quickly, and just like the money market funds, caused a bad disruption in credit markets. I think a future financial stability problem could be occurring if we don't start thinking carefully about what happens to things like stablecoins next time we have a bad market difficulty.
ZACK GUZMAN: Joining us now for more on that is one of the smartest people in crypto, the CEO and founder at Avanti Bank, among the first to win a banking charter in crypto. Caitlin Long joins us now. And Caitlin, good to be chatting. I guess, you know, if you think about the size of Tether, it's not small, $65 billion roughly, roughly the same size of one of the Reserve funds we run into issues in the crisis. I mean, what do you make about the attention that it's getting from the Fed sablecoins writ large, the attention they're getting from the Fed now?
CAITLIN LONG: Well, stablecoins have been getting attention from the Fed for quite a while. It's just maybe hit most mainstream folks' radar screens more recently because you saw, actually, Jay Powell himself record a video, which is not very common. For those of us Fed watchers, you don't see that very often. And he talked about stablecoins back then. You just played the clip from Boston Fed President Rosengren.
But if you go back, actually, Lael Brainard, Governor Lael Brainard been speaking about stablecoins for quite some time. She holds the remit within the Federal Reserve for payment systems. So this has been on her radar screen for a while. And she's been talking about the potential for systemic risk.
But one of the things that happened-- and kudos to Yahoo Finance for getting that Rosengren interview-- the Federal Reserve, for the first time, mentioned one of the companies by name. I can't think of another example when the Federal Reserve mentioned a company as a potential systemic risk before there was actually any risk that actually happened, right? Any issues that happened. And I talked to a number of sort of Fed watchers who have a little bit of proverbial gray hair, and none of us could think of another example of that.
So that's why the Friday speech, in part, was unusual. It repeated some of the same concerns about systemic implications, but actually named one of the companies by name.
ZACK GUZMAN: Yeah, I suppose there's not a lot of examples out there, too, as kind of an institution like that at its size that also settled with the New York attorney general office around some pretty serious allegations about not having the backing to say or to match up with what they said they had over there at Tether.
But one of the questions, I guess, that a lot of people in crypto might push back on is the idea of maybe not seeing a, quote unquote, "run" on withdrawals in Tether. Because it's used, and we know how much volume it makes up in these crypto trades. We don't see a lot of people maybe withdrawing and converting Tether to US dollars. I mean, how much truth might be there when it comes to looking into that as a piece of the systemic risk?
CAITLIN LONG: Well, all stablecoins are subject to some of the run risk. So for example, there was an accidental hard fork that lasted for a few hours in Ethereum last November. Accidental hard forks are-- they happen on blockchains. These are not unusual activities. And usually, within minutes, they resolve. Most people don't even pay attention to them. The reason why the one in November was potentially significant is that it lasted for hours.
But at the time, our engineering team and-- here at Avanti-- and I were speculating what would happen if the stablecoin issuers that had issued on Ethereum had to redeem within the span of minutes or hours all of the stablecoins outstanding and cash out the assets? That's an example of one of the potential run risks.
I don't know that that's what Rosengren was referring to. Because he was more referring to what would happen if there were issues in the short-term credit market, i.e. the commercial paper market, that could end up spilling over into mainstream markets that the crypto industry could cause, given the fact that Tether has roughly half of its reserves in commercial paper. Now they've never disclosed what type of commercial paper that is.
And I don't know if the Federal Reserve has more information than the rest of us about what that commercial paper is. In theory, the Fed does have that information. Because there is a correspondent bank somewhere and a custodian bank somewhere holding those assets for Tether. But we just don't know how much the Federal Reserve has dug into that issue. They're certainly flagging it. And again, what's unusual is they named a company by name. That just doesn't happen. They usually talk in general terms.
ZACK GUZMAN: Yeah, the only disclosure that I've seen, too, from Tether that they've written on was that they said that the majority of the commercial paper they hold was from A2 rated level companies and above, but not much, I think, beyond that. But when it comes to that, I mean, obviously, it's an interesting point because it's one of those stablecoins that is, obviously, very large in the crypto space. And it revolves around trust in what is supposed to be a trustless system. You kind of have to trust that they have their commercial paper holdings in order and that everything's right here.
And it maybe points to other systemic risks when we talk about crypto lenders. There hasn't been a lot of transparency on some of these lending platforms about maybe how levered they are or what they look like, which is, I guess, supposedly kind of one of the issues around this that got us into trouble in the last financial crisis. So talk to me about what you're seeing there and maybe how much more can be done to address the issue of leverage in crypto now.
CAITLIN LONG: You know, Zack, it's so interesting. Because one of the biggest critiques I've had of the traditional financial system, which is where I spent 22 years before jumping over to crypto full-time, is the information asymmetry. That's the biggest frustration that people have, that users have with the financial system, is usually that your counterpart holds more information than you do. And you don't really know everything they know. And there's no transparency.
And the intermediaries in the crypto industry are guilty of the same thing. They have information that the users don't have. And we just don't know whether any of the counterparties-- I'm not singling anyone out by name. They're all guilty of it. There's just not disclosure. There is a movement in the crypto industry for intermediaries to disclose what's called proof of reserves, which is a cryptographic proof that's verifiable using public blockchains to prove that the intermediaries actually do have reserves.
But of course, if the reserves are traditional financial assets, you couldn't cryptographically prove those because they're not issued in a crypto native format. So only the crypto native companies can offer that proof of reserves. And I welcome that because it-- when crypto native companies are doing those proofs of reserves, it does solve that information asymmetry problem. Then everyone actually has access to the same information.
And that is one of the things that, frankly, the DeFi world is better at than the centralized world. Because that information-- now there may be other issues in DeFi. There may be bugs in the smart contract, right? We've seen that in a number of instances. But the ideal that they're reaching for is a full transparency, where there is no information asymmetry. And you don't have a financial institution that has more information than you do. And you have no idea whether that financial institution is even solvent.
What we've seen in-- and when financial institutions go down, whether it's in crypto or whether it's in the mainstream world, what we've seen is that there's, behind the scenes, a lot more leverage than any of us thought there was, right? That happened in Lehman. That happened in Mt. Gox and Quadriga in the crypto industry, right? It always happens that way.
ZACK GUZMAN: It's a very good point. And it's one that I think, you know, increasingly might be getting overlooked. You can love Bitcoin. You can love the technology. But the systems being around it or being built around it are very important to watch. And Caitlin Long, appreciate you coming on here to chat to walk us through all of that, the CEO and founder there at Avanti.