Distinguishing Stablecoins from Tokenized Deposits

Stablecoins and tokenized deposits differ fundamentally: tokenized deposits represent bank deposits for efficient transactions, while stablecoins provide a decentralized method for value transfer. Understanding these differences is essential as they redefine traditional money concepts.

TL;DR Stablecoins and tokenized deposits are both fiat-backed blockchain tokens but serve different roles. Tokenized deposits represent actual bank accounts on the blockchain, enhancing traditional banking efficiency, while stablecoins act as decentralized alternatives to fiat money, offering greater flexibility but facing regulatory challenges. This distinction highlights the need for updated regulations to accommodate evolving digital money.

Stablecoins and tokenized deposits might seem similar since both are fiat-backed and operate on-chain, but they are fundamentally different. These differences go beyond their functionality and treatment, reflecting distinct approaches to money.

Understanding the distinction between tokenized deposits and stablecoins is important not only for their specific use cases and the broader potential of blockchain technology but also for the way regulations might develop. Each of these financial instruments also illustrates different aspects of how our concept of money is evolving.

Tokenized deposits, also known as deposit tokens, represent fiat currency bank deposits on the blockchain. Issued by banks and backed by fiat deposits, these tokens can operate on either private or public blockchains, although regulated entities typically prefer private blockchains to maintain control over access.

For example, JPMorgan’s JPM Coin is used to settle transactions between JPMorgan clients, while SocGen’s EURCV can be transferred to clients without accounts at the issuing bank, provided they are whitelisted. Tokenized deposits enhance the efficiency of fiat transactions by streamlining trade execution and settlement processes, and they offer greater transparency and flexibility for issuers.

On the other hand, reserve stablecoins are blockchain tokens backed by fiat currency, with issuers—who may or may not be banks—committing to maintain the token’s value relative to the chosen fiat by allowing redemption at any time.

Unlike tokenized deposits, stablecoins do not represent actual bank deposits but are pegged to fiat values through backing reserves. This distinction is crucial as it affects their operational, conceptual, and legal frameworks.

While both tokenized deposits and stablecoins involve fiat-backed tokens on the blockchain, their underlying mechanisms and purposes differ significantly, impacting their use cases and regulatory treatment.

How Tokenized Deposits and Stablecoins Differ

Operationally, transferring a deposit token between clients typically initiates an off-chain fiat transfer between their accounts. Since these tokens represent bank deposits, the fiat balances in the accounts must align with the token balances. In contrast, stablecoins move freely between users without needing to adjust underlying fiat accounts.

The reserve account only needs to be available for redemption on demand, regardless of who holds the stablecoins. While not everyone can redeem them directly, stablecoins can still be exchanged for fiat on various platforms.

Conceptually, deposit tokens are intended to enhance the liquidity of traditional bank deposits rather than replace fiat money. They make transactions more efficient without serving as a substitute for fiat currency.

On the other hand, stablecoins were initially created to provide an alternative for those without access to bank accounts. Over time, they have evolved into a more efficient method for transferring funds between exchanges, often preferred for their speed and lower costs, even when fiat options are available.

Deposit tokens are issued by banks for their clients and represent actual bank deposits. Stablecoins, however, were designed for individuals without bank accounts and act as a substitute for bank deposits. They represent value rather than a commercial relationship.

Additionally, stablecoins are bearer instruments, meaning whoever holds them owns the asset. In contrast, deposit tokens are not bearer instruments; they represent named deposits held at a bank.

From a regulatory perspective, representing bank deposits is generally acceptable, while substituting them with stablecoins poses more challenges. This distinction is significant as it influences how each is treated under the law. Interestingly, the lines between these two concepts are starting to blur, leading to a more complex and philosophical discussion about the nature of money and financial instruments.

Implications for the Future of Money

Money relies on the principle of “singleness,” meaning that one dollar remains one dollar regardless of who holds it or how it's used. This consistency is why regulators oversee the issuance of currencies like the dollar, ensuring that this fundamental aspect of monetary law is preserved.

If multiple entities were to issue dollars without a central guarantor, the uniformity and equivalence of each dollar could be compromised.

Stablecoins, however, don’t always adhere to this principle of singleness. For example, one USDT or one USDC isn’t always exactly equivalent to one dollar, even though they generally aim to maintain their value relative to the underlying fiat currency.

This inconsistency means regulators may not classify stablecoins as “money.” Additionally, issuers like Tether, which manages the largest stablecoin USDT, do not have FDIC insurance. As a result, the assurances provided by one USDT differ from those of a traditional dollar, potentially affecting its monetary value.

This raises the question: if stablecoins aren’t considered “money,” what are they? They might be viewed as securities, similar to tradeable money market funds. However, this classification is problematic because stablecoins are used as money and don’t meet the Howey Test criteria, such as the “expectation of profit” and “common enterprise.”

Despite these challenges, stablecoins do meet the “establishment” definition of money by settling transactions, being widely accepted, serving as a unit of account for various assets, and maintaining their value over time.

The main issue lies in stablecoins breaking the singleness requirement, which is a significant concern for regulators who determine who can legally issue and use them. If stablecoins are ultimately classified as securities due to this lack of singleness, it could blend previously distinct financial concepts.

This reclassification might lead to a fundamental shift in the financial landscape, where securities, through stablecoins, become a widely accepted substitute for traditional money.

A Dollar, But Not Exactly a Dollar

Deposit tokens might appear to regulators as money, while stablecoins seem perplexingly excluded from that category. However, the reality is more nuanced.

While deposit tokens represent money, they aren't legally classified as such. They carry different risks compared to traditional bank deposits. Banks often lend out or invest their deposits, meaning that in the event of a bank collapse, deposit tokens might not be fully backed as expected. Unlike traditional deposits, which are usually partially insured, tokenized deposits currently lack such protections.

Technological issues can also pose problems. A glitch might result in missed payments or duplicate transactions, causing discrepancies between deposit token balances and fiat account balances. Resolving these issues raises questions about accountability and decision-making processes.

Innovative banking ideas suggest adding programmability to deposit tokens to enhance their efficiency and flexibility. This could involve conditional payments triggered by specific events, transforming deposit tokens from mere representations of money into more complex financial instruments.

Such changes challenge the fundamental nature of deposit tokens: if they can perform additional functions, do they still qualify as money? Do they meet the “singleness” requirement and the criteria of being a medium of exchange, a store of value, and a unit of account?

The introduction of these new technologies into traditional monetary systems highlights the need to update our definitions and concepts of money. Currently, regulators are constrained by outdated understandings, hesitant to embrace innovations that require new frameworks. By restricting "acceptable" uses to existing functionalities, authorities may inadvertently hinder real progress and innovation in the financial sector.

Reflecting on Stanford Professor Paul Saffo’s observation, “We tend to use a new technology to do an old task more efficiently. We pave the cow paths,” it's clear that adapting to new financial technologies requires rethinking established paths. Recognizing that modern innovations may no longer fit within traditional definitions of money is crucial for fostering continued advancement and integration of new financial instruments.

Bottom Line

In exploring the distinctions between stablecoins and tokenized deposits, it becomes evident that while both are fiat-backed and operate on blockchain technology, they serve fundamentally different roles within the financial ecosystem.

Tokenized deposits function as digital representations of actual bank deposits, enhancing the efficiency and transparency of traditional banking operations without replacing fiat currency. They maintain a direct link to bank accounts and adhere to existing regulatory frameworks, ensuring stability and trust within regulated environments.

Conversely, stablecoins offer a more flexible and decentralized alternative, enabling seamless value transfer across diverse platforms and catering to individuals without traditional bank access. Their bearer instrument nature and ability to operate independently of specific bank accounts introduce both innovative possibilities and regulatory complexities.

The inherent challenges stablecoins face in meeting the “singleness” principle of money highlight the ongoing tension between technological advancement and regulatory oversight.

The evolving landscape of these financial instruments underscores the necessity for regulatory bodies to adapt and refine their frameworks to accommodate new forms of digital money. As stablecoins and tokenized deposits continue to blur the lines of traditional financial definitions, they not only demonstrate the transformative potential of blockchain technology but also prompt a reevaluation of what constitutes money in the modern age.

This evolution calls for a balanced approach that fosters innovation while ensuring stability and protection within the financial system.

Ultimately, the differentiation between stablecoins and tokenized deposits reveals a broader narrative about the future of money. As digital and traditional financial instruments increasingly intertwine, a redefined and more inclusive understanding of money will be essential.

Embracing these innovations while thoughtfully addressing their regulatory and conceptual challenges will be crucial in shaping a resilient and adaptable financial landscape for the years to come.