Stablecoins and CBDCs: Their Rise, Risks and Possibilities
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Welcome to Money for the Rest of Us. This is a personal finance show on money, how it works, how to invest it, and how to live without worrying about it. I'm your host, David Stein. Today is episode 527. It's titled, Stable Coins and CBDCs, Their Rise, Risks, and Possibilities. Last week, Circle Internet Group, ticker CRCO, conducted an initial public audit.

offering. Circle is the issuer of the USDC stablecoin with over $60 billion of USDC outstanding. The IPO price was $31 a share, and it has soared to over $100 per share.

It's been about three years since we've taken a close look at stable coins. In this episode, we want to understand how they have evolved, what's their use case, what are their risks, and whether this is something we should even use. Now, as a review, let's think about the different types of money. The first type of money is the stable coin.

The first type of money we think about is currency. This is central bank money. The central bank can create money out of thin air. If you hold a U.S. dollar bill, it says it's a Federal Reserve note. It is issued by the Federal Reserve. This is public money. We can use it anonymously in many cases, unless you're trying to transport over $10,000 worth. But for smaller transactions, we can pay cash. It's not tracked anonymously.

Generally, we have that anonymity and it's physical. We can hold these coins and bills. There's a second type of central bank money, though, that's digital. These are known as reserves. These are electronic deposits that commercial banks hold at the central bank. And these reserves are what are used to settle transactions between

between banks. These reserves can be created out of thin air as part of quantitative easing programs, and commercial banks earn interest on the reserves that are held at the central bank. Now, as individuals right now, we don't get access to central bank reserves, an electronic form of central bank money, although in this episode, we'll talk about how some central banks have it.

issued what is known as central bank digital currencies. And it's just like reserves that commercial banks have, but individuals can use this central bank digital currency to make payments.

In other places, such as the U.S., and we'll talk about an executive order that came out from the Trump administration in January, as well as a House bill, there is severe resistance to the issuance of central bank digital currencies.

Now, in addition to this public money, currency and reserves, and in some cases, CBDCs, there's also private money. And central banks facilitate this third type of money. This private money can include electronic commercial bank deposits, our bank checking and savings accounts. This private money is created by commercial banks when they make new loans. Our checking account or savings account at a commercial bank is an IOU from a bank.

Another type of private money are money market mutual funds. These are funds where we can place money with and earn interest. The difference being with a money market mutual fund, it takes the money that's deposited and then they invest it in shares.

short-term treasury bills, short-term debt issued by corporations. It can be placed with the central bank in terms of some type of repurchase agreement, but they're earning interest and they're paying most of that interest to the depositors. It's a type of private money. The problem with private money, it's convenient, but it is subject to runs.

If investors, depositors are worried about the collateral not being good for a money market mutual fund because their aim is to keep it at a dollar per share, and if they believe the collateral is not sufficient to meet that, that the money market mutual fund could break the buck and the share price could fall below a dollar, then investors could rush to pull their money out. Same with a commercial bank. If they believe that a bank is

is not going to be able to honor demands from the depositors to receive their cash back, then there can be a run on a bank.

Because private money is subject to runs, the central bank, as a lender of last resort, steps up to provide in insurance, often through the federal government, such as in the U.S., the FDIC insurance, but also in the case of money market mutual funds, the Federal Reserve has had to step in in 2008 and 2020 to create programs to backstop money market mutual funds to protect against runs on these private monies.

money accounts. Stablecoins are a new type of private money. We last looked at them in detail back in episode 387, three years ago, why most money fails. And we released that episode because a number of stablecoins had failed, including TerraUSD, Luna, Cash, Beanstalk. They collapsed.

And because there was no central bank to step in and backstop them or government insurance schemes, the depositors that own those stable coins lost money.

There are two types of stablecoins. The first is true stablecoins, and that includes the two largest, Tether, which is USDT, and USDC, which is the stablecoin issued by Circle, the company that just went public. These are called true stablecoins because they're backed by collateral that's not part of the blockchain. So stablecoins trade online.

on blockchain. It could be Ethereum. It could be Solana. These are rails that facilitate transactions to send money. And the true benefit of stablecoins is the ability to send and settle transactions almost instantaneously in just a few seconds. Whereas if you try wiring money with a commercial bank, it can take hours for it to settle. Or other payment schemes, it takes hours to

to settle that transaction. But with stable coins, using these blockchain rails, such as Ethereum, the settlement is very, very quickly. And that is a big advantage. So Tether and USDC are the two largest true stable coins. They're on the blockchain, but the collateral that's backing them, keeping their price at a dollar per share is similar to money market mutual funds. They own transactions.

treasury bills as collateral. They'll own other very safe assets to back that. For example, Tether does a quarterly reserve report and they...

Say in the most recent report that has been verified by an outside accountant is 82% of their reserves are cash and cash equivalents. They have 0.01% in corporate bonds, 4.5% in precious metals, 5% in Bitcoin, 3% in other investments, and 6% in secured loans. Now, in their case, they're a little more aggressive in terms of how they invest that collateral.

collateral, which potentially subjects Tether, a stablecoin, to more risk as a form of private money because of the potential for a run. Investors get spooked, believe the collateral isn't worth enough to pay out at a dollar per share. Given the amount outstanding, then that can lead to mass redemptions, which can further push down the price of that collateral.

That's how true stablecoins work. There's also algorithmic or synthetic stablecoins. In their case, they still use collateral, but that collateral could be other cryptocurrencies. They'll often use over-collateralization, so they'll have more than a dollar worth of cryptocurrency backing each dollar of the synthetic or algorithmic stablecoin. The two largest are

Athena, USDE, and Dai, DAI. Collectively, the two largest synthetic stablecoins have about $10 billion in assets, so a much smaller allocation compared to the $61 billion in USDC and $155 billion in Tether.

Now, I mentioned that there have been runs on algorithmic stablecoins that caused them to crash. But if we look at the history of DAI, which has been around for over five years, it's actually been fairly stable and successful. One of the few successful algorithmic stablecoins. AthenaUSDE has less of a history, but it also kept a fairly stable price relative to the dollar.

Now, there's also stable coins that are converted or backed by non-dollar assets. So Circle has EURC, which is a stable coin, a true stable coin backed by European assets that seeks to keep its price at one euro per share.

When we own public money, just currency, we don't earn interest. It's a non-interest bearing perpetual liability of the central bank. That's what a piece of currency is, be it a bill or a coin. We don't earn interest on it. Similarly, a digital dollar in the form of a true to stable coin, there is no interest paid on that dollar. To earn interest on our physical currency, we have to deposit it

into a bank or a money market mutual fund, convert it from physical to digital and put it in a private money vehicle that pays interest. There are ways to deposit stablecoin on a blockchain to earn interest, but in and of itself, true stablecoins, you don't earn interest.

We earn interest by investing in what's known as a potentially a tokenized money market mutual fund. So we take the USDC and we invest it in Circle has some tokenized funds. There are some other providers, BlackRock, Franklin Templeton that have created money market mutual funds that settle on the blockchain that can be funded with stable coin and you earn interest. But in

In order to move the money out, you have to liquidate your shares in the money market mutual fund in order to spend the stable coin. In the same way, if you have money in a money market mutual fund, sometimes you have to pull the money out or at least write a check. Sometimes those that still do that. But if you have a money market mutual fund that you're storing funds at your brokerage, you've moved it into Schwab's money market mutual fund in order to access those funds, you have to sell the shares in the fund. And it's similar on the block chain.

Because these true stable coins such as Tether and USDC are collateralized by interest-bearing assets, treasury bills, yet they don't pay interest, that's the main business model for Circle and others. They're earning huge amounts of interest. Over

over a billion and a half dollars in the case of USDC or Circle in 2024. And for that reason, these two stable coins are becoming very attractive. So PayPal has issued one, has about a billion dollars in assets. World Liberty Financial USD, which is connected to

to the Trump family. They issued that earlier this year or late last year, about $2 billion in assets there. But that's what's attractive about it. Here's a digital asset that can be created. It's on the blockchain. It's backed by real collateral and you just get to collect the interest if you're the sponsor of it. But the key with any type of stable coin is there's a network effect. It's like that with any money. It's easier to use money if other people trust it and accept it.

as money, which is why USDC and Tether, they're by far have the leading market share. They've been around the longest, you have the first mover advantage. And so that's why they're used so extensively and they're growing in terms of the amount outstanding that they have.

Now, with these synthetic stablecoins, as part of keeping them fixed at a dollar per share, they have these algorithms. But there's a way when you hold DAI or you hold Athena USD, you actually get interest in those cases just based on how they're structured synthetically. But that's not the case with true stablecoins. You have to invest them in some type of tokenized mutual fund or other interest-bearing scheme to earn interest.

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I reviewed the S-1 filing for Circle Invest. This is a document they filed with the SEC in preparing for the initial public offering in order to better understand what they see as the opportunities and risks with stablecoins. Now, they point out that Circle supports wire transfers for creating and redeeming USDC in 185 countries. So this is truly global with 600 million plus end users' wallets with access

access to USDC. There was a letter in the S-1 filing from Jeremy Allaire, who's a co-founder of Circle. And this is interesting. It gets back to the fact that true stable coins are a type of private money subject to runs.

Allaire writes, we have faced challenges. For example, in 2023, USDC went through an extended period of circulation decline related to a number of factors, including an increase in U.S. short-term interest rates. Again, if you're not earning interest on your true stable coin and you can earn it in a money market mutual fund, then that leads to lower demand. There was also a decline in digital asset prices. So there was just less interest in cryptocurrency. And so USDC wasn't growing.

There was an associated decline in leverage in the digital asset trading ecosystem. Much of what occurs in cryptocurrency is speculation, using leverage, trying to maximize return. And stable coins are used as part of the process because it's a way to use the stable coin as collateral for leverage, but also to be a holding place if somebody wants to get out of a more volatile cryptocurrency, take profits and move it to a stable coin.

And then Allaire said one of the other challenges was a temporary price dislocation in the secondary markets in March 2023, resulting from the collapse of certain U.S. regional banks that caused some market share to move to a competitor.

What is Jeremy talking about? He's talking about the collapse of Silicon Valley Bank in March 2023, where Circle had $3.3 billion of cash reserves in the bank that collapsed. About 8% of USDC reserves were stuck in this bank that failed. We did an episode on

on Silicon Valley Bank back in March 2023. I'll link to that in episode, I believe it was 424. But Silicon Valley Bank, 96% of the deposits were uninsured. So they were above the $250,000 FDIC insurance limit, including the deposits, the billions of dollars of deposits by Circle.

Silicon Valley Bank was a bank run. It had these deposits and then it had a large amount of treasury bonds. And as interest rates rose, the value of those bonds fell. Bank depositors got spooked and in one day moved 24 percent of assets out of the bank, which banks are highly leveraged. And with that type of movement and interest

The concern regarding the bank would have to take losses as it had to sell treasury bonds in order to meet depositor demands, leading to further losses, which wiped out their capital, which is why the federal government had to step in and take over the bank. So then you had all these uninsured depositors, including Circle. And on that day in March 2023, the

The value of Circle broke below a dollar, not by a ton, but enough, and could have been even worse if the federal government hadn't stepped in over the weekend to say that they would cover losses for uninsured depositors. And that allowed USDC to bounce back in price. But that was an example of a real-world bank run that impacted

impacted a stablecoin, USDC. Now, that's a primary risk. And if we look at the risk of stablecoins and in the S1 filing, that is the first risk they list. Stablecoins may face periods of uncertainty, loss of trust, or systematic shocks resulting in the potential for rapid redemption requests.

or runs. Extreme scenarios such as market shocks that affect the value of USDC's reserves or simultaneous requests redeem all or substantially all of USDC in circulation or concerns related to Circle stablecoin reserves may lead to redemption delays and USDC reserves being insufficient

to meet all redemption requests. And in the case of true stablecoins, there isn't a central bank or other government insurance scheme to protect holders of stablecoin. That's a risk.

Another big risk with stable coins, which we'll talk a little bit more in this episode later, is regulation. Stable coins are not securities under U.S. federal securities laws, at least now. And the offer and sale of circle stable coins is not a security transaction. But that could change and these stable coins could be more regulated. In fact, there's a working group, StableCoin,

set up by the Trump administration to come up with potential regulation for stablecoins and other digital assets. We'll get to that in a moment. Let's first, though, going back to the S-1 of Circle, let's take a look at some of the opportunities that they see with stablecoin. This is the second leading provider in the world, just went public. So this S-1 is them making the case for why invest in their company whose primary asset is

is USDC stablecoin. They point out that their mission is to raise global economic prosperity through the frictionless exchange of value. They write that finance is fundamentally built upon the movement of money in the form of the transmission of data wrapped in trust and protected by regulation. And the blockchain networks enable the creation of the internet financial system.

And the advantage of stablecoin is their ability to settle transactions very rapidly around the globe. It's that frictionless movement of money. There's the trust aspect of it, which in the case of true stablecoins, it's just the collateral, but there's no one backstopping the collateral in the terms of a central bank like you would see with assets held at a commercial bank.

Other opportunities within this new internet financial system is things that we've talked about in terms of smart contracts, the ability to exercise a contract without an intermediary and payment can be made. And if the provisions of the contract are met, there can be an automatic redemption or something along those lines, some type of tokenization of a real world asset and

And everything is driven automatically as specified in smart contracts on the blockchain. Could be Ethereum blockchain, Solana or others. It's a new world. That's why we've done episodes on DeFi and others. And then they point out that this new Internet financial system could increase everything.

economic inclusion among underserved populations, particularly those that their government currency, their central bank cash isn't trustworthy due to hyperinflation. Stablecoins and this internet of money to be able to hold something that maintains its value at a dollar per share, generally speaking, is a huge advantage. And that has been a huge driver of stablecoin demand. There

Their goal is to build the largest and most widely used stablecoin network in the world. They write money is fundamentally a network whose utility is dependent on the number of users using it and willing to accept it. And so they're trying to build a suite of products that foster the expansion of the Circle stablecoin network.

Many of these things are still not being used very much, such as digital asset exchange or trading real world assets on the blockchain. We have some money market mutual funds out there and you can trade stocks on the blockchain. But the reality is the advantage of trading stocks on the blockchain aren't really that much greater than doing it offline. And that's one of the criticisms.

of cryptocurrency, what can you do on the blockchain that isn't done just as well off the blockchain? Now, one of those things is the ability to send money very quickly and very inexpensively immediately. That is an advantage of true

stablecoin. Yet even there, off the blockchain, we have rails or different layers on top of the existing financial network. Think Venmo and PayPal. That money can be sent quickly. But then if you actually want to move the money from your Venmo wallet to your bank, there is a several day delay there. So much of the potential for blockchain over a decade later is still yet to be realized. Yet this infrastructure continues to grow.

Now, you might be thinking, well, why don't central banks just do this, make digital wallets available so that we can access without having to use a true stable coin that isn't backed by the central bank? And that's something that central banks are looking at. There are dozens and dozens of

pilot projects of central banks trying out digital currencies. There's actually been three digital currencies, central bank digital currencies launched and being used in Nigeria, Jamaica, and the Bahamas. Still very small, not wide adoption. China continues with their project. And in my mind, there is a true advantage to a central bank digital currency in

in terms of its convenience, in terms of being backed by the insurer of last resort. The entity that creates the money is backing the money. That's base money and to have access to that. But surprisingly, there's a significant amount of pushback on that.

In January 2025, the Trump administration issued an executive order where one of the components was to take measures to protect Americans from the risks of central bank digital currencies.

which threaten the stability of the financial system, individual privacy, and the sovereignty of the United States, including by prohibiting the establishment, issuance, circulation, and use of CBDC within the jurisdiction of the United States. And that includes any type of CDBC that the Federal Reserve would create.

Similarly, the U.S. House of Representatives is working on a bill to outlaw central bank digital currencies. And much of it is privacy concerns that the central bank could see all these transactions, that the central bank could maybe pay negative interest rates on CBDC balances.

I think a lot of it of the pushback is commercial banks don't want to see a CBDC digital currency because that undermines their existing market share as an important rail in the financial system.

I had not seen or read this executive order in detail because the main point of the executive order was this working group was established to recommend regulatory and legislative proposals that advance the other policy aims of this executive order, which includes fostering the responsible growth and use of digital assets, blockchain technology. And that would include

the use of stablecoin. And so 180 days, that would be this summer sometime to see what the working group comes up with in terms of legislative priorities.

The simplest thing, the safest would be a central bank digital currency, but that might not have the smart contract ability that you find on the blockchain. And so there's all these projects going on. Stablecoin is here to stay. CBDC, maybe not, given the pushback and the privacy concerns.

With stablecoin, it is a type of private money. It currently is not backstopped by central banks. It can be used and will be used in DeFi and tokenization. There could be more regulation for stablecoin, including know your customers so that who is using the stablecoin can be known in order to protect against financial crime. The advantage of stablecoin

stablecoin is greater speed, if the efficiency that we can see. But it's, again, still in the early stages. And we've talked about these things for the five years or more. But now we have a publicly traded company that is primary asset and revenue stream is interest on reserves from USDC, their true stablecoin. There's competitors trying to come into that market. Fascinating area. We'll continue to see how it evolves.

evolves in the years ahead. That's episode 527. Thanks for listening.

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