USDC stablecoin as a backdoor central bank digital currency

The US-based Bank Policy Institute (BPI) is raising concerns that a sizeable proportion of Circle’s USDC stablecoin reserves could be parked at the Federal Reserve, despite Circle not having a central bank account. Since November, BlackRock has been managing about two-thirds of the reserve assets in a bespoke money market fund, the Circle Reserve Fund (CRF) , which invests mostly in U.S. short-dated Treasuries. The BPI claims that Blackrock has applied for the fund to access the Fed’s overnight reverse repo (ON RRP) facility, which provides money funds and government-sponsored enterprises a standing option to invest overnight with the Fed at a fixed rate, currently 4.3%. This involves the fund buying Treasuries from the Fed, which are resold to the Fed at a future date at a slightly higher price. The net effect of the cash flows, with the transfer of money to the Fed, is not dissimilar to depositing the USDC reserve cash at the Federal Reserve. The use of the ON RRP by the CRF could effectively transform USDC into a “backdoor” synthetic central bank digital currency (CBDC) if all of the assets are parked there. [Read more at the BPI]

However, Ledger Insights points out there are some frictions and applications to the application process that might trip up BlackRock’s purported ON RRP application on behalf of the CRF. First off, applicants must have been operating for at least one year, and the CRF was launched in November 2022 so the earliest it could apply would be in November 2023. Also, the application form asks about the proportion of shareholders in high risk sectors from an anti-money laundering (AML) perspective. Given Circle is the sole shareholder and its involvement in the cryptocurrency and DeFi sectors, that would be 100%. Nevertheless, the BPI fears that if and when the CRF gets Fed ON RRP access, USDC would become equivalent to an account at the Fed and a “breathtaking example of regulatory arbitrage… and introduce the potential for systemic contagion from the crypto markets into the traditional financial system.” However, IMF and New York Fed staff have written rather positively about the possibility of stablecoins backed directly by central bank deposits, although the Fed has been reluctant to give Master Account access to non-depository institutions, and even banks, like Wyoming-chartered Custodia Bank.

Interestingly, the Fed covered this in an appendix to a 2022 paper on the Macroeconomic Implications of CBDC that is well worth reading (see below).  It concludes that, “while research has shown that take- up in the ON RRP can crowd out private repo, and that the demand for safe assets can increase ON RRP take-up at the expense of private repo, the overall impact on the banking sector so far has not led to a significant contraction in bank deposits or bank lending… That said, the effect on the banking sector could change as short-term interest rates increase and the Federal Reserve’s balance sheet contracts.”