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How are stablecoins different to CBDCs in terms of risk?
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Welcome to the Crypto Compliance Podcast. Big eight now Hi, this is Crypto Compliance by GateKnox. We are here in Warsaw on the National Compliance Conference. I'm here with Karol Van Cleef using the opportunity to actually speak face to face in Warsaw. So, Karol, a pleasure to have you here in Warsaw. It's actually probably the first time different view as well for the world than the US perspective. How do you like it so far? Oh, it's great and it's wonderful to be here in person with you today.
So we had a very interesting panel, we are just off the panel, and we are talking about FTX and the lessons we learn from FTX and we touched on a couple of interesting points. And obviously FTX was the event which we remember very, very much, but also the event that created a lot of waves also to the traditional banking industry And the one thing which we touch on is the stablecoin area and CBDCs. Why don't we focus on this in this episode? And let's talk about the US perspective, the global perspective, and the crypto perspective in particular for the CBDC and stablecoins. We've got a lot to untangle there.
Maybe it would be helpful if we start with a real quick synopsis of what's happened in the past I think probably since the agenda for this program was put together, picking FTX as a focal point was a great idea, but in the last two weeks in the United States in particular, but there's a little bit of a global contagion as well, as we've had a number of very significant events happening in the banking industry.
We've had three bank closures and I'm very careful in the use the term that I'm using because one of them was actually a voluntary orderly wind down where the shareholder values would be protected protected at least to some extent and certainly all the depositors would be protected, followed by a very well publicized bank failure that was a real run on deposits that caused the regulator to move very quickly. And we had a third failure that followed within a matter of about 48 hours that employed a different element of US law and really was a different set of issues.
A bank run had sort of started on the entity, but it was a different set of issues the closure was due to what the Federal Reserve said was systemic risk issues, which raised a lot of eyebrows and we can unpack that one a little bit more as we talk. But if we go back to a couple of key points that you raised with respect to stablecoins and CBDC, is clearly we've all been on edge with respect to stablecoins now really for almost three years.
The Federal Reserve in the United States raised the issue of systemic risks associated with stablecoins back in June of 2020 2020 in typical sort of Fed fashion, very quietly, in a PowerPoint presentation made by a Federal Reserve bank president, not the chairman of the Federal Reserve, but by the head of one of the 12 banks Federal Reserve banks just buried into a PowerPoint presentation that was given for I think internal purposes it raised the first specter of the fact that a stable coin could present systemic risk.
Now it came out later, a couple of weeks later almost two years later, I think, when now Secretary of Treasury Janet Yellen actually named Tether as the stable coin of concern.
In the end, not the stable coin itself, but the sort of the principles around the stable coin USDC was the one that really was the catalyst for the series of events that unfolded in the US almost two weeks ago Yeah, and so let's, I think, you know, there's for everyone who is watching our podcast, let's unpack, you know, what we are talking about specifically, right? Because I think there's a lot a lot within this buzzwords which we are using, I would say, to unpack and there's interesting risks involved from the compliance perspective in every part of this. So we are talking about stable coins.
Stable coins would be cryptocurrency created by an entity, right? And effectively we have USDC and Tether, right? USDT, different entities with different, I think, you know, point of view in the world and different risk as well One is the US-based circle, the other one is what used to be Bitfenix, right? A connected team. Still is. Still is, right. Which is an interesting story, by the way, with Tether was created to salvage BitFenix and effectively created incredible project. And right now BitFenix is nowhere to some point but you know Tether is being used as rails for crypto and safe haven in terms of crisis. And it's funny because. USDC It's very specific.
I mean, it's specifically different. Why is it different? Well, let's back up and talk about stablecoins first. And I think a little bit of the history around Tether is probably very helpful. And I've heard this recounted a few times over the last couple of years couple of weeks is that Tether was actually created out of the turmoils of trying to get money into, getting fiat into crypto. Because back in the time period of the, 2016-ish time frame, we were going through one of those debanking or de-risking periods that we've experienced periodically over the last 20 plus years now.
And what was happening is that the banks were becoming less and less comfortable with their clients moving fiat to crypto exchanges. And they were closing accounts. In one case that I know, someone had an account for 20 years at a large bank. And just because he was a big, was associated with a company that had BTC in the name, his account was closed. He wasn't using it. Big problem for the industry.
Right, but bottom line is, and then what would happen once you made a trade? So let's say I was able to get my fiat to the exchange and I bought some, let's say Bitcoin, and the price went up, I wanted to recognize my gains. Did I go back to fiat and go back through the on-ramps that would, or off-ramps that would include a bank? Or could I, was there a way I could stay? in a vehicle that would allow me easily then to go into crypto, whether it's Bitcoin or Ether. So in principle, the stablecoin is something that's supposed to be stable.
And I'm saying supposed because we have USDC recently, right, dropping 10%, which is unusual for Bitcoin usual for a stablecoin? So let's talk about what makes it stable. So I'll take you back in time. I actually worked with what I would say was the first real stablecoin. It wasn't a crypto stablecoin, crypto-related stablecoin. It was a gold-backed stablecoin digital currency, but in that case the currency that was being issued in digital form was 100% backed by gold. It meant that there were gold bars sitting in a gold repository. Precisely, precisely. So I got a lot of excitement experience going back to the 2008 timeframe.
In fact, when that system was unwound, I oversaw the sale of $100 million worth of gold. So fast forwarding is that a stable coin today really could mean a number of different kinds of vehicles But the one that's what we're really talking about here today are our fiat backed. Where fiat is is converted into the stable coin and that fiat is then put into a bank account. And that's the critical element. It's going into a bank account. OK, so So let's talk about this.
I think this is a critical point and very interesting dynamics as well, especially between USDT, Tether and USDC every dollar created, every USDC created, one to one is backed with dollar or anything which is equally liquid. Correct? Government securities. Government, which is another interesting aspect in the relationship right now.
And on the other hand you have Tether which is they have fractional, effectively fractional reserve, right? So they don't have one-to-one backed? Well, they're one-to-one backed, but the question is what are they backed by? And this became a point of controversy that the New York State Attorney General looked into about starting in 2018 or 19, the composition of the backing for USDT, as we call Tether, was a combination of fiat, of government-issued securities, as well as commercial paper And this is where the systemic risk came in, is that if banks invest in commercial paper, and banks are allowed to invest in commercial paper, at least some banks are, is that it has to be of a certain rating.
Triple A rating Which in the case of Silicon Valley Bank didn't help too much, right? Well, that. But the issue was what was that commercial paper and how good was that commercial paper? And this became a big issue back in, I think it was 2018 time frame when there were some problems in the Chinese real estate market and the entity that was at greatest risk risk at that time, this rumor started circulating that Tether had commercial paper from that company. They had essentially made a loan with their dollar backing into this company that might go bankrupt.
And that's what raised in in the public opinion 2020, the concerns of the Federal Reserve is that systemic risk if that stablecoin, which now had become a center point for much of the activity in the crypto world, if there was something that was going on that happened to the backing, that not maybe every dollar that was backing it was going to be there, what kind of impact would that have on world trade as it had been evolving? check this, but do you know where USDT is actually created from or is there an entity behind this operator? I mean, we know Circle being the main basis for issuing USDC and they are on the hook in terms of keeping the reserve right and all this stuff and they are in the US.
So it's kind of you can feel security from this point of view, right? What about USDT? I'm going to leave you to. . . Okay, let me just google. So if you go to the New York State Attorney General's website where they have the order that was ultimately issued against USDT, or it may have been a negotiated agreement. At the end of the day, the New York Attorney General had taken issue with the fact that they said it was a 100% backed by fiat, but in fact, it was this combination of fiat plus government securities and commercial paper that caused problems.
And one of the issues was what was that mix? And there were rumors at the time, it was anybody place the fiat could have been as little as 4% to as much about 40% and the ultimate outcome of that case is the New York Attorney General wanted more disclosures and required a quarterly report on the reserves. Prepared by an entity that had appropriate credentials to provide the report. So I found it, it's operated from Hong Kong, I mean entity owned by iFenix, which is an association with Bitfinex And who is, let me just check, who is the auditor? Because I think, you know, the other point is.
And that was certainly a point of contention. Yeah. Because going back to 2018, team time frame into 2019, Tether had been making promises to provide an audit and it hadn't been forthcoming. And that's what ultimately led to the New York Attorney General stepping in. So essentially this is we now have a lot of conversation around proof of reserves that more and more the community, the crypto community is requiring or not requiring not requiring but sort of demanding that a proof of reserve be demonstrated with respect to stable coins.
But if you, I mean, let's, I mean, first quarterly reporting, right? That's actually gives us you know, three months of actually affecting operating without any, you know, substantiated papers or money, right? It can be gone and nobody would notice, right? That is the, you know, I think not many people realize how risky it is that you not only have, let's say, Bye state, you know, the technological coin which you have, but anything which is backed by this, I mean, is backing, you know, Tether could be gone I'm just googling who is the author for this For Tether, I cannot find it.
So I need to find it, but I think not of any major audit I think if you go to the website, you'll find that the audit has been published and regularly updated But while we're talking about this, a couple of points with the stablecoins. First of all, I think if you ask many in the crypto community, they don't consider a stablecoin to be a cryptocurrency per se. It's using the technology rails, but it is a different kind of. . . Yeah, it is definitely a different kind. Yeah of currency. But it's critical. And in fact, it's probably the single leading vehicle for getting greater adoption in crypto.
Because it's successful, it is backed. If you ask someone what's the future of crypto, they're gonna say, well, it's a very, why don't you own Bitcoin? Oh, because there's nothing backing it. It's usually the first, the question is, what is it? And you say, what is USDC or what is Tether? Well, it's backed by something. And I have some assurance of the value of what I'm holding in my portfolio some assurance, not a lot of assurance, I would say. It depends. Yeah, it could be gone like, you know, FTX collapse, you know, very, very quickly. Well, and Terraluna is the perfect example.
Now, Terraluna- A couple of billion gone from FTX, you know, in like, you know, what, two months, three months, which could be- in a very similar, I'm not saying it's going to happen, right? But we can have similar situation with USDT. Well Terra Luna is probably, is a good example of what can go wrong with respect to a stable coin. However, what's important is that important in the Terraluna case is that that involved an algorithmic coin where where you had the math setting the pegging and it was actually very late in the process when the idea of something backing the coin was introduced to begin to work combined with that algorithmic.
If you say that algorithmic should work but we bring something to actually back this up, I think that's immediately a question and the whole project was starting to fall. And I think there are a number of people who would say that an algorithmic coin, pegged coin is not necessarily should be put in the same category as a stablecoin. I think Jeremy Allaire may be a big proponent of that, the founder of USDC. It's okay, we have stablecoins, right? So before we go too much, one thing to note is that the circulation on Tether is exceeds, I think, basically every other crypto or stablecoin when all of them are combined.
And it usually has circulation at least on-chain, which is something that's reported in the news and it's something you can see, equal to at least the the capitalization, which in this case is the same as what's back again. And what are the numbers that you're seeing? About 45 to 50 billion a day? 42 you know last 24 hours USDT 42 billion. And does it show a capitalization number? 70, 77. 77, okay so it's actually roughly about half. Yeah and then you have USDC 4 billion. And what's its capitalization? It's 35, you know, so it's half, but you know, it means that In terms of trading, I think that's something ridiculous.
So, Tether has been, historically, has really sort of moved at about what its capitalization level is, though those numbers have come down significantly. You never know, you know how much is printed, right, and how much is bought. And it's effectively, that's coming to the US government almost, the status of, you know, I can print how much I want Well, this is why the Fed hit the panic button on the systemic risk back in 2020. And at that point, Tether was just hitting about 50 billion. And I think USDC was just hitting about 25 billion.
And those are the numbers Those are numbers that historically have been critical in banking regulation, 50 billion. When a bank hits 50 billion dollars in size in the US, it goes into a different regulatory category. And here you were suddenly having, they suddenly woke up to the fact that you had an entity that had a 50 billion dollar bank. And that's a huge amount of money had $50 billion of deposits, essentially, that was really unregulated. And then, that's very interesting point on USDT and USDC. Effectively, one, we have established entity in the US, supported by the US government, et cetera.
And then you have USDT, which is- Be careful when you say supported by the US government In the sense of the regulatory framework is coming from the US regulations, right? So they're operating in this world. Well, again, we need to be careful about that because that's what the Treasury Secretary has been calling for is regulation to state-owned companies coins because there's a feeling that there are gaps in the regulation that's available. I'm not saying that there are no gaps, but in principle, they are based in the US, operating from the US on ramping, off ramping of US dollars actually in order to issue.
You need to buy Thank you USDC before it's actually issued Right? And you need to buy this with real dollar That's the process. And then once it's issued, it can be circulated within the crypto economy, correct? That's right. But I would be again, cautious in saying what the level of regulatory overlay is. It has been, Circle has been issued been the organizing party. Coinbase also is an issuer, and both of them are regulated at the state level as money transmitters. And it's more or less under the guise of that authority or regulatory supervision that the government has these coins are being overseen.
Move beyond that though, I don't think there's another, well I take back Paxos has a regulatory structure that's also in place. But Paxos interestingly enough, was recently ordered by the New York Banking Department to stop issuing the Binance BUSD which was actually issued on the Paxos platform. All right, so coming to my point, point but then we have Tether right and Tether is out of Hong Kong and You can say that regulatory scrutiny, let's say from European, US perspective, it's lower. But at the same time, in terms of market, like immediately you can see that, you know, the acceptability of USDT is much lower much higher than USDC.
It can be connected with the, you know, how many chains are available for USDT, which I think partially, you know, when I was in my, you know, blockchain analytics shoes Bye the more blockchains you use for your stablecoin, the more difficult it is to trace. You know, that's something I just leave it there. Right. So, but anyway, you know, so we have this and then the market is choosing actually more risky assets, which is operating better Which I think is coming to the point of what is currency, right? Where we are in terms of, the function of currency is the trust which we put in this currency.
And I think the cryptocurrency market is the same It's putting much more trust in USDT as opposed to USDC. Well, I think in part it's got first mover advantage. Okay. Because it was out there sooner than the rest. It definitely filled a void in the marketplace. And one of the things that in the US at least, we don't appreciate maybe as fully as others around the world do, is that you can settle at any time of the day, day or night in USDT. And so if you're in Asia, you don't have to wait for the US markets to happen open up to settle your transactions.
So it's that instant settlement capability to do it 24-7 that's a very significant advantage over other payment rails. Yeah. So this has stayed in the market And then we have another category, which is stablecoin, but it's supported by the government. And this is the central bank, what's called the central bank digital currency Right. And you know, there's a lot of discussion, but you know, everyone in Libertarian world hates the idea of central bank digital currency.
But at the same time, I think we are starting to face the problem with rails into crypto on-ramping, off-ramping in a secure way and when I talk to you know, my clients, people from the industry, the last couple of weeks for them, it was where can I actually open a bank account additional.
It's almost like there is a team who is opening constantly bank accounts, you know, in bigger exchange because this is sustainable risk for them and being cut off from the on-ramping, off-ramping, for cryptocurrency exchange or any similar centralized financial, I mean, centralized crypto business, it's actually, it's a killer, right? It's a killer I mean, they're effectively gone from the market So when we and then we have you know the The word of crypto is saying, oh, we don't want CBDC, but CBDCs will be solving a lot of problems. So I'm gonna turn the tables and ask you the question of why people don't like CBDCs.
You made a comment that they're not favored in the crypto community, but why? Sure. Okay, so because There is belief that they will be easy to trace by the government. The government will be able to switch off, switch on you know, your crypto in your wallet or your CBDC in your wallet. But they can control it better. They can program CBDCs to be, oh, you need to spend this in 30 days and the things that you can spend, that's the limited amount of things that you can spend you can spend on.
So because it could be programmable, there's a lot of things you can be concerned and there's privacy aspect which is like okay I can trace this so I can see you which is very interesting because you can do exactly the same with with USDT and USDX as you see, which is crazy, right? Well, and if you play that out further, many of us, at least in the United States, use either credit or debit cards. And the rails that they move over, you've got a fair amount of transparency with respect to at least the credit least where you're spending and how much you're spending.
And based on where you're spending, you may have, you know, even greater detail on what you actually bought with it. So that kind of granularity already exists in certain ways and I think one of the complaints is obviously as you se said the control the government may have over your spending. I think that if you look at some of the government run programs now where the funds are being distributed using prepaid cards, that there are controls that are put on some of that government money spending, where that card can be used, if it's certain types of benefits, what it can buy.
So I'm not sure there's as big a gap as it may seem. I'm not sure if saying that your money, your fiat is being controlled is actually good you know, good answer for CBDC will be controlled. Oh, don't worry because your fiat is already controlled. You know what I mean? Well, and I guess, first of all, I give a fair amount of credit to the criminal element that they're going to figure out how to exploit a CBDC pretty darn well and quickly. From that, you and I are going to also learn techniques that will allow us to move our spending probably into some more private channels.
So our ability to get the money out of the bank is going to be a big part of that. So I'm going to stop sharing my screen now the currency and use it initially. At least in the United States, and I don't know how it is here in Poland, but we have a long history of private currencies of all types, all shapes, community-based, company-based you name it, my favorite was always Disney dollars. But, you know, I don't think that's going to necessarily change that we are going to have these outlets and certainly we're going to have crypto.
And I think as we move to more tokenization of all sorts of outlets assets that we're going to have the ability to hold value in different kinds of assets and not necessarily all in a currency. So where in your opinion we are in this conversation about, you know, CBDC from the U. S let's say from the US perspective? That's a fascinating question because I've really been spending a lot of time thinking about that in the last 10 days or so after the government, US government moved in to ensure all deposits regardless of the country size. We had a limit of they would we would be protected up to 250,000 USD.
But that went out the window and the government's now protecting everything and you start to wonder you know at what point does it just make more sense instead of just giving that guarantee out and allowing, I'm going to be careful to say encouraging risky behavior with our money by entities that may not be as qualified as we think they are to manage our money. That why not just allow move it into a safe haven and allow it to sit at a bank.
And there's a fair amount of controversy that's building in the United States because one proposal that was turned down a few months ago to allow the custody of crypto assets at the Federal Reserve, the former custodian bank that you've probably heard about, the Caitlin Long's project, and that was rejected. But when you start to think about what we've been going through, you know, the step towards moving towards the fed being the ultimate bank and holding deposits, you know, you start to wonder if that may be the solution to prevent the next crisis. Wow, that will be a big move. But that's taking us, that's where the CBD is DC is where we're headed.
I think you can argue, you know, there was big discussion, especially I remember, you know, the time when this was very active conversation in the UK where, you know, like how we distribute. Okay, I mean, one is that let's say the issuance and you know protection of CBDCs but at the same time who will be the issuer for customers or who will be holding this for the customers. There was a discussion whether this should be Central Bank of England or the banks, the retail banks, the commercial banks in the UK. I think it ended up nowhere. This is where conversation stopped.
I don't know exactly where we are with this in the UK, but that's going to be very interesting interesting area and so how do you think I mean how long it's gonna take for the US to I mean when it's gonna happen I don't have a crystal ball to to do my predictions here I I think one of the issues is that we all say, hey, why don't we have this or we're moving to it? But the question is how mature is the technology? Because when you start talking about, you know, this kind of a movement, you've got a number of different issues to think about.
And at least I'm not doing this from a layperson's perspective and probably a rather naive perspective, but if you think about how many hacks happen with respect to different tokens and cryptocurrencies that are out there now, and hacks that are happening at a very high level a blockchain level or happening in wallets, you know, happening on your computer or on your phone, you know, we need to be to a point that we can have a great deal of certainty around that technology and I know it's been improving, you know, on a minute by minute basis minute basis over the years, but how close are we really to having that? Then you've got the issue of adoption and that's moving people.
I tell you, back in my time in Coinfield, we've been engaged by the Japanese MUFG at the time when they're considering issuing MUFG coin And the use case for this is incredible I mean, frankly, I think that that's like You know, suddenly you just simply need to pop up this coin and you have access to, what is this right now, 300 million users? So imagine, this is like from a commercial point of view, you have, you know, with one issuance, you have access to 300 million users that's a huge market, huge opportunity.
And when you think from this perspective, it's almost like you know, like how, how, why it's taking so long, you know, it should be done immediately or what, because the market opportunity, especially when you think about the, the, the, the, the, you know, the, let's say leadership in, in fiat of the US dollar, right? if we issue CBDC that suddenly, you know, the entire ecosystem of crypto would adopt this as blood of the industry and replace USDC, USDT. Crypto would adopt the crypto community, but how big is the crypto community at this point? Is it 2% of the total population? And I'm looking at US terms.
Is it 10%? Is it 15%? I mean, it's still 2% of global population. Right, and that's a tiny, tiny amount. And I think that your millennials, your Gen Zers, and whatever it is, else will get there a lot faster, but you still have, you know, you still have these, you know, the baby boomers and beyond that will be slow adopters. I think back to my father-in-law who died a couple of years ago at the age of 17 of 96, I believe. And he had made a decision when he retired in 1990, early 90s, that he wanted nothing to do with a computer.
And he lived 30 plus years after that and did not adopt the technology including a smartphone. Okay, I agree but I think you know this it's a huge opportunity. Oh it's a huge business opportunity but adoption is going to be something different and I think back to the experiences around prepaid cards is that the way you're going to to a drive adoption in part will be through the delivery of government benefits. So the way you will get the baby boomers is by delivering social security. But I think if you know US will not do this China is going to step up. So I think that's the. . .
It's already well underway. Exactly. So that's the risk which we, the risk. But there's a little bit different government structure in China than in the US. And we don't have quite that authoritarian rule True. Quite. All right. Okay. I think, Karol, thank you very much. Crypto Compliance brought to you by GateKnox .
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