Submitted by Nicholas Colas of DataTrek Research
There was something in today’s FOMC meeting minutes that, from our cursory word search of prior meetings, doesn’t appear to have ever been a topic of conversation before: virtual currencies. Here is the exact quote:
“Some participants cited various potential risks to financial stability including the risks associated with expanded use of (virtual currencies) or the risks associated with collateral liquidity at central counterparties during episodes of market stress. In connection with the former set of risks, a few of these participants highlighted the fragility and the general lack of transparency associated with stablecoins, the importance of monitoring them closely, and the need to develop an appropriate regulatory framework to address any risks to financial stability associated with such products.”
We’ve even read some buzz that Chair Powell will devote at least part of his Jackson Hole speech to virtual currencies, presumably wrapped into a discussion of a US central bank digital currency. All this is a good enough reason to take a flying tour of this space.
Three brief points:
1: The combined dollar value of all virtual currencies ($1.9 trillion) now essentially equals the total amount of all US physical currency in circulation ($2.2 tn).
It is worth noting, however, that there are only $289 billion in “transactional” ($1 - $20) bills in circulation since most of the value is in $50 and $100 notes ($1.75 trillion in total, $1.6 tn just in $100s).
Bottom line: this is a good enough reason on its own for the US central bank to finally pay attention, because virtual currencies have gone from curiosity to a multi-trillion-dollar ecosystem that rivals the Fed’s own “printing press”.
(Yes, we know it’s actually the Treasury that prints the money, but it still says “Federal Reserve note” …)
#2: There are over 11,000 virtual currencies out in the wild (11,305, to be exact) worth that aggregate $1.9 bn, but 80 percent of the entire system’s value is tied up in just 10 names and +50 pct of that value is in just 2 names.
No prizes for naming the 2: the one that starts with “B” (which we cannot name without risking a spam email warning) is 44 percent of the total and Ethereum is 19 percent.
Worth noting: the Fed seems most focused on “stablecoins”, which are pegged to the US dollar, rather than the best-known/largest virtual currencies.
We covered these recently and described how they function as money market funds in the world of virtual currencies. Mindful of the legacy of the Reserve Fund, one of the matches that lit the 2008 Financial Crisis, the Fed is rightly focused on stablecoins now. Regulation is clearly coming on this front, which we suspect will only increase their appeal.
#3: Whenever the Fed starts focusing on something new one can rightly ask, “fine, but why now”?
Our first point about the size of the virtual currency market is clearly one answer, but so is its increasing complexity and (even more) its global scope. Like it or not, the Fed must see that stablecoins are slowly becoming an ersatz US central bank digital currency.
Summing up: we’ve said it before, but the message bears repeating – the Federal Reserve is the incumbent in the classic paradigm of disruptive innovation, with virtual currencies as the upstarts looking for a product/market fit with their tech-enabled solutions.
That’s not to say the Fed-backed dollar is doomed; Macy’s still exists to this day, after all. It’s just that Amazon is a whole lot larger.