How crypto giant Circle could create a US-backed digital currency

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Crypto giant Circle has announced plans to become a bank, fully regulated by the Federal Reserve, the Office of the Comptroller of the Currency, and the FDIC.

Why this is important: we are still very far from this. But if so, Circle’s USDC stablecoin could become a de facto central bank digital currency.

How it works: Circle’s dream is to become a narrow bank that completely eschews fractional-reserve banks and instead places all reserve deposits at the central bank.

Only banks can open accounts directly with the central bank, which credits them with pure money. In Circle’s case, the “depositors” would be the holders of the USDC, and the collateral backing the USDC would be the money on deposit with the Fed. Circle would pocket for itself the interest the Fed pays on bank reserves.

The big picture: If the dream came true, Circle would effectively issue a cryptocurrency backed by the Fed itself for all intents and purposes, a central bank digital currency, or CBDC.

If Circle were allowed to do such a thing, then presumably other banks would be too, and they would quickly start competing with each other to pass most or all of the interest the Fed pays on reserves. Buying these stable coins would be like having the money on deposit directly with the Fed.

Between the Lines: A potential bank called TNB tried to do tight banking in the United States and came to nothing. The Fed doesn’t like the idea, for reasons well explained by Bloomberg’s Matt Levine in 2019.

Fractional reserve banking is the engine that powers money creation and even modern capitalism. Full reserve banks risk disrupting this model in a way that could prove dangerous.

Be smart: Circle’s chief strategy officer, Dante Disparte, told Axios the company hasn’t even started the bank application process properly yet; he has just announced his intention to do so. Disparte says they are ready to do “whatever the makers want.”

It could mean giving up the dream of having 100% of the assets in the form of Fed reserves, even though that’s something all other banks are allowed to do.

The bottom line: Most of the assets of most banks are loans that, in theory, can default. This is also true of Circle’s assets, at present it is mostly commercial paper and other low risk loans.

Switching to a risk-free system would create a backdoor CBDC. It seems unlikely that the Fed will let this happen without being extremely deliberate about it.

Going further: central banks are moving towards digital currencies

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