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July 27, 2022

The Real Risk of Stablecoins

with

Patrick Murk, President and Chief Legal Officer at Transparent Financial Systems

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Today, we're talking about stablecoins with Patrick Murk, the President and Chief Legal Officer at Transparent Financial Systems.

Why? Because stablecoins are one of the most popular crypto utilities in terms of active use cases. Today, the two largest stablecoins account for over a hundred billion dollars in market cap. That's a really big amount. In fact, stablecoins account for a disproportionate number of top coins by market cap, and in a lot of ways these stablecoins are helping fulfill the promise that Bitcoin initially proposed, namely efficient, decentralized payments. So let's establish the lay of the land and identify the most successful approaches to stablecoin deployments today.

Patrick Murck is President and Chief Legal Officer at Transparent Financial Systems. He works with regulators and policymakers around the world and serves as a member of the IMF’s High Level Advisory Group on Fintech, the Fintech Advisory Group for the Federal Reserve Bank of New York, the Fintech Working Group for the Massachusetts Securities Division, and the Delaware First State Fintech Lab. Prior to Transparent Systems, Patrick helped set up Cooley's blockchain and fintech practice, and he is also a co-founder of the Bitcoin Foundation, where he served as General Counsel and Executive Director. Beyond these accomplishments Patrick has been involved in a number of startups as a founder, investor, advisor, and counsel, and has also been named among America’s 50 Outstanding General Counsel by the National Law Journal.

Mark Lurie:

Welcome to WTF Crypto, where we peel back the layers of the onion of the crypto universe to understand what's really going on and how it affects you and your portfolio.

Mark Lurie:

I'm your host, Mark Lurie and as a caveat, nothing in this podcast is legal or investing advice.

Mark Lurie:

Today, we're talking about stablecoins with Patrick Mirk. Welcome, Patrick. Thank you so much for joining us.

Patrick Murck:

Hi, Mark. Yeah, it's great to be here. Thanks for having me!

Mark Lurie:

Stablecoins are one of the most popular crypto utilities in use cases. Today, the two largest stablecoins account for, combined, over a hundred billion dollars of market cap.

Mark Lurie:

That's a really big amount. They're both part of the top five coins. People commonly use them for trading and payments. In a lot of ways, stablecoins might fulfill a lot of the promise that Bitcoin was initially supposed to, which is about payments.

Mark Lurie:

Let's start by just establishing the lay of the land. What are the approaches for stablecoins today, and how are they actually used today as distinct from how we hope or expect they might be used in the future?

Patrick Murck:

Yeah, I will say that I, and personally, I was very slow to warm up to stablecoins and they've been something that have been discussed for years and years and years, and then they've sort of exploded onto the scene along with DeFi, fairly recently, but the ideas and concepts have been there and some of the protocols have been there for a little while now.

Patrick Murck:

There are a few different approaches to these stablecoin offerings, and there's no real good taxonomy that I've seen yet that has fully captured all the distinctions cleanly.

Patrick Murck:

But we can look at some of the ones that have existed and just talk about what they did.

Patrick Murck:

So, the older line versions of stablecoins are very traditional in the sense that you have a centralized actor that takes money from users of the stablecoin, holds that money out as a guarantee that the stablecoin has value and will redeem those coins for that value. You have one centralized actor that's in the middle.

Patrick Murck:

A couple good examples of that are Tether and USDC, right? You have some old line very traditional approaches to how to issue these payment instruments.

Patrick Murck:

When you think about it, when you really look at it and peel it away, there's not a lot of difference between those and things that are, you could say, pre-cryptocurrency.

Patrick Murck:

Whether it's PayPal or DigiCash or even things like Liberty Reserve or Eagle. They all function roughly the same way.

Patrick Murck:

There's one centralized entity that holds the collateral and guarantees the payment instrument and it's redeemability.

Patrick Murck:

It's a very kind of old school approach. Tether and USDC, I believe are some of the most dominant players in the market right now, currently.

Patrick Murck:

There's issues around transparency and those types of things, which you would expect with sort of a centralized framework.

Mark Lurie:

Yeah, USD Coin, that is put out by Circle. That is in the US that has about 55 billion outstanding.

Mark Lurie:

Tether, which is, I believe regulated in The Bahamas?

Patrick Murck:

Yes.

Mark Lurie:

And that has about 66 billion outstanding.

Patrick Murck:

Then you have things like Dai, which is for product that comes out of the Maker DAO protocol, which does some similar things.

Patrick Murck:

The collateral tends to be native to the cryptocurrency ecosystem that backs it up. And it's kind of orchestrated through a DAO in a more decentralized fashion.

Patrick Murck:

I wouldn't say it's purely decentralized, but it's, I'd say more decentralized.

Patrick Murck:

But they're still trying to figure out ways to integrate with traditional finance in order to bring other forms of collateral into the ecosystem, to support Dai as well, instead of just being reliant on cryptocurrencies and things like that.

Patrick Murck:

In fact, Dai is heavily reliant on USDC in its basket to backstop the value of Dai. So it's a little bit recursive in that way.

Patrick Murck:

That creates an interesting dynamic between Dai and USDC of course. We can talk about that some more later, but more to point out that there's very centralized approach, there's these, more decentralized approach to it.

Patrick Murck:

Then you have things like the algorithmic stablecoins and probably the most notorious.

Mark Lurie:

So Maker... I guess the distinction you're making between an algorithmic stablecoin and Maker is that Maker is decentralized, but it's over collateralized.

Patrick Murck:

Correct.

Mark Lurie:

Right, it's basically like you withdraw a dollar and it's backed by some other asset to 140-150%.

Mark Lurie:

In some ways, that's algorithmic, but it requires over-collateralization. That's a big difference between an algorithmic stablecoin that would not require over-collateralization.

Patrick Murck:

That's just my way of thinking about it. Like I said, there are, in my opinion, no clean taxonomies yet.

Patrick Murck:

You can kind of point at these vectors, whether from a governance perspective, the centralization, which is what I'm focusing on right now, you can focus on sort of the collateral and you can also focus on sort of the mechanisms, right?

Patrick Murck:

How the money comes in, how it goes out... Things like that. They're all valid ways of making these distinctions to, so I'm just picking one, but I wouldn't argue with anybody categorizing it a different way if they wanted to.

Mark Lurie:

That is interesting. I mean, already, you're looking at a number of second order dimensions to think about the difference between stablecoins that I think people don't typically look at.

Mark Lurie:

It's not just about how it's governed. It's not just about whether it's centralized or decentralized.

Mark Lurie:

It's not just about whether it's collateralized or not. It's about what the collateral is and it's about how you get in and how you get out.

Mark Lurie:

It's a good point that there's a bunch of ways you can slice it.

Patrick Murck:

Yeah, it is. It is really interesting. I think people are learning and learning quickly as tends to happen in the crypto E ecosystem... that sometimes it's the getting in and out that's the most important.

Patrick Murck:

Which brings us to the most notorious of them all right, which is the Terra stable coin. Which epically collapsed in on itself.

Patrick Murck:

That was sort of a uncollateralized self-regulating stablecoin that created like, you know, a secondary coin to basically stabilize the value with its own value.

Patrick Murck:

If it sounds like turtles all the way down, it was, right? At some point, one of the turtles got swiped away and then all the turtles fell.

Patrick Murck:

Then it, all of a sudden went from billions and billions of dollars in notional USD value held by consumers across the world to $0.

Mark Lurie:

$18 billion.

Patrick Murck:

$18 billion to effectively zero because the algorithm was gained, which... That's how it works in crypto. Right?

Patrick Murck:

If you put a challenge out there, people will take up the challenge. It's an unfortunate lesson. It's unfortunate that people were harmed by it. I know people who were harmed by it and I feel badly for them.

Patrick Murck:

It was pretty clearly just a grossly irresponsible kind of scheme. That's of course, being worked out in the legal sphere now, which is the place you never want to be just in life in general, I think, but certainly not in crypto markets.

Patrick Murck:

Getting in and out becomes very important. That's a really important mechanism, of course, how it... Not just is it collateralized, but how that collateral works, who's actually maintaining that collateral, how liquid is it, and how accessible is it and things like that.

Patrick Murck:

Which turns us back to what people think are the safest of these products. Whether it's Tether or USDC because USDC has finally started publishing some information on their holdings, which is a good, solid move towards transparency for them.

Patrick Murck:

If it's long overdue and probably forced measure, to some degree, but it's good that they're finally doing it.

Patrick Murck:

Even still, the quality of that collateral is not just... It's U.S. Treasury so the U.S. Treasury is good for it. It's how fast can they actually get that liquid into your hands if you're stuck in a run and you need to get out of that position.

Patrick Murck:

The fact is USDC is not a dollar, and it's not a dollar in your hand, whereas they expand into other jurisdictions.

Patrick Murck:

It's not a Euro in your hand, either. It is script that is written by Circle, that you are accepting in lieu of a dollar.

Patrick Murck:

That's a critical thing to understand, especially if you're active in the markets, if you're trading things like that, or if you're accepting as payment for goods and services.

Patrick Murck:

Then until you redeem that into actual dollars, euros, yen, whatever that you haven't actually got the money in your hands.

Patrick Murck:

If there's one lesson that people should learn from this Terra fiasco, it's not that only algorithmic stablecoins are bad. It's that until you have a dollar in your hand, you don't have a dollar in your hand.

Mark Lurie:

Okay. So I think we should spend a bunch of time digging into that one because stability is perhaps most important when the world's falling apart. Right?

Mark Lurie:

But that does bring up a couple things which are perhaps the end of our taxonomy, which are CBDCs, because that is a dollar in your hand, right?

Mark Lurie:

Would you consider that a stablecoin? And sorry, for the audience, that's a central bank digital currency. It's as if the government issued directly a stablecoin.

Patrick Murck:

[inaudible 00:10:43]

Mark Lurie:

But that's exactly what they do with U.S. dollars. It's like issuing digital.

Patrick Murck:

Yeah, CBDCs are absolutely fascinating, and there are some really bad ideas. Just really bad ideas that are just widely circulating right now around CBDCs, and there are some good ones too.

Patrick Murck:

The general idea is that we've gone from sort of analog paper money to digital money. That digital money right now is sitting in a bank and gatekeeped by the bank that you bank at.

Patrick Murck:

Which has a, sometimes modern, but generally not modern infrastructure to allow you to access that money. There is just a lot of sort of integrated thinking about that and a lot of cost associated with maintaining that system and money that way.

Patrick Murck:

If you want to spend your money, you have to... Through the bank, you want to spend the actual dollars, the digital dollars that are sitting in your bank account, wherever you're banking... bad OPSEC, don't tell me where. The bank of Mark.

Patrick Murck:

We go to the bank of mark and there my digital dollars sit, and if I want to spend those dollars, I can log into my account, I can issue an ACH payment or wire payment.

Patrick Murck:

These aren't instant transactions. It's clunky, and it's cumbersome. Compare that to sending, say, USDC or Tether or Dai to somebody and it's just absolutely night and day, right?

Patrick Murck:

I can send Dai to somebody 24/7, 365. Anytime I want, I can program it in to a so-called smart contract or digital decentralized application.

Patrick Murck:

I can do all sorts of things with it that I just absolutely cannot even fathom to do with the digital dollars sitting in my bank account.

Patrick Murck:

That distinction has created an absolute ton of demand. I think you said $50 billion or so worth of demand currently in the stablecoin marketplace.

Patrick Murck:

That's the demand right there is that you need a second order effect in order to use your digital dollars that are gatekeeped by the banks right now.

Patrick Murck:

The question then is, well, how do we get the do digital dollars out from those sort of old line archaic systems where they're more extensible?

Patrick Murck:

Maybe not as extensible as USDC for policy reasons or whatever, but at least from a technology perspective that they're usable in the same way. That's sort of the idea and the promise of CBDCs in general now.

Mark Lurie:

That actually also touches on the benefits of stablecoins and the reason people are even wanting stablecoins in the first place. Right?

Mark Lurie:

That applies to CBDCs, but it sounds like the programability of these digital dollars where you can use it in code and other applications, without requiring accounts and walled gardens of specific financial institutions is one of the big things that creates demand for this.

Mark Lurie:

It seems like it's that, perhaps it's traders who just want to risk on risk off like their long Bitcoin or their short Bitcoin, so they want to hold some dollars. Perhaps people storing money who are otherwise unbanked.

Mark Lurie:

I guess from what you said, it's programmability, so call that decentralized finance. There's all sorts of structured instruments that are arising.

Mark Lurie:

Are there other, any other things you think are really building and drawing this demand today for stablecoins?

Patrick Murck:

Yeah, so I think for the... that's where the demand today is coming, but it's not all of the demand that exists.

Patrick Murck:

In fact, I think it's only a tiny slice because when you think okay... $50 billion, that's a lot of money, but you what's a lot of money? $5 trillion.

Patrick Murck:

The actual like currency that is transacted on a daily basis is just orders of magnitude more than what stablecoins are addressing.

Patrick Murck:

I mean, it's such a tiny, tiny sliver of sort of the payments marketplace currently. We can talk about, just for a second to digress, other sort of second order approaches to getting to your digital dollars, right?

Patrick Murck:

We talked about stablecoin as one, but that's for one particular market to do. It's very much around the use cases you just suggested, but there are others, right?

Patrick Murck:

There's Zelle, there's Square cash app. There are lots of ways where you're taking the notional value that's being issued by a centralized issuer, into an app where you can then have 24/7, 365 access to a payment instrument that is closely related to the digital dollars in your bank account and be able to send them around and use them.

Patrick Murck:

Now those are less extensible than a stablecoin, but they serve a huge, huge market and [inaudible 00:15:52] WISE and there's... for international remittances and it goes on and on and on, right?

Patrick Murck:

Where you have centralized issuers who are issuing script through their gateways whether it's again, USDC or whether it's Square or whether it's Zelle, or whoever, to affect the same type of thing and attack different types of markets in the payments ecosystem.

Patrick Murck:

Stablecoins are sort of the use cases that you described and particularly designed to be used, issued within and used within sort of the crypto ecosystem and DeFi ecosystem specifically.

Patrick Murck:

Again, we... You mentioned one of them is risk on risk off. If that's... I would really hope that is one of the lessons again from this Terra fiasco, is that understanding that you aren't fully risk off when you just take on a stable coin obligation and you exit your cryptocurrency position, right?

Patrick Murck:

That's exactly what happened to a lot of people believing that Terra was risk off, but it was far from it.

Patrick Murck:

In fact, it was riskier than the asset that they were risking off of. They... It was just unclear for those users that was the risk that they were taking.

Patrick Murck:

That's how you get crushed in any market, is just not really appreciating the risk you're taking USDC might not be as risky as Terra, but it's not risk free.

Patrick Murck:

People should absolutely recognize that and imply the correct discount when they're holding USDC.

Mark Lurie:

Okay, so let's dig into that because I think that's super interesting.

Mark Lurie:

A couple flags just before we do. You're right... I just looked up the M1 money supply and it is about 20 trillion. So, stablecoin...

Patrick Murck:

I was off by factor four, two. So there you go.

Mark Lurie:

Yeah, it's large. Stablecoin is still small potatoes relative to cash out there.

Mark Lurie:

Another flag is payments, which is like you say, probably the biggest use of cash in our economy is a whole other topic.

Mark Lurie:

The subject of another podcast episode with Jess Houlgrave of checkout.com, who's head of crypto over there.

Mark Lurie:

If you want to... I won't digress and talk about the status of payments and crypto stablecoin in payments around the world, but that's a whole other conversation which you can listen to on another episode.

Mark Lurie:

With that said, I think this is the key topic, right? Is what are the lessons we can take from the fiascos of algorithmic stablecoin.?

Mark Lurie:

And then what are the issues that we should be aware of with respect to centralized stablecoin which, as we talked about, are the bulk of the market cap today that may one day be chickens coming home to roost.

Patrick Murck:

Yeah, so one of the lessons really relates back to what we were talking about the very beginning, when it was, we were trying to classify these different things and we were pulling on these different terms to create a taxonomy.

Patrick Murck:

I was just sort of doing my own [inaudible 00:19:00].

Patrick Murck:

Like I said, I wouldn't contest anybody else's version of it because I don't think there is a good one right now, but those same terms kind of lead you back to well, okay, so how should these things be designed in a way that decreases the risk to the maximum extent possible?

Patrick Murck:

If that's sort of the goal is that this is supposed to be a risk off asset in DeFi, or if that's one of the goals, right?

Patrick Murck:

Probably not the only goal, but it's certainly one of them then how do you know, de-risk this as much as possible, right?

Patrick Murck:

Is that by creating a single central intermediary that manages all of the property? Or is it through a decentralized organization that manages collateral on behalf?

Patrick Murck:

Is there an algorithm that you can use allows for under-collateralization that is actually effective and will not be gamed and disrupted?

Patrick Murck:

I think it's... These are questions to be answered both in the market and through innovation potentially. But those are the lenses that we should be looking at.

Patrick Murck:

What's the governance? What are the governance rights of the different participants? Who's ultimately liable? What do they have backstopping them effectively besides just their reputations?

Patrick Murck:

If there is collateral, which there probably will be collateral, what is the quality of that collateral? How liquid is that collateral? How accessible is that collateral?

Patrick Murck:

Then there are things... legalistic things in terms of how bankruptcy remote is that collateral? Am I the beneficiary of that collateral? Or am I... Do I come after other creditors effectively in the stack, in the capital stack?

Patrick Murck:

Those are difficult questions and it's not something that just, you can just enter into and understand, right?

Patrick Murck:

In many cases, it's not just that these are sort of opaque questions intellectually. They can be opaque in the sense that there's just not data out there to understand these questions, right?

Patrick Murck:

Again, I know that there's more transparency in the space than there used to be, especially from the centralized parties that are doing this still insufficient, if you're really trying to de-risk them.

Mark Lurie:

What are the risks that you see? I mean, the specific risks that you see with Tether and Circle - the dominant stable coin issuers out there today?

Mark Lurie:

I mean, there's been a lot of talk about how algorithmic stablecoins were a little bit crazy, a lot a bit crazy, that collapses happened. So, okay... Lesson learned there.

Mark Lurie:

I think you're right that most people think... Still rely on the centralized stablecoins and what are some scenarios that you actually see potentially playing out that people should worry about?

Patrick Murck:

Yeah, so whatever, when.. It's sort of, and I can't take credit for this, it was central banker who made this point at a meeting once.

Patrick Murck:

I won't... It was Chatham house. I won't say more, but it was a good point that they made where they had said that in relation to stablecoins, this was a couple of few years ago now, that anytime you see money pooling like that, it is inevitable that they will be banking with it.

Patrick Murck:

Effectively conducting maturity transformation, which carries some risk for the holders of the payment instrument that's meant to be collateralized by the instrument. Lo and behold, look at what Tether does, right?

Patrick Murck:

They do not just hold dollars and bank accounts against the liabilities that they have issued in the form of Tether on the blockchain.

Patrick Murck:

They issue.. They buy treasuries, they issue commercial paper, they do all sorts of things with that money in order to generate a higher yield for their shareholders. Because the economic benefit of that pooled money goes exclusively to them.

Mark Lurie:

One of the reasons it's inevitable to your point, it's a fiduciary duty they have. They are almost bound by law to do something with it because they're fiduciary duty is to the shareholders and to maximize equity returns. And so, they kind of have to it's almost like they don't have a choice.

Patrick Murck:

If to, and this is where I get the rubber meets the road. It's sort of a lesson going forward. I will say, it's something that's near and dear in my heart, because it's something that we work on, right?

Patrick Murck:

I am definitely talking my book here to be clear, but it is all about how you structure the instrument itself. That is the token, right? That is the stablecoin itself and the assets that are collateralized and effectively your money that's going into the pool to collateralize it, right?

Patrick Murck:

There are different ways to structure it. One is I just hand the money to Mark and Co., and I hope that when I want to redeem it, that he'll give me my money back.

Patrick Murck:

In the interim, you can issue reports and say how transparent you are and do a bunch of things, but I don't really have that assurance and there's no way that I can really see your capital stack.

Patrick Murck:

Because you're not going to be a hundred percent transparent on your capital stack, even if you show me reams of like documents about every treasury you've bought with my money to ensure the backs up my stablecoin.

Patrick Murck:

I don't know that you haven't taken other loans or that you don't have other obligations to other investors that could supersede my interest in that.

Patrick Murck:

That's one way to do it. Another way is that we could create a trust, and we could create a trust where I am the beneficiary of the trust property, in which case now your fiduciary obligations are very different from the ones you just mentioned.

Patrick Murck:

It is no longer to maximize shareholder value. You're a fiduciary over the trust property, the corpus of the trust and your fiduciary obligations extend to me as the holder of the coin. Which also helps with bankruptcy, remoteness and some other things.

Patrick Murck:

There are ways legally to structure these such that you can decrease the risk for the holders. Now, those aren't appealing to central entities because the return on that is... The return profile is just not as exciting. You can't make as much money doing it that way.

Mark Lurie:

That's why Circle and Tether don't do it that way already because it's more profitable to do it the way they're doing it, which is just to keep the money and use it to make money themselves through longer dated and higher yielding instruments and cash.

Patrick Murck:

Sure. I don't want to oversimplify their structures either because it's a little bit... We're talking and because we have like only a brief amount of time to discuss this, we're talking in simple terms and their structures are slightly more complex than that.

Patrick Murck:

Effectively, if we wanted to just put up and take the names off of it, two very simple constructs that are very different, then yes. That holds, right?

Patrick Murck:

That's a potential way for it to further de-risk this and make this a more equitable arrangement between parties. Because as it stands, in that simple model that we talked about where your fiduciary obligation is to maximize shareholder value, it's...

Patrick Murck:

What's the difference between that and WISE or Green Dot issuing money packs? There's there is no difference. It's just... The function is the same, the form is different, right? Frankly, for that matter, a Starbucks gift card or your Starbucks balance on your app.

Patrick Murck:

I guess the difference there is they don't sell coffee. So you're kind of like... don't have that redemption option, but otherwise, they're very similar structures.

Patrick Murck:

We can do better than that, right? We have both the legal know how, the learnings, the regulatory understanding and the technology to do a better job than that in my opinion.

Mark Lurie:

So what... You've mentioned, talking your book, do you want to talk to your approach?

Patrick Murck:

Yeah, so I mean, our approach is a little bit different and we're not operating in the consumer or retail space at all.

Patrick Murck:

We're not competitive with a lot of these different products. We certainly don't consider what we do a stable coin. Again, that definition is, I mean, there's no good definition of what is and what isn't a stablecoin. Take that with a grain of salt, I suppose.

Patrick Murck:

We work with the users of these payment instruments to create tokenized bank deposits that they can use to pay each other in a enterprise setting.

Patrick Murck:

If Mark and Co. wanted to pay Patrick and Co., then you could at your bank create a tokenized claim against trust property that sits in a bank account, standard bank account that you can send to me that I can take and I can redeem for money that is held in trust property at a bank account. A regular old bank account on my end even if we're at two different banks.

Mark Lurie:

Interesting. Okay, and that's transparent systems. Great. I mean, that makes a lot of sense. That sounds a lot like banking, but of course it's can be used programmatically.

Mark Lurie:

If I think of the Circle model, I mean, it's kind of similar, right? It's a deposit and a token that represents that deposit.

Mark Lurie:

I guess the thing you're pointing out, the difference between like Circle and a bank is well, one, the bank deposit is what it's a different regulatory structure than simply keeping a dollar with Circle because they're [inaudible 00:29:07]

Patrick Murck:

Circle is not a bank and it is not regulated as a bank. It is not insured the way a bank is insured. It does not have the same level of regulatory scrutiny that a bank has. It doesn't have to meet the same risk criteria that a bank does.

Patrick Murck:

There's not as much clarity in bankruptcy. What happens with the assets in Circle bankruptcy as there is in a bank, bankruptcy or insolvency.

Patrick Murck:

The banking sector has hundreds of years of learnings behind it and understandings of how to deal with different situations where there's issues.

Patrick Murck:

That's again, it's not to say that anything is without risk. Everything has risk. If everybody decides to bank at silver gate bank and conduct all their crypto trading activity at Silvergate Bank, just because they're bank doesn't mean they're risk free, you still have the counterparty risk of working at Silvergate Bank.

Patrick Murck:

I think what makes our solution a little bit interesting and different is that we federate that risk across multiple banks.

Patrick Murck:

You're not ever going to get a zero risk anything, right? But we can really minimize that risk and continue to, by not relying on one single bank, but to hold the corpus of the trust across a network of banks so that it's spread out and federated.

Patrick Murck:

If there's one issue with one bank, then you haven't lost the entirety of the corpus of the trust. The other difference is that we hold it in a trust where the holders of the claims are beneficiaries up to the amount of full collateralization.

Patrick Murck:

That's again, a another piece of that puzzle that makes that helps with the risk as well.

Mark Lurie:

I see, okay. There's this concept of a deposit in a bank that has some sort of protection under at least U.S.law. You can, further diversify your risk by spreading across many banks and put it in a trust to make clear who that's in benefit for.

Mark Lurie:

Why... I mean, I think a lot of people think about using Circle as if it is a deposit.

Patrick Murck:

Big problem.

Mark Lurie:

Why isn't the government... Or do you think the government is going to make Circle, become a bank and treat these as deposits? Why not just apply the same regulatory regime?

Patrick Murck:

There's a concept called shadow banking, which I don't want to presume that other people know what that means, but it's effectively like non-bank institutions doing bank-like things and creating excess liquidity in different markets.

Patrick Murck:

Shadow banking became a notorious kind of practice in some ways during the great financial crisis where they pumped a lot of liquidity, hedge funds and things like that from offshore pumped, a lot of liquidity into the CDO swap markets, things like that.

Patrick Murck:

Circle effectively operates as a shadow bank for DeFi. There's no doubt that's part of what they do. When you listed out your use cases, that's a hundred percent, they're creating liquidity within the DeFi ecosystem through a non-bank institution.

Patrick Murck:

They're not the only ones of course, right? I mean, Tether, whoever, right? That's, that's effectively what all these stablecoins are doing. They're effectively shadow banks for DeFi.

Patrick Murck:

The question is, should they become real banks? The answer is probably not. I think that in Circle's wildest dreams, they would be allowed to become a bank.

Patrick Murck:

That's exactly what they would love to be, because then they could backstop all of this with a government charter that allows them to do maturity transformation and print money and into the DeFi ecosystem and become the ultimate gatekeeper in and out for liquidity.

Patrick Murck:

That's a great business. God bless... Jeremy is a friend from a long time. So I wish him the best, but it's not the right framework in the same way that we don't think Starbucks is a bank, right? We don't think that sort of in any of those things, we don't think that DigiCash would be a bank, right?

Patrick Murck:

Anybody, just because they're issuing payment instruments or prepaid access or any of these different types of things, that's not the essence of banking.

Patrick Murck:

Banking is actually like got three pillars. It's deposit taking, and lending, and maturity transformation, right?

Patrick Murck:

The point of taking deposits is so that you can lend them back out and that's really an important part of the function of any sort of bank is to do both of those things.

Patrick Murck:

If you are interested in just narrow banking, which is effectively what Circle is doing. You're only taking deposits and issuing these payment instruments and conducting the maturity transformation piece, sorry, it's deposits payments and loans into the business model maturity transformation.

Patrick Murck:

They're taking deposits, they're doing payments. They're not really doing the lending part and we don't want them to do the lending part. I mean, why not just have JPMorgan do that, right?

Patrick Murck:

Obviously what they're going for with the sort of stablecoin-type charter is to be a narrow bank. Then they're not really increasing the pool of money and increasing sort of access to credit and the economy or doing those types of things.

Patrick Murck:

They're just sort of taking a rake as an intermediary. They're not really providing that public benefit in the same way, but they are getting the backstop of the U.S. government.

Patrick Murck:

They're getting access to the Fed window, Fed master account, which allows them to then take your money and park it at the Fed, truly risk free for them and make a return on it, which is, again, banks have a sweet deal.

Patrick Murck:

It's literally a public private partnership and a charter to, I mean, they say a charter to print money. It's a charter to print money. So it's a sweet deal if you can get it and do it right, and find your niche.

Mark Lurie:

Just so the audience understands maturity transformation. So by maturity transformation, you have a deposit which can be... The maturity is basically on demand, so someone can withdraw it.

Mark Lurie:

When you give that deposit to the bank, you get a very small interest rate because you can pull it out whenever. The bank takes that money and goes and lends it out for a longer period of time, and generally when you lend it out for a longer period of time, you get a higher interest rate and that defines the yield curve.

Mark Lurie:

That's what you mean by maturity transformation, which is like... You take these deposits, which can be pulled out at any time. You lend it out, but you can't pull that back at any time. You've lent it out for, let's say a 30 year mortgage.

Mark Lurie:

The risk there is that everyone wants to pull out instantly, and then you've lent your money for 30 years, and then you have bank run.

Mark Lurie:

The Feds there is a backstop for banks specifically, so that they can go access capital against this collateral which is going to be there eventually, but they can't pull back right now.

Mark Lurie:

That is what you mean by maturity transformation and what a bank can do that a non-bank can't correct.

Patrick Murck:

Yes, thank you. That's a great, great sum up. To take an another example of another sort of DeFi shadow bank, where this becomes very pertinent, we have Celsius, right?

Patrick Murck:

Which engaged in the practice of maturity transformation effectively. They were taking, they weren't doing payments, they were taking deposits in lending, right? They had a maturity mismatch where they had assets, but those assets were long-term assets that they couldn't pull back.

Patrick Murck:

When there was a run because people got spooked, rightly so in that case, they couldn't come up with the money to pay them out and redeem people out in a timely manner, which leads to withdrawal freezes, which leads to further erosion of confidence, which means more people are asking for money.

Patrick Murck:

Before you know it, the walls come tumbling down. Now they're in, I think chapter 11 bankruptcy, just reorganization.

Mark Lurie:

That makes a lot of sense. You talked about, I mean... Why doesn't JPMorgan write to your point that they have these other resources, why don't they just acquire Circle? And then JPMorgan does the stable coin business and they are a bank.

Patrick Murck:

That's 50 million... 50 billion in liabilities, that's generating what kind of yield, with what risk profile? I don't think JPMorgan's very interested in that business right now.

Patrick Murck:

Now, if this keeps growing that the rate has been growing 10 years from now, they, I don't know that they would buy Circle. I think they would maybe just out compete Circle, right?

Patrick Murck:

Now again, if I was Jeremy over at Circle, I would be trying to get my bank charter as fast as possible. I work with the President's Working Group and everybody else to see this idea that the solution to stablecoin regulation is banking regulation.

Patrick Murck:

Now, I don't personally agree that's the appropriate path, but I understand why they want that, and it's for that very reason because then that's... That makes a lot of sense. It also makes them more easily -

Mark Lurie:

That's a good point. It's a... It's a great gig.

Patrick Murck:

It's a great gig. It also makes them more easily acquirable by a bank under the bank holding company act and some other things. There's a lot that's going on regardless. That's a great gig.

Patrick Murck:

I still, I don't think that's the appropriate regulatory framework for what is effectively a prepaid instrument and a payment instrument.

Patrick Murck:

Just to be clear, like we live in a world where we have a plurality of payment instruments and types of money that exist out there that are... They're not digital dollars per se like in your bank account. They ride above that, just like stablecoins do, but they're plethora of them.

Patrick Murck:

They're all over the place and it's expanding. It's like a Cambrian explosion of types of money that are existing and we should embrace it. I think it's really interesting. It's a fascinating time. It's not like it's never happened historically, it happens from time to time.

Patrick Murck:

We're living in one of those times right now. I think it's great. Again, from a regulatory perspective, you want to see as much innovation as you can stand with the least amount of harm, right?

Patrick Murck:

It's a balancing act, but you should see more and more innovative platforms. The other risk of stepping in now and saying, well, these are banks let's regulate them, let's give them banking charters is that you have drawn a line and foreclosed future innovation.

Patrick Murck:

You have put a damper on these different types of instruments that can be created. You've stopped in its tracks, all the innovation that's happening around governance, around trustless systems and decentralization, access, extensibility, everything else, because then everything is going to get wired into the existing bank regulatory infrastructure.

Patrick Murck:

Again, if I was somebody who had a large centralized offering, locking that future in right now to benefit my business model is awesome.

Patrick Murck:

I would do it in a second, especially when I look on the horizon and I see how much innovation is happening. That could be very disruptive to my business model. I would absolutely want to lock it in.

Mark Lurie:

Yeah, that's a great point. Regulators are super well meaning people, I think they get a lot of flack. We complain about them a lot, but they're doing their best and doing nothing to your point allows innovation to continue.

Mark Lurie:

As long as there's not systemic risks, it might just be better to do nothing and kind of let... See things where things settle out rather than throwing in a lot of red tape.

Patrick Murck:

Regulatory clarity.... Everybody loves to ask for regulatory clarity. I'm sure you've heard this before, "We just need clarity," and it's like clarity, only benefits incumbents. It does not benefit entrepreneurs just to be clear.

Mark Lurie:

It's a good point. People want clarity and, but they also complain about red tape.

Patrick Murck:

Exactly. Clarity is red tape.

Mark Lurie:

It's kind of a... You can't win.

Patrick Murck:

It protects incumbents. If we had absolute clarity on how to do stablecoins, how to issue them and how to capture that market share, JPMorgan would eat everybody's lunch or, or whoever, right?

Patrick Murck:

Which is an example of good bank, but that the reason they aren't in the space and that the risk is too high and the rewards aren't worth it is because of the lack of clarity. That's what allows entrepreneurship to flourish, frankly.

Mark Lurie:

Do you think that's also why CBDC, haven't been issued?

Patrick Murck:

We talked... We started touching on CBDCs and they really, they are interesting. I mentioned that there are some really terrible ideas floating around out there.

Patrick Murck:

One of those terrible ideas is U.S. digital dollars, CBDC that is directly issued by the Fed. So this, it sounds like, sure, why not, right?

Patrick Murck:

Effectively give everybody access to the Fed Master Account, [inaudible 00:42:34] right? All finding good. But you, I mean, you would be living in a truly centralized economy at that point.

Patrick Murck:

You would disintermediate all of the banks from one of the primary pillars of banking that we talked about, which is deposit taking and another one, payments.

Patrick Murck:

A;l the banks would be doing is lending, but they wouldn't have any deposits to use for lending. Why would you ever deposit money at a bank and take on counterparty risk? If you could deposit it directly at the Fed and take zero counterparty risk and have greater access to your money on a real time basis?

Mark Lurie:

Yeah, and we need people who will lend, we need banks to lend.

Patrick Murck:

We need banks to lend and if you want to really talk about a Copernican Shift in how we deal with the economy, that would be it, right?

Patrick Murck:

Just wipe all the banks out, start over and have one bank effectively. Really it's all of the Fed banks, but the Fed bank network just run the economy directly.

Mark Lurie:

Yeah, when you put it like that, it doesn't, it doesn't sound so good.

Patrick Murck:

Yeah, so that's not a realistic idea, but creating more digital alternatives through sort of the existing network of intermediation, whether it be that be bank or other sort of payment instrument issuers, which do not all have to be banks, nor should they all have to be banks, we're going to keep seeing like this expansion of different types of money.

Patrick Murck:

I think that's really interesting. Maybe greater access to the Fed window is part of that, not just for banks, but there's a lot of talk about with state charter trust, getting access to the Fed window and that's an important part of that too potentially.

Patrick Murck:

Maybe it's, non-bank having access to the Fed window, which has been... Which happens in other countries. It's not like something that's never been tried before.

Patrick Murck:

Maybe granting FinTech's access to the Fed window is another way to open up sort of the window for even even more entrepreneurial activity and innovation.

Mark Lurie:

My takeaway though, is that you sound absolutely right, which is, we're not just going to have a... so, a essentially Soviet CBDC.

Mark Lurie:

Instead we're going to continue to have stablecoins, a diverse and rich system of payment methods and money storage means.

Mark Lurie:

That will continue to evolve for quite a while until we see how it settles out. That in a lot of ways is great news and we'll make the future very interesting.

Patrick Murck:

We can be hopeful, right? We can be hopeful.

Mark Lurie:

Always are. We wouldn't be in this industry if we weren't. Exactly. Patrick, thank you so much for joining us today. Is there anywhere listeners can find you or follow you if they want to hear more from you in the future?

Patrick Murck:

You know, I try and keep a pretty low profile nowadays.

Mark Lurie:

Fair enough.

Patrick Murck:

I'm on Twitter, I suppose. I don't tweet very often, but it's there.

Mark Lurie:

Okay, noted. Well, thank you again for joining us. Really appreciate it. Any parting thoughts you or words you want to give us before we sign off?

Patrick Murck:

No, just, I just reiterate what you said. It's... I'm very hopeful about the future and looking forward to seeing what people come up with, what new innovations around governance and things like that.

Patrick Murck:

I think we're living in a really interesting time in the best sort of way.

Mark Lurie:

Absolutely. Thank you so much.

Patrick Murck:

Thanks.

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