Stablecoins vs Tokenized Deposits: Why the Differences Matter

Noelle Acheson, who was previously in charge of research at CoinDesk and Genesis Trading, and host of the CoinDesk Markets Daily podcast, is the author of this article. The content comes from her “Crypto Is Macro Now” newsletter, which explores the intersection between the evolving cryptocurrency and macroeconomic environments. Please note that these views are personal, and should not be construed as investment advice.

Deposit tokens, also referred to as tokenized deposits, are digital counterparts of traditional bank deposits, recorded on a blockchain. These tokens are issued by banks and are backed by actual bank deposits. They can operate either on private or public blockchains, with the issuing banks maintaining control over access due to heavy regulation. For instance, JPMorgan’s JPM Coin is used for settling transactions between its clients, while SocGen’s EURCV can be transferred to clients without accounts at the issuer bank, subject to a whitelist approval process.

Refining transactions with tokenized assets streamlines the process of fiat exchange by skipping certain stages during trade and settlement, all while improving visibility and adaptability for those managing these resources.

Instead, let me clarify that unlike other forms of stablecoins (like algorithmic or yield-bearing), which I won’t delve into right now, stablecoins are digital tokens on a blockchain. These tokens are tied to the value of a traditional currency, often referred to as fiat money. The entity responsible for issuing these stablecoins, whether it be a bank or another type of organization, guarantees that the token’s worth remains consistent with the selected fiat currency by providing an option for immediate redemption.

This may sound like a tokenized deposit, but it’s not. The stablecoin doesn’t represent the deposit, it is pegged to the fiat value via the backing reserves: a small distinction that makes a big difference.

The difference is operational, conceptual and legal.

They do different things

In practical terms, when one client moves a deposit token to another, it often initiates a transaction outside the blockchain for the corresponding fiat currency to be transferred from one account to another. Since these tokens symbolize bank deposits, the amounts in the fiat and token accounts should ideally correspond.

Instead of traditional currencies, Stablecoins function differently. They can be easily transferred between users without requiring adjustments to corresponding bank accounts. The reserve account associated with the Stablecoin doesn’t actively participate in these transactions. It merely needs to be accessible for redemption whenever requested, regardless of who makes the request (though there are some exceptions as not everyone can redeem, but this is generally true – those who don’t redeem can exchange Stablecoins for traditional currency on various platforms).

This brings us to the idea that deposit tokens differ conceptually from traditional deposits. Instead of being considered a swap, they are intended as a more fluid alternative. They don’t aim to supplant physical currency; rather, their purpose is to streamline it.

Stablecoins serve as an alternative solution, initially developed during the early days of crypto exchanges when they struggled to secure bank accounts. Over time, they evolved into not just a bypass but a more streamlined method (faster and cheaper) for transferring funds between and within exchanges. In many cases, they are preferred over fiat onramps even when they’re available.

Deposit tokens are created by banks, for bank clients. They represent bank deposits.

Stablecoins were initially designed as an alternative to traditional bank accounts for individuals who didn’t have access to them. Essentially, they function like a stand-in for bank deposits. Unlike a business agreement, their value lies in the representation of worth, rather than complex transactions or negotiations.

What’s more, stablecoins are bearer instruments: whoever holds them, owns them. They are the asset.

Deposit tokens aren’t considered bearer instruments; rather, they symbolize the assets themselves, in this instance, they stand for bank deposits.

This discussion leads us to consider how these two ideas may develop legally over time. Generally speaking, from a regulatory perspective, traditional bank deposits are acceptable, but bank deposit alternatives might pose greater challenges.

Here’s an intriguing part, where the initially distinct ideas surprisingly begin to overlap.

Here is also where it gets philosophical.

What does that mean for future of money?

One fundamental aspect of money is its uniformity, meaning that regardless of who possesses it or where it comes from, a single dollar remains the same (using the U.S. dollar as an example). This consistency is crucial for monetary regulations, ensuring that one of the key assumptions in monetary law will always remain valid. In a scenario where multiple entities could issue dollars and there’s no central authority to back them up, it’s plausible that not all dollars would hold equal value.

It’s important to note that while stablecoins like USDT and USDC, the two largest examples, are supposed to be equivalent to a dollar, they don’t always maintain this parity. In other words, there may be times when one USDT or one USDC doesn’t equal one U.S. dollar. Because of this inconsistency, regulatory bodies can’t technically classify them as “money.” Additionally, the company that issues the largest stablecoin, Tether (USDT), is not protected by the FDIC. This means that the security backing 1 USDT isn’t the same as that behind $1, which could potentially affect their monetary value in theory.

Stablecoins aren’t exactly like traditional currency, could we say they resemble tradable money market funds in some ways? However, that seems unusual because stablecoins function as money and they don’t meet the criteria of “expectation of profit” under the Howey test. Also, it would be challenging to demonstrate that they represent a “common enterprise,” another requirement under the Howey test, since their success isn’t primarily tied to promoters or investor pools.

Furthermore, stablecoins meet the traditional criteria of a currency: they facilitate transactions, they are broadly recognized as a standard for valuation across various assets, and they maintain their worth consistently over prolonged periods.

However, these do not comply with the single-issue rule, a crucial point for authorities determining the legality of their issuance and usage.

If these assets are considered securities due to their lack of singular nature, similar to non-yielding money market funds, it could potentially blend traditional ideas and significantly alter the way finance operates. In this scenario, securitized stablecoins might gain widespread acceptance as an alternative form of currency.

A dollar but not a dollar

Indeed, it might seem that deposit tokens can be viewed as money by regulators, while stablecoins appear not to fit this category easily. However, let’s clarify this point more carefully:

While deposit tokens might symbolize money, it’s crucial to understand that they aren’t legally considered as such. One key difference is the level of risk involved. Unlike regular bank deposits, a significant portion of which gets lent out or invested, deposit tokens may lack the support thought to be present in case of a bank failure. In contrast, conventional deposits often come with some degree of insurance. As for tokenized deposits, they currently do not offer this protection.

In the event of a technical issue causing missed or duplicate payments, which may result in discrepancies between digital tokens and traditional currency (fiat) balances, how might these discrepancies be rectified and by whom would this decision be made?

Additionally, certain forward-thinking bank strategists discuss the possibility of making deposit tokens programmable, which could significantly boost their efficiency and adaptability. Instead of focusing on conditional payments, which are more related to wallets, consider a deposit token with a small piece of code that initiates a function, like granting access to a bid or paying a dividend.

This seems quite intriguing, but it alters the fundamental properties of deposit tokens beyond merely representing money. If a token can transform into something else, is it still considered money? Does it meet the “one and only” requirement? Does it conform to the traditional definition by serving as a medium of exchange, store of value, and unit of account?

I’m hoping that the emergence of a novel form of transfer technology, which challenges the established boundaries of traditional monetary economics, will serve as an eye-opener for many, prompting us to revise and modernize our terminology and ideas.

Currently, regulators seem stubbornly tied to traditional perspectives, reluctant to embrace the notion that novel technologies necessitate fresh approaches to understanding. By confining “approved” applications to what’s currently feasible, regulatory bodies are effectively hindering genuine innovation from shaping and advancing progress.

Reflecting on this, I can’t help but recall a sentiment often credited to Stanford Professor Paul Saffo: “It seems we frequently employ novel technologies to perform traditional tasks with enhanced efficiency. In essence, we smooth over the old ‘cow paths’.

Undeniably, there’s room for improvement, yet let’s not forget that our initial move should be acknowledging that the flying cattle no longer require trails, traditional concepts of currency are overly restrictive, and regulatory barriers to advancement gradually lose their significance.

Note: The views expressed in this column are those of the author and do not necessarily reflect those of CoinDesk, Inc. or its owners and affiliates.