This issue is brought to you by:

“My pen and paper causes a chain reaction, to get your brain relaxing.”

— Eminem

Planning for a narrow bank

Oh man, did Byron pick a great week to take some well-deserved vacation! While your regularly scheduled newsletter writer is off relaxin,’ drinking proverbial Mai Tais, all eyes are on the US banking sector.

Can regulators effectively stop a chain reaction that started with the liquidation of Silvergate Bank, continued with the bank run on SVB (which led to FDIC receivership) and culminated (for now) in Sunday’s takeover of Signature “systemic risk exception” Bank by New York regulators?

I don’t know, but the banking kerfuffle rippled through DeFi markets — thanks to its effect on one systemically exceptional stablecoin. Circle’s USDC dipped under 90 cents late Friday and was anything but stable over the weekend before recovering Monday.

USDC has been, up to now, considered one of — if not the — safest stablecoin: It is fully-backed with cash and T-bills, held by reputable banks and audited by a Big 3 accounting firm.

None of this opaque off-shore Tether nonsense, mind you! USDC is so safe, some DeFi protocols don’t even bother to use a price oracle and just hard-code it to $1!

But that’s now being reexamined; no one wants an on-chain dollar that can lose 5-10% of its value, even for 48 hours.

That crisis of confidence will have Circle reexamining its banking relationships to figure out how to restore trust — and keep it.

Safety first: Circle’s banking should match its backing

Unlike SVB itself, which apparently assumed unhedged interest rate risk beyond reasonable levels, Circle holds its vast reserves in cash and short-term Treasurys. That’s ostensibly what US regulators want to see.

Yet even though its deposits were spread across six different banks, the need to pause redemptions while it sought to extricate $3.3 billion from SVB was enough to send the token price to stablecoin Goblintown.

So, Circle chief Jeremy Allaire wants to cut out the middleman and hold cash with the Fed itself.

This is not a new idea, of course.

The concept of "narrow banking" was the norm in the USA during the 19th century, up until the Banking Act of 1933 (also known as the Glass-Steagall Act), which created the Federal Deposit Insurance Corporation (FDIC).

Back then — note this was before the Federal Reserve System existed — narrow banks issued only short-term loans, typically for less than 80 days and backed by collateral or a guarantor.

The modern incarnation would be a bank which offers customers direct access to central bank money, thereby eliminating four types of risk: credit risk, duration risk, interest-rate risk and market risk.

That sounds pretty useful for a stablecoin issuer like Circle!

But not only Circle. Even before stablecoins were a thing, a Connecticut chartered bank called simply “The Narrow Bank” or TNB USA Inc. tried to make a go of it. Unfortunately, its plans have been perpetually stymied by…the Federal Reserve!

TNB intends to accept customer deposits, large ones from institutional clients. But rather than make loans or otherwise invest the deposits using a fractional reserve approach, TNB would hold 100% of the funds in a Fed Master Account (FMA) instead.

Why?

Well, why not? Since 2008, the Fed has paid interest on the full amount of bank reserves on its balance sheet — what's now known as the "IORB" (interest rate reserve balances) — currently 4.65%.

TNB wants to pass that interest, minus a small cut, of course, on to its customers.

Fed up with the Fed’s roadblocks, TNB eventually sued. But the judge in the case dismissed the suit in 2020 on grounds that the application was, technically, still in process, and had not (yet) been denied.

That’s still the case today! Effectively, the Fed has been allowed to bury the issue through inaction — for years.

Fed staff worry that a bank like that (they invented a new term for it: Pass-Through Investment Entities or PTIEs) could complicate the implementation of monetary policy, disrupt financial intermediation in ways that are hard to anticipate, and have a negative effect on financial stability.

Sounds a lot like crypto.

TNB, meanwhile, argued that the existence of a narrow-bank style approach wouldn’t just help big institutions keep their cash safe while earning a yield, it would also serve to nudge retail rates higher.

(Ever notice how when the Fed cuts rates, your bank immediately slashes the interest on your savings, but when interest rates rise, they find a way to avoid passing that interest on to you?)

Jerome Powell disagreed, writing at the time, “the potential for rates offered by PTIEs to have a meaningful impact on retail deposit rates…seems very low.”

Exactly why was unclear.

The FRB also reckons it would reduce available funding for commercial banks, which couldn’t compete.

OK, fair enough.

It’s worth noting that many of the same concerns raised by the FRB would apply to a retail CBDC, as Powell himself has told Congress in hearings regarding proposals to make Fed accounts available to individuals.

In fact, I’d say the Fed’s intransigence regarding TNB makes it unlikely we’ll see much progress on a US CBDC under the current leadership.

Circle’s business model is just like TNB’s, only better — they aim to earn a return on their reserves by investing in the safest assets — only they pocket the interest and in exchange make USDC effectively available to anyone, not only large institutions.

The motto of the Centre Consortium (Circle and Coinbase), regarding USDC, is "connecting every person, every merchant, every financial service, every currency. Everywhere.”

Hear, hear!

Custodia forcing the Fed’s hand

A more recent twist on the narrow bank comes from the pursuit of an FMA by Wyoming-based Custodia Bank.

After multi-year foot-dragging, the Fed denied Custodia’s application to become a member of the Federal Reserve System.

That’s after Custodia sued over an already multi-year delay. A motion to dismiss the suit was recently denied, and Custodia was allowed to amend its complaint to specifically challenge the Fed's authority.

Is the government’s position part of some “operation choke point 2.0”? Who knows?

But the Treasury’s 2021 stablecoin report raised similar objections to the FRB’s case against TNB.

“If insured depository institutions lose retail deposits to stablecoins, and the reserve assets that back stablecoins do not support credit creation, the aggregate growth of stablecoins could increase borrowing costs and impair credit availability in the real economy,” the Treasury wrote.

That’s debatable, and there are other reasons why promoting US dollar usage may serve policy interests.

In any case, the next line hits a little differently today, with fears of regional bank runs running rampant:

“The perception of the safety of insured depository institutions relative to stablecoins could also shift during times of stress, with large and sudden inflows or outflows of deposits possible.”

Stablecoins are meant to be safe. By forcing Circle to park its funds with relatively risky banks, policymakers are definitely stress-testing DeFi.

But maybe that’s part of the plan.

— Macauley Peterson

P.S. — Find this newsletter helpful? Share it!

Was this newsletter forwarded to you? Sign up here.

Top Stories

CoinMarketCap Acquisition of CoinDesk ‘On Hold’ — Blockworks
ETH Staking Not an Investment Scheme, ConsenSys Execs Argue — Blockworks
Bitcoin Dominates Bank Stocks Amid String of Failures — Blockworks
Euler Suffers $200M Exploit in Flash Loan Attack — Blockworks
Looming Tax Deadline Has Businesses, Investors Scrambling To Get Returns in Order — Blockworks
Circle Boasts New Banking Partner To Calm Markets After USDC Depeg — Blockworks
The Secret Behind ‘Set It and Forget It’ Crypto Investing Hacks [Sponsored] — Blockworks
Biden: SVB, Signature Executives Will Be Fired — Blockworks
Top Stablecoins Flirt With USD Peg After Crashing to All-Time Lows — Blockworks
What We Need To Scale Blockchain Technology Into the Future [Sponsored] — Blockworks
Crypto ‘Risk Rally’ Comes Despite Broader Contagion Concerns — Blockworks
Signature, Silicon Valley Bank Depositors Will be Made Whole — Blockworks

We're Hosting

How does UDSC help solve the Emerging Markets Liquidity Gap?

Date: Thursday, March 23rd

You've Waited All Year For This...

Still waiting to buy your Permissionless ticket, anon?

Prices increase every two weeks.

Grab your ticket today!

This issue is brought to you by:

The emergence of new global markets presents entrepreneurs with opportunities to build and grow businesses. But historically, the biggest challenge they’ve faced is a limited supply of USD-denominated capital.

The rise of stablecoins such as Circle’s USDC has started to overcome this challenge for entrepreneurs and institutions. Our upcoming Blockworks webinar will discuss USDC’s programmability to create efficiencies and transparency in capital markets, stablecoin regulatory considerations, and many more topics for those interested in closing the liquidity gap in emerging markets.

Join Blockworks Webinars and leaders from Circle, Clave, Credix, and Cumberland who will discuss the opportunities and use cases for deploying USDC in emerging capital markets.

Spots are limited. Register now for this important conversation on March 23rd.

Blockworks Research Alpha

Curve, the leading DEX for swapping stable assets, saw a record high in trading volume of $6.4B on Saturday. 95.7% of all the volume was seen on non-volatile trading pairs. The 3pool remains heavily imbalanced despite the assurances made by Circle around USDC’s backing. The pool is designed to be weighted evenly between DAI, USDC, and USDT, but the pool remains heavily weighted towards the former two. USDT currently composes ~5% of the 3pool, with the remainder as both USDC and DAI.

For daily alpha delivered to your inbox, subscribe to Blockworks Research Newsletter.

We're Watching

Signature and Silicon Valley Bank have collapsed. In this breaking news episode of Empire, hosts Jason Yanowitz and Jack Farley interview Joseph Wang to discuss the banking system failures and what to expect next.

Watch and listen to Empire on Youtube, Spotify, and Apple Po dcasts.

Written by Macauley Peterson

Produced by Kat Dittmeier

Follow Blockworks on Twitter, LinkedIn, YouTube, Telegram and Instagram.

Was this email forwarded to you? Sign up for free to join over 180,000 investors who read Blockworks newsletter daily.

Update your email subscription preferences here.

🟪 Planning for a narrow bank