A Pegged USD Stablecoin Increases and Improves the Money Supply

By Daniel Wheeler

Hypothesis: 

A cryptocurrency stablecoin pegged 1:1 (1-to-1) with the U.S. Dollar is created in which the stablecoin issuer accepts 1 U.S. Dollar (“USD”) as payment for the purchase of 1 such stablecoin (called “USDS”).  The 1 USD is deposited by the USDS issuer in a U.S. bank account.  The purchaser of 1 USDS uses 1 USDS in commerce to transact (make payments). 

Every such USDS stablecoin increases the effective money supply by an equivalent of 1 USD, enhances economic efficiency, and does so with minimal inflation risk.

Assumptions:

·         There is one sponsor/issuer of USDS, the entity tentatively named “Dyepack.”  There may be as few as one and as many as all depository institutions that hold the USD reserves for USDS. The depository institutions are not issuers or sponsors of USDS; they only hold the USD reserves as custodian or trustee.  To the extent that the concept of a “deposit token” means a bank-issued token to represent sums on deposit, this is not a deposit token because it is not issued by a bank.

·         1USDS can be redeemed at any time for exactly 1USD.  1USDS is always sold for exactly 1USD.  The sponsor’s technology ensures that the 1:1 ratio of USDS to USD is permanent and does not vary. 

·         Transaction fees similar to credit card interchange fees may be collected as USDS changes hands but the price is always 1USD.

·         There is never a gain or loss to a holder of USDS; and as such, no tax is payable when transacting in USDS.

·         The funds underlying USDS are FDIC-insured to the same extent as USD bank deposits (pass-through insurance coverage principles would apply).

·         Buyers/senders and receivers of USDS only use it to transact (send money) because there is no possibility of appreciation or of receiving interest or dividends. 

·         The price paid by the buyer / sender to buy and send USDS < the price that would be paid by the buyer / sender to send USD (e.g., fees for sending money via wire, ACH, or money transmission services, etc.).  That is, USDS transaction costs are lower to the sender even when the price of the goods or services being purchased are exactly the same. 

·         The price paid by the receiver to receive USDS < the price that would be paid by the receiver to receive USD (e.g., debit card and credit card interchange fees paid by a merchant, etc.).  That is, USDS transaction costs are lower to the receiver even when the price of the goods or services being purchased are exactly the same. 

·         The value (not the price) of 1 USDS to the buyer / sender in a transaction > 1 USD.  Stated another way, the value to the buyer/sender of 1 USDS = 1 USD + premium (the “sender premium” or “sP”). 

·         The value (not the price) of 1 USDS to the receiver in a transaction > 1 USD.  Stated another way, the value to the receiver of 1 USDS = 1 USD + premium (the “receiver premium” or “rP”). 

·         Neither senders nor receivers need to open new or additional bank accounts.  Each party in a transaction can send USD to effect purchases or redemptions from or to their existing bank account.  The USDS system will effect the redemption from the “nearest” bank account where the “nearest” possible is the party’s own bank (such as where the USDS issuer happens to have a USD reserve account at the user’s bank). 

·         sP may ≠ rP and the sP/rP ratio may change over time; the ratio is expected to drive USDS transaction pricing.

·         Premium exists because:

o   USDS transaction speed > USD.  Transactions in USDS are settled instantaneously on the USDS sponsor’s ledger.

o   USDS transaction costs (estimated at 30 – 100 bps (to cover the costs of processing incoming USD as well as user authentication fraud prevention / clawbacks) < USD transaction costs (e.g., 300 bps interchange costs to receiver in card network transactions).  See Figure 2 below.

o   USDS acceptance > USD for some goods, services, and transactions (e.g., acceptance of USDS for cross-border transactions > USD)

o   USDS allows micropayments

o   USDS is programmable and its functionality > USD

o   USDS is designed to be easily exchanged for other cryptocurrencies.

o   Additional benefits or value are perceived by the sender or receiver 

·         The premium in value to using USDS does not depend upon improving the speed of the legacy system, including the speed by which USDS can be redeemed for USD (or vice versa).  Any comparative lags in the legacy system will reinforce to users the superior speed and value of using USDS in transactions.

·         USDS will eventually be universally accepted in transactions because its value in transactions > USD.

o   Sellers of investment assets (interest or dividend producing assets, including banks offering interest-paying USD deposit accounts) accept USDS.

o   Sellers of other fiat currencies accept USDS as payment.

·         100% of USDS is used immediately by buyers/senders because of the opportunity cost of holding a currency that does not pay dividends or yield.

o   “immediately”  means the period of time for which the opportunity cost of holding USDS < the transaction costs incurred to hold yield-producing investment assets.

·         Less than 100% of USDS received by a receiver is redeemed immediately.  This is a significant concept and explains why the USD reserves will grow inexorably with structural reasons why they will not draw down or be withdrawn.

o   The average percentage of USDS that is retained and not redeemed (the “retention percentage”) will generally correspond to the inverse of the percentage of universal acceptance.  (If 1% of the eligible population accepts USDS, then a receiver will, on average, retain 1% of received USDS to fund the receiver’s need to send money and the receiver will redeem the rest (99%).)

o   In a low interest rate environment (when bank checking accounts are paying nominal interest rates), the retention percentage will be higher than the predicted rate based on universal acceptance rate. In a high interest rate environment, the retention percentage may be lower than the predicted rate, but likely not by a material amount because of the user’s need and perceived value to transact in USDS.

o   Each transaction in USDS will, on average, increase the supply of USDS in an amount = retention percentage x transaction amount.

·         The purchaser of USDS uses USD held in a U.S. bank account (not currency) to purchase the USDS.

·         Redemptions of USDS into USD are redeemed solely to the holder’s previously-designated bank account. 

·         USD in bank account à USDS à USD in bank account.  If a user withdraws USD in currency to transact and then deposits currency proceeds back in the bank account, then the source of funds and the user’s activity is invisible to everyone for all time.  USDS permanently records that data and it is available to law enforcement following due process of law and respecting privacy rights.

·         All USD received by the USDS issuer is deposited into and held in a U.S. bank account as reserves to back the USDS and to fund all requests to redeem USDS for USD.

·         The USDS issuer has the regulatory entitlement (e.g., money transmitter licensure or the USD reserve account is set up as an “fbo” account to provide a money transmitter license exemption to the USDS issuer; or the USDS issuer has a trust company or bank charter) and the technological capability to:

o   Be the account owner of record as trustee /and or custodian for the holders of USDS.

o   Maintain accurate records as to each USDS holder and their holdings.

·         Users/purchasers of USDS agree contractually that they will not be paid interest and that all interest paid by the depository bank may be paid to, and retained by, the USDS issuer.  This is the same contract that Tether users/purchasers enter into with the Tether sponsor.

·         Purchases and redemptions of USDS are done via intrabank transfers (where the purchaser or redeemer’s USD account is at the same bank where the USDS issuer has USD on deposit) or by ACH (where different banks are involved).  Either method carries a low per transaction cost.  That cost can be paid by purchasers/receivers as a deduction from their USDS receipts under the USDS user agreement or that cost could be absorbed by the USDS issuer.  There are no commissions or other fees involved in moving USD, which is done automatically via algorithm built into the USDS system.

·         The costs of issuing and maintaining USDS (including the ACH costs of moving purchase and redemption USD funds) < interest paid to the USDS issuer by the bank depository of USD.  The difference (profit) ensures that USDS continues to operate as assumed. 

·         The USDS issuer is paid transaction or “gas” fees from USDS transactions.

·         USDS does not pay interest or dividends, does not fluctuate in value, and is not a security.

·         There is no discount to USDS value because there is no risk of hacking or misuse of the USD backing USDS.

·         The depository bank holding the USD backing USDS uses the deposit in the same way it uses its other deposits—to fund lending by the bank.  The leverage or rehypothecation of USD is being done by the FDIC-insured depository bank, which is the most regulated and safest way of creating leverage because of rules like borrower and sector concentration limits.  The depository banks are required to comply with sophisticated liquidity rules to ensure that, should a “run on the bank” occur, the bank can satisfy withdrawal requests.  Banks have available central bank liquidity facilities to provide further protection from the effects of a run on the bank.  Structurally, actual runs on banks are very rare and FDIC insurance applies if a run occurs.  The key is that the “run” is not occurring with respect to the USDS issuer; the responsibility for dealing with a “run” is shifted to the depository banks that must—by law—be prepared to withstand a run.  Tether-type stablecoins are invested into a portfolio of securities which cannot be instantly liquidated without taking a loss. USDS is the only way to engineer a stablecoin to be fully and instantly USD liquid.

·         The USDS blockchain is not sponsored or controlled by any governmental entity.

Analysis and Implications:

1.    Because of the money multiplier, the contribution of 1 USD to the money supply when that USD is deposited into a bank account is greater than 1.

Money Supply (“MS”) = 1USD + (1USD – Reserve Ratio x 1USD)

            MS = 2USD – RR(1USD)

2.    When 1 USDS is purchased with 1 USD, the supply of USD does not change. 

3.    Because the USD remains on deposit (and is used by the depository bank to fund loans in the same way that all bank deposits generally are used to fund loans) and the USDS remains in circulation per the above assumptions, the USDS is used as money for transactional purposes.  Therefore, the money supply measured in USD effectively increases by the USD amount of USDS:

            MS = 2USD – RR(1USD) + 1USD

4.    Inflation could be created if USD and USDS were chasing the same goods or services.  However, USD and USDS--although theoretically interchangeable—have different occupations within the money supply:

·         USDS is used purely for transactions and is always high velocity money.  USDS saves transaction costs and frees up money to be more efficiently allocated.

·         The USD reserves become permanent deposits and are well suited for long term lending.

Any inflation is likely to be muted or non-existent because of the specialization of each component of the money supply and the economic efficiencies created.

5.    If all USD becomes reserves for USDS, USD banking would only involve long-term lending.  Interest paid by borrowers in USD would continue growth in the USD money supply.  Because of the stability of USD deposits backing USDS, long-term lending would be bid down to the lowest rate that could still provide profit sufficient to compensate operators of the US banking system. The US banking system would become perfectly capital efficient, freeing up money to be more efficiently allocated.

6.    The USDS issuer can speed USD / USDS conversion by maintaining a USD account at all USD depository institutions (banks and credit unions).  However, the system can operate even if the USDS issuer holds all USD in a single bank account.  Depositories have an incentive to open an account for the USDS issuer in order to keep USD on deposit in their institution. In theory, all purchases of USDS would be effected by an intra-bank bookkeeping entry making the USDS acquisition cost effectively zero.  Presumably, most redemptions could be handled the same way if the USDS issuer’s USD bank account at the bank where the redeeming user has a sufficient USD balance.  See Figure 1 below.

7.    If a fractional reserve banking system using USDS were to develop with a different required reserve (“DRR”), then the money supply would increase further:

MS = 2USD – RR(1USD) + 2USD – NRR(1USD)

Because of heavy regulation of the financial sector in the U.S., it would be challenging for a true fractional reserve bank to engage in USDS banking without a bank charter.

8.    Unless a cryptocurrency token is rigidly pegged to USD verifiably held in a bank account:

·         The cryptocurrency token will vary in perceived value and price in terms of USD.

·         Capital gains or losses are realized when transacting with such cryptocurrency.

·         Volatility and taxation make it expensive to transact with such cryptocurrency.

·         Holding such cryptocurrency as a store of value or way to speculate on price increases is the primary reason to purchase or hold such cryptocurrency.

·         The cryptocurrency does not increase the money supply.

9.    USDS would spawn a third-party ecosystem.  With clearly understood rules governing the system, a variety of service providers and credit providers will emerge similar to the ecosystem surrounding the Visa and Mastercard networks.  These ecosystem participants will include:

·         Law enforcement tools and services, including digital subpoenas, search warrants, and freeze funds orders.

·         User underwriting and authentication (leverage Worldcoin or a similar oracle).

·         Risk allocation (contractual and technological clawbacks / returns for fraud, unauthorized use, etc.).  This failsafe could be implemented automatically by imposing holds on receivers after a threshold amount is reached, such as a 48 hour hold after transfers received in a week exceed $1,000.  The hold period could also be shortened and/or the threshold raised automatically to reward users with strong track records.

·         The same economic incentives for transaction costs to be borne by sellers/merchants/payees will likely arise; however, the costs of transacting in USDS for merchants will be much lower than legacy credit and debit networks.

·         USDS “credit cards” in which the buyer signals the lender to directly pay the designated merchant / receiver. 

·         Merchant financing in which the lender underwrites the merchant / receiver and finances any hold periods.

·         “Instant USD” can be facilitated as a credit function in which bank transfers are done ahead of actual settlement.

·         “credit scores” driven by usage patterns.

·         Efficient currency exchange where the USD custodian bank structure is replicated in other countries with depository institutions.

10.  A privately-sponsored stablecoin creates none of the severe problems of a central bank digital currency (“CBDC”):

·         A private sponsor is subject to enforcement of privacy and data protection laws; a CBDC is issued by an independent central bank would impose central controls and surveillance with no effective citizen oversight or recourse.

·         CBDCs are authoritarian; privately sponsored stablecoin is voluntary.

·         CBDCs are deeply unpopular and would face broad resistance to adoption in the U.S.

·         A private sponsor has a profit motive to ensure security and functionality of new technology; governmental entities have sharply limited expertise.

·         In the U.S., the central bank lacks legal authority to impose a CBDC; a privately-issued pegged stablecoin complies with existing regulatory regimes.

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Figure 1 below is a simplified representation of how USD can flow from the sender of USDS to the receiver of USDS.  This diagram does not show the receiver’s use of USDS in transactions.

Figure 2 below illustrates the substantial savings in transaction costs for senders and receivers in using USDS compared to fiat payment transactions.  USDS will be engineered to minimize “gas” fees (the costs of validating transactions on the USDS blockchain).