The Bank Policy Institute is concerned that the BlackRock fund used for USDC stablecoin reserves could access quasi-deposits from the Federal Reserve

Reflexes:

• The bank’s think tank fears that some USDC reserves may be parked at the Fed
• BlackRock now manages most USDC stablecoin reserves through a money market fund
• Reports claim that BlackRock is requesting the use of reverse repos (RRPs) from the Federal Reserve
• Cash flows from RRPs are similar to depositing money at the Federal Reserve

The Bank Policy Institute, a bank-backed think tank, published a blog post raising concerns that a proportion of the USDC’s stablecoin reserves could be parked at the Federal Reserve, even though the issuer of stablecoins do not have a central bank account. If this were allowed, in times of uncertainty when there is a flight to quality, this could result in bank runs diverting cash towards the USDC stablecoin, which could be perceived as just as good as a central bank digital currency (CBDC).

Since November, BlackRock has been managing a large portion of the USDC stablecoin’s reserve assets on behalf of the stablecoin’s issuer, Circle. BlackRock created a bespoke money market fund, the Circle Reserve Fund, which invests in short-term US Treasury bonds. It currently manages about two-thirds of the assets of the $44 billion stablecoin, which keeps 80% of its reserves in Treasuries.

A December research note from Barclays noted that money market funds can use the Federal Reserve’s reverse repo facility (RRP).

This involves the fund buying Treasuries from the Federal Reserve, which will be resold to the Fed at a future date at a slightly higher price. The net effect of cash flows, with the transfer of money to the Federal Reserve, is not unlike the USDC’s reserve cash deposit at the Federal Reserve. The BIS called it a ‘backdoor CBDC’.

The BIS states that BlackRock has requested the RRP facility. He further stated that 20% of USDC reserves currently sitting in banks could be transferred to the RRP program. We’ve reached out to Circle and BlackRock to confirm, but haven’t heard back in time for publication.

The RRP route is potentially better than a synthetic CBDC. The latter involves a CBDC that is backed by the cash of a stablecoin issuer at the central bank. This reduces counterparty risk because there is no bank risk. However, the account is still owned by a private entity so there is some risk, while the counterparty to the RRP is the Federal Reserve itself.

BlackRock and USDC for capital market transactions

BlackRock invested in Circle in April as part of a $400 million funding round. At the time, the asset manager said that he was interested in using USDC for capital market transactions. But stablecoins are not considered a risk-free settlement asset. So the RRP would considerably improve USDC’s risk profile.

In general, there is a strong preference for using central bank money for securities transactions. Fnality is backed by 17 global institutions and is effectively creating a synthetic CBDC designed for capital market transactions. Some bankers not involved in the project see it as a good intermediate step, but would still prefer to use a CBDC.

Why the Federal Reserve Might Refuse RRP Access

As for the application process for the RRP, the Circle Reserve Fund should be running for a year to begin with, so it won’t happen before November 2023.

A major hurdle for the Circle Reserve Fund could be compliance. The RRP request form asks about the proportion of shareholders in high-risk sectors from an AML perspective. Since Circle is the sole shareholder and its stake in the cryptocurrency and DeFi sectors, that would be 100%.

Is PVP a temporary tool?

The BIS argues that the RRP was intended to be a temporary tool introduced in 2013. Between 2018 and May 2021 it was used occasionally with small balances. The current balance is $2.2 trillion. The spread between interest rates on reserve balances and the overnight RRP rate is just 10 basis points (0.1%) and used to be 25 basis points. The BIS wants the spread to reverse. “The Federal Reserve should not only deny the Circle money pool access to the ON RRP facility, but should take steps to expedite the liquidation of the facility as an attractive nuisance.”

A perspective beyond the banks

Clearly, the BIS’s outlook is skewed towards banks, although its concerns are not without foundation. If one accepts that stablecoins can provide utility, then there should be a desire to make stablecoins more secure and resilient. The RRP is a potential avenue to protect stablecoin reserves.

However, a key problem with stablecoins is the network effect. In other words, without intervention, there will likely only be a handful of widely used stablecoins, or even perhaps a monopoly. While monopolies are highly desirable for the company, they are often not optimal for the ecosystem. And for stablecoins, a monopoly or oligopoly presents significant risks to financial stability.

To encourage competition, the central bank could limit the number that can be supported through the RRP. Start low, say at $5 billion, and raise the cap as stablecoin adoption expands. If stablecoin issuers are forced to publish the figure, then rational stablecoin users should migrate to stablecoins with a higher proportion of ‘guaranteed’ reserves.

However, to date, crypto Stablecoin users have not behaved rationally, as evidenced by the adoption of market leader Tether. If the proportion of conventional The use of stablecoins increases, maybe that can change.