Tether, a bigger badder PayPal

My recent article on Tether, a stablecoin, was just published at Coindesk. In the article I commented on Tether's recent settlement with the New York Attorney General's office. Because the settlement forces Tether to adopt a bunch of new practices, I think it's a win for stablecoin consumers.

Why have I been focusing so much of my time on Tether stablecoins? Diligent readers will recall I wrote about it twice last month. (1 | 2 ).

First, I've been writing about stablecoins for a long time now, and Tether has always been the biggest of the bunch. So it merits our attention. But it isn't just the biggest stablecoin. These days it's also becoming big by regular fintech standards. According to its website, Tether recently passed $35 billion in deposits, ranking it above PayPal's $34 billion. Which means that by my estimates it is now the largest U.S. dollar non-bank payments platform in the world ranked by customer funds.

Tether now holds $35.4 billion in customer funds, more than PayPal held at the end of last quarter.

Does that make Tether the largest fintech in the world ranked by US$ customer balances held?

Source 1: https://t.co/EjdXpH6wLR 2: https://t.co/wIz520nP5N

— John Paul Koning (@jp_koning) March 2, 2021

Tether imprints dollars onto a blockchain. PayPal registers dollars in a centralized database. But apart from that, they're technically the same beast. Both keep some dollars (or not) on deposit with their banker and then issue dollar IOUs to their customers. And customers can in turn use these IOUs to make payments amongst each other.

The second reason I've been writing about Tether is that it is dubious. As I wrote here, it avoids U.S. money transmitter regulation by locating itself offshore. And it has somehow managed to wrest first spot away from PayPal despite doing very dangerous things with its customers' funds.

Its impropriety is a matter of public record. Even before last month's settlement with the New York Attorney General we already knew that, among other things, the firm had invested millions of dollars of customer money in a fraudulent third-party payments processor, all the while informing users that Tethers were backed by dollars "safely deposited in our bank accounts." If you want to get into this in more detail, Bennett Tomlin has been exploring these things in far more detail than I.

I am fascinated by this strange combination of popularity and sketchiness. And I'm not the only one. Tether analysis is a growing sub-field of cryptocurrency analysis.  

Tether is imbued with an aura of Trumpian invincibility. Hey, look at all these bad things we do. But we're getting away with it. The market keeps buying. We're bigger than PayPal! Tether's success makes outside observers wonder whether up is down, or bad is actually good.

But I want to dispel some of this seeming invincibility.

As I suggested in my Coindesk article, much of Tether's stablecoin dominance is probably due to network effects. That is, Tether was the first stablecoin to market, and so a Tether standard of sorts emerged. Like any standard, once everyone plugs into it it's hard to move away to a better standard. New and safer stablecoins—ones that have been licensed under a financial regulatory framework—have certainly emerged, including Paxos Standard, TrueUSD, Gemini Dollar, Binance USD, and USD Coin. But Tether enjoyed a four-year head-start, and so even if it murdered someone in the middle of 5th Avenue it would still be the leading stablecoin.

For instance, Tether is the only stablecoin that doesn't provide regular attestations.

Among stablecoins, attestations have become industry standard. An independent accountant is engaged to verify that the stablecoin has the reserves that it claims, according to an accepted standard for carrying out attestations. See table below. ⬇️

Two things stand out... pic.twitter.com/sGm9oJqwV0

— John Paul Koning (@jp_koning) February 4, 2021

Why doesn't Tether make an effort to adopt an industry-wide practice? It could be that it is just too sketchy to be able to hire an accounting firm to provide attestations. Alternatively, maybe its position as the standard stablecoin means it needn't bother. It gets to coast while everyone else has to peddle.

But if it's difficult to move away from a given standard, its not impossible. The first example that pops to mind is how the international monetary system was on a British sterling standard in the 1800s, but now we use U.S. dollars. Somehow sterling dominance evaporated. The same can happen with Tether's dominance.

In fact, I'd argue that we're already seeing a movement away from the Tether standard, particularly in decentralized finance, the set of financial protocols established on the Ethereum network.

It's hard to underestimate how much decentralized finance, or DeFi, dislikes Tether. Consider the biggest DeFi lending platforms, Compound and Aave. Both platforms allow USD Coin stablecoins to serve as collateral. (USD Coin is the second largest stablecoin). But these platforms say no to Tether. That is, if you want to get a loan from Compound or Aave, you can't use your stash of Tether as security. As I pointed out in my article, Compound's decision is based on reports that Tether is “undercollateralized” and has the “potential to collapse at any time.”

MakerDAO, a combined stablecoin/lending protocol and one of the top-three DeFi tools, has also adopted a say-no-to-Tether policy . It sets a hawkish 8% borrowing rate and 150% collateralization ratio on anyone who wants to take out a Tether-backed loan. That may sound like gibberish, so let me translate. For a $100 loan from Maker you've got to lock-up a hefty $150 in Tethers. You'll pay 8% in interest each year on the loan.

But if you want to take out a USD Coin-backed loan (remember, USD Coin is one of the newer safer coins), Maker's terms are far more dovish. It'll cost 0% and 101%. So to get a $100 loan, you need only provide $101 in USD Coin. And the interest costs is nil.

Given Maker's policy, there's absolutely no reason why you'd take out a Tether-backed loan rather than a USD Coin one. And that's why to this day Maker has a measly $700 in Tether sitting in its smart contracts versus a massive $700,000,000 in USD Coin. Below is an abridged list of collateral that has been deposited in Maker as security. The top red circle highlights how much USD Coin (USDC), that it holds. And the bottom circle indicates its Tether (USDT) holdings.

Source: Makerburn

It's worthwhile to revisit the policy meetings where Maker originally established its Tether policy. Citing Tether's "history of opaqueness and fractional reserve," administrators recommended conservative parameters in order to "protect Maker." At the same time, looser parameters were suggested for Paxos Standard stablecoins because it was "significantly more transparent."

In another discussion, Maker community members disapprovingly cited a tweet in which Stuart Hoegner, Tether's lawyer, jokes about Tether's approach to safeguarding customer funds. I've screenshotted it below.

Source: MakerDAO forum

Maker voters went on to approve a stringent approach to policing Tether, and rightly so given Tether's cavalier approach to managing customer funds. Defi grew exponentially in 2020. So did Maker. But almost all of its thirst for stablecoins was directed into non-Tether stablecoins. That's why there's still just $700 in Tether in Maker.

A back-of-the envelope calculation reveals how much money Tether may have missed out on. Had Tether taken pains to become safer to consumers, say by providing regular attestations and/or applying for a money transmitter license (like USD Coin and other competitors have done), it might have around $300 million Tethers sitting in Maker right now. Assuming that it invested this extra $300 million at an interest rate of 1%, Tether would be earning $3 million more each a year. 

And that's just one platform. Do the same for Compound, Aave, and more, and Tether's reputation has cost it tens of millions of dollars in profit.

Below I've charted out the ratio of the total value of all Tether stablecoins in existence to the total value of all USD Coins.The Tether-to-USDC ratio typically registered around 10 Tethers to each USDC through 2019 and early 2020, but this month it fell below 4 for the first time. USD Coin is steadily catching up to Tether for the title of largest stablecoin.

We all like the idea of justice. If you shoot someone in the middle of 5th Avenue, people should be appalled. In the case of a financial company, if you manage your customers' funds in a reckless manner and avoid informing them about the mistakes you made (and then joke about it after), then the market should discipline you, not reward you.

In the case of Tether, that is happening. As the chart above illustrates, Tether's poor stewardship of customer funds means that it is inexorably being replaced by safer stablecoins. Gresham's law, the adage that bad money pushes out good money, does not apply. The good is slowly pushing out the bad.

Ponzis and bitcoin as a response to a bad economy: the case of Nigeria

Usually when I think about gambling and speculative excess, I've always associated it with giddy prosperity. When an economy is doing well, productivity is improving, new technology is being introduced, and unemployment is low, people have extra income that they can throw away at the casino. Or they put it into their brokerage account and, with the help of margin, generate speculative bubbles.

But lately I've been rethinking this view. Speculative bubbles and over-gambling are just as likely to be driven by sick and decaying economies as they are by prosperous ones. And Nigeria is a prime example of this.

Nigeria, one of Africa's largest major oil producer, plunged into recession in 2015 as oil prices collapsed. It saw only anemic growth from 2017 to 2019 before COVID-19 pushed it back into a much deeper recession.

Over that period Nigeria has seen an explosion of ponzi schemes. It started with MMM in 2016. Since then Ultimate Cycler, Icharity Club Nigeria, Get Help World Wide, Givers Forum, Twinkas, Crowd Rising, and Loom have all ripped through the country. Jack & Ibekwe (2018) provide a full list below, although it misses a large chunk of ponzis since it doesn't go past 2018.

Jack & Ibekwe (2018)

Jack & Ibekwe's paper is just one in a burgeoning Nigerian academic literature on ponzi schemes. This body of work provide us with plenty of useful information about what sorts of Nigerians are participating in ponzis and why.

How many Nigerians participate in ponzis? In a survey of 287 Port Harcourt business students, Bupo & Abam-Smith (2017) found that an astonishing 72% of students were involved in various ponzi schemes. Onoh's (2018) survey of 230 Nigerians found a participation rate of 78%.

The high participation rates that Bupo & Abam-Smith and Onoh pinpoint are confirmed in a 2016 poll run by NOIPolls, an established Nigerian polling agency. After querying 1000 Nigerians, NOIPolls found that 68% of survey participants had either participated in a ponzi, or knew someone who did. I would find a 5-10% national ponzi participation rate to be mindbogglingly high. But if the above data is correct, Nigeria far exceeds this. Given a population of over 200 million, tens of millions of Nigerians have participated in ponzis.

Who are the Nigerians that are playing? In their survey of 135 ponzi investors, Jack & Ibekwe found that young Nigerians aged 20-29 were most likely to be involved in ponzi schemes. Participants tended to be students and had post-secondary education. In a 2018 survey of 190 ponzi investors in the city of Calabar, Agba et al (2018) reported similar results. Most investors were unemployed, held a Bachelor of Science degree, and had a low income.

Another fact that blew my mind away is that many of the Nigerians who are involved in ponzis are self-conscious ponzi investors. That is, these aren't dupes. They know the nature of the game they're playing.

For instance, 66% the university students that Bupo & Adam Smith surveyed were aware that they were participating in a scam, one that would soon crash, but they played anyways, presumably because they believed they were skilled enough to get out before the end. Onoh found somewhat less ponzi self-consciousness in his survey of 230 Nigerians, with 34% realizing at the outset that the scheme made high returns by re-cycling contributions. But that's still a lot of savvy players.

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Let's back up a bit and define the term ponzi scheme. A ponzi is a type of zero-sum game, much like a lottery or a casino game such as roulette. By zero-sum, I mean that nothing of value is created. For each person who makes a profit, there is necessarily someone who loses. Put differently, ponzis and lotteries don't generate funds, they redistribute funds.

All zero-sum games have an algorithm, or sorting method, for figuring out who will lose and who will win. A lottery, for instance, redistributes funds from all losing ticket numbers to the winning ticket. A poker game redistributes the pot from bad card hands to good hands. A ponzi scheme's unique algorithm is to pay early entrants at the expense of late entrants.

What attracts people to zero-sum betting games is the allure of massive returns. Buy the right lottery ticket and your life will change. Choose the right number on the roulette table and you earn an immediate 3400% return on your investment. Get in early on the right ponzi, and you'll be vaulted into a totally different socioeconomic class. Of course, on net these schemes don't generate any wealth.

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Back to Nigeria. What the Nigerian ponzi scheme literature suggests is that ponzi schemes were self-consciously used by Nigerians as a coping mechanism for economic malaise.

For instance, in their survey of ponzi investors Jack & Ibekwe found that 60.3% cited harsh economic conditions as their reason for joining ponzi schemes. In a survey of 384 ponzi investors, Obamuyi et al (2018) found that one of the most popular reasons for participating in ponzis was the "current economic situation." And in Bupo & Abam-Smith's analysis of 287 Port Harcourt business students, 231 agreed that the scheme helped reduce the impact of the present recession.

So let me paint a picture. Nigeria has always been a highly unequal country. The poor are very poor, the rich are very rich. There is plenty of poverty (although this is improving) and not much of a government-run social security net. Nigeria also suffers from endemic corruption, and this impedes the ability of regular folks to improve their lot.

The yearning and frustration that this creates gives rise to a constant demand for quick financial escapes, or zero-sum games. But what sorts of zero sum games? Nigerian authorities take a relatively paternalistic approach to gambling. Depending on the game, Nigerian law either prohibits it outright or limits it. For instance, Nigeria has only three land-based casino for 200 million people. Non-skill based card games are illegal. Apart from sports betting, online casinos are prohibited, and many foreign websites don't accept Nigerians. 

So a big part of the demand to play life-changing betting games gets channeled into whatever the underground market can provide, like ponzi schemes.

If you start with a large population of unhappy young people who want to play life-changing zero-sum games, combine that with limitations on legal gambling, and add in a massive economic collapse which only makes their lives worse, you're going to get a big wave of illegal ponzi schemes cropping up.

Canada and the US also have problems with inequality and poverty, albeit not as extreme as Nigeria. Our economies have also been hit by the biggest shock in decades.

But unlike Nigeria, Canada and the US have well-developed capital markets. So when desperate Canadians and Americans look for long shot life-changing bets, they needn't limit themselves to traditional gambles like lotteries, casinos, or online poker. Online brokerages like Robin Hood and Wealthsimple make it easy for us to make hundred-to-one bets in options markets or leverage up on Tesla or GameStop stock.

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In addition to embracing ponzi schemes, Nigerians have also become the world's most prolific owners of cryptocurrencies, as the chart below illustrates. This data comes from Global Web Index via this article.

[Source]

I've been tracking bitcoin usage in Nigeria for a while now. We know that bitcoin is being used in combination with gift cards by Nigerian-based business email compromise and romance scammers as a convenient way to repatriate extorted funds:

"Paxful portrays itself as bringing financial services to the world’s unbanked, and perhaps they are, but the US-based company has become a bazaar for West African scam artists selling stolen gift cards."

How Nigerian BEC gangs launder money via Paxful: https://t.co/5XGRuwNJ6w pic.twitter.com/SsFK1eVNbz

— John Paul Koning (@jp_koning) October 15, 2020

We also know that Nigerians living in the US are making remittances to their Nigerian friends and family using this same combination of gift cards and bitcoins. Buying gift cards and exchanging them for bitcoin and then Nigerian naira may sound like a circuitous way to make remittances. But it is economical because families get the superior black market exchange rate rather than the official rate.

Great article by @MattAhlborg. He documents an exotic remittance corridor that has sprung up between US and Nigeria to avoid exchange controls:

US cash → Gift cards (iTunes, Amazon, etc) → Bitcoin → Nigerian naira deposits. Quite the crazy journey.https://t.co/2yQ5Urwemg

— John Paul Koning (@jp_koning) December 5, 2019

Nigerians who shop at foreign online stores face monthly card limits, some as low as US$100. Again, this is because Nigeria's central bank rations access to foreign exchange. Cryptocurrencies may be a hack around this. Also, Nigerian importers have been using cryptocurrency as a trade currency for Chinese imports. Rather than having to rely on acquiring carefully-rationed foreign exchange from the Central Bank of Nigeria, they can offer a Chinese exporter some bitcoins and the goods will be shipped.

So cryptocurrency is certainly being used as an alternative form of doing payments. But this can't explain why 20% of Nigerians (around 40 million people) hold some of the stuff. After all, unofficial imports, scams, and remittances are a small part of economic activity.

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I'd suggest that Nigeria's cryptocurrency adoption is a natural extension of its earlier ponzi scheme addiction. 

Like a poker game or roulette or the lottery, cryptocurrencies such as Bitcoin or Litecoin are zero-sum betting games. They redistribute a fixed pot among participating players. Of all types of zero-sum games, cryptocurrencies are most similar to ponzi schemes. Both use an "early bird" redistribution algorithm: late entrants' funds are paid out to early birds. But cryptocurrencies are not quite ponzi schemes. Whereas ponzis such as MMM or Ultimate Cycler are centrally managed by a coordinator, a cryptocurrency is spontaneous and decentralized.

In the same way that young Nigerians turned to ponzi schemes as an economic drug for coping with the 2015 collapse and ensuing lack of opportunity, they may be doing the same with cryptocurrencies. COVID-19 has pushed Nigerian unemployment to its highest level in a decade, the young being hurt the most. And so once again desperate Nigerian students are on the hunt for life-changing zero-sum bets. This time they've settled on cryptocurrency, the decentralized nature of which renders them almost impossible for authorities to stop.

My "ponzi" interpretation of Nigerian cryptocurrency adoption runs counter to the crypto-optimist view.

Cryptocurrency advocates see adoption of cryptocurrencies in developing nations like Nigeria as a vindication of cryptocurrency-as-monetary technology. Their thesis is that legacy payments systems and central banks in developing countries are failing at their task, and so cryptocurrencies like bitcoin are being adopted because the offer a better monetary alternative.

The crypto-optimist view overestimates the usefulness of cryptocurrency-as-currency. There are certainly some cases where Nigerians are using cryptocurrencies for payments, and I presented them above. But the main reason that cryptocurrencies are popular is why any zero-sum game is popular: they intoxicate players with the promise of huge price gains.

Viewed in this light, Nigerian adoption of cryptocurrencies isn't a bitcoin fixes this moment. Rather, it's a repeat of Nigeria's earlier adoption of MMM and Ultimate Cycler. That these games keep sweeping through Nigeria is a symptom of underlying economic misery. Desperate to escape their plight, young Nigerians are once again making last-ditch bets on zero-sum betting games.

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There is a silver lining.

Traditional ponzi schemes are often run by scammers rather than honest game managers. In an honest ponzi, 100% of the invested funds are paid out by the manager before the game closes down. But in a ponzi scam, the game manager absconds with the pot. And so ponzis often collapse before coming to their inevitable, natural end.   
 
Cryptocurrencies aren't run by a central game manager. As long as players custody their own coins, there is no one who can abscond with players' funds. So a desperate Nigerian student who wants to make a potentially life-changing zero-sum bet may do a bit better buying ₦10,000 of bitcoins than putting ₦10,000 into the next version of Ultimate Cycler, since bitcoin is more secure. (See this post for more).

But let's not kid ourselves. A nation of desperate gamblers, ponzi players, and cryptocurrency punters is a sad development. It is a symptom of a sick economy, one in which unemployed young people are flocking to make zero-sum bets because that is the only way they see their lot in life improving.

Defining the "regulated" in "regulated stablecoin"

1/n This is a thread on what is means to be a "regulated stablecoin." (This was originally meant for Twitter, but I didn't feel like wrestling with the 240-word limit and threading, plus it got a bit long, so now it's a blog post).

2/n People in the cryptocurrency space often use the term of art "regulated stablecoin." No one has a monopoly over what "regulated stablecoin" means. It is a community-defined term. It's not terribly well-defined. But it should be. 

3/n It should be well defined because when newcomers enter the crypto space, and they have to choose what stablecoins to adopt, they may assume that those stablecoins that are tagged as "regulated stablecoins" are products that offer a degree of government-provided consumer financial protection.

4/n But are there government agencies that actually provide consumer financial protection to stablecoin users? If so, which agencies? What is the nature of this protection? And what stablecoin should you buy if you want to benefit from this protection?

5/n Novices can take heart. In the U.S., state financial agencies such as the New York Department of Financial Services (NYDFS), Florida Office of Financial Regulation, and Texas Department of Banking do in fact check the assets, investments, and reserves of financial institutions that issue stablecoins and/or other payments instruments. The also vet executives and directors of these payments companies, conduct examinations, and ask for audited financial statements.

6/n For instance, below is a screenshot of "eligible securities" as set out by California's Department of Financial Protection & Innovation (DFPI). When a customer deposits funds with a payments company operating in California, this list circumscribes how that company can invest those funds. In theory this should stop a payments provider from betting their customers' savings on wild and dangerous speculations, and losing it all.

California Money Transmission Act [source]

7/n So what companies do these regulators supervise? PayPal is licensed by the NYDFS. So are stablecoin issuers Paxos Trust, Circle, Coinbase, and Gemini Trust. 

PayPal, Coinbase and Circle are also regulated by the Florida Office of Financial Regulation, the Texas Department of Banking, California's DFPI, and a number of other regulators.

8/n To repeat, all of these state departments provide users of supervised payments instruments and stablecoins with an extra layer of financial protection. 

9/n Other countries may have agencies that also provide customers of payments platforms with a degree financial protection. For instance, in Singapore the Monetary Authority of Singapore (MAS) provides a financial regulatory framework for payment companies. In the U.K., the Financial Conduct Authority (FCA) does. 

However, many jurisdiction do not have an established regulatory frameworks for protecting customers of payments companies. These are unregulated jurisdictions.

10/n So to qualify as a "regulated stablecoin," a stablecoin issuer should be licensed with a regulatory body like the NYDFS or DFPI in the U.S., MAS in Singapore, the FCA in UK, or any other similar body. 

11/n FinCEN-registration isn't sufficient for qualification as a "regulated stablecoin." The U.S Financial Crimes Enforcement Network (FinCEN) does not get involved in consumer financial protection. FinCEN is an anti-money laundering watchdog.

12/n Which gets us to a recent article I wrote for Coindesk about one particular stablecoin, Tether. A spokesperson for Deltec, Tether's banker, suggests that Tether should be included in the category "regulated stablecoin." He puts forward Tether's FinCEN registration as the basis for inclusion.

13/n Deltec further invokes Tether's FinCEN-registration to say that Tether's regulation is just as iron-clad as its stablecoin competitors. Paolo Ardoino, a Tether executive, approves, saying: "It's deceitful how some competitors claim to be 'more regulated' as part of their pitch. No such thing."

 

14/n Unlike its competitors, Tether is not regulated by an agency that provides consumer financial protection.

15/n That is, Tether appears to operate from a jurisdiction that does not have a financial regulatory framework for payments companies.

16/n Meanwhile, Tether's stablecoin competitors such as Paxos, Coinbase, and Circle have gone to great lengths to be approved by agencies that do in fact offer these assurances to consumers (i.e the NYDFS). These stablecoins are, in short, better regulated than Tether, which lacks a license from a regulator that provide consumer financial protection.

17/n  Tether's counsel disagrees with my article.

By the way, I think it's laudable that Tether is registered with FinCEN and has a solid anti-money laundering (AML) program. As best as I can tell, Tether is based in the British Virgin Islands, which would mean that it is legally obligated to follow AML standards set by the British Virgin Island's anti-money laundering authority. Presumably it has doubled-up by also registering with FinCEN.

18/n However, to earn the moniker "regulated stablecoin", an issuer should—at a minimum—combine registration with an anti-money laundering agency like FinCEN AND supervision by an agency that provides a degree of consumer financial protection. That way a crypto novice's expectations of "regulated", i.e. offering a degree of government-controlled consumer protection, do in fact correspond with reality. I'm afraid Tether doesn't make the cut. But USD Coin, Gemini Dollar, and Paxos Standard do.

19/n That isn't to say that Tether isn't safe for consumers to use. Over the course of history there have been many well-run financial institutions that have not operated under a specific financial regulatory framework.

20/n In fact, to this very day Canada still does not have a financial regulatory framework for payments companies. So whereas PayPal USA operates under a financial regulatory framework that provides consumers a degree of financial protection, PayPal Canada operates as an unregulated payments company, just like Tether. But even though PayPal Canada is unregulated, I still use it.

21/n In last week's blog post, I brought up the Banque d'Hochelega, a successful private Canadian note-issuer in the 1800s, an era with minimal financial regulation. I gave some examples about how the Banque d'Hochelaga managed to communicate to the public how safe their payments media were.

22/n To demonstrate how well Tether consumers are protected, Tether could borrow from the Banque d'Hochelega's bag of tricks. Why not start providing the public with more verified financial information?

23/23 Alternatively, it could seek to become a "regulated stablecoin." That is, it could try to get licensed in a jurisdiction that has a financial regulatory framework that protects customers.

Fin.

The fabrication of trust in various types of dollars

How are we consumers to know whether the dollars that financial institutions provide us aren't fraudulent dollars? On what basis can we assume that the funds we hold at PayPal, for instance, or in Cash App, are "good money"?

It's an age-old problem. If you were alive in 1889 and someone offered to pay you with a $10 note from Banque d'Hochelaga (see below), a privately-owned Montreal-based bank, how could you know the issuer wasn't a fraud and that it had enough assets on hand to always redeem notes with gold and/or silver?

1889 $10 note, Source: Bank of Canada

The question of fabricating trust in dollars also applies to today's rapidly growing stablecoin sector. Stablecoins are dollars issued on public blockchains like Ethereum or Tron. Tether has an astonishing $24 billion in U.S. dollar stablecoins in circulation, up from just $1 billion three years ago. Competitor USDC has issued about $5 billion in stablecoins, up from $0.5 billion at the beginning of 2020. On what basis can a potential user trust these stablecoin dollars? How do we know that the $500 in Tethers or USDC that someone wants to send us won't melt to $0 a few days from now?

Consumers use simple rules of thumb to differentiate between good dollars and bad ones. We'll call them:

- everyone's using it
- Warren Buffett owns some
- JP Morgan trusts them
- show us the money
- big brother is watching

The first rule of thumb is the everyone's using it approach. If all your friends and family are using Tethers or PayPal or Banque d’Hochelaga notes, then it's probably safe for you to do so too.

There is plenty of wisdom in everyone's using it. If there are thousands of Tether users, then it's likely that at least a few of the more diligent ones have already dug deeper to ascertain the issuer isn't fraudulent, and so we can all piggy-back off of their work. This saves us the hassle of doing our own audit.

Everyone's using it is by no means a fail-proof method of determining the validity of a dollar. If no single user has done sufficient due diligence, then everyone is operating blindly. That's how Bernie Madoff managed to keep things going for so long.

The second rule that consumers use to validate dollars is the Warren Buffett owns some approach. Similar to everyone's using it, the Warren Buffett owns some approach piggy-backs off the work of others. But rather than relying on other users, it free-rides off of the expertise of sophisticated investors.

To see how this works, let's head back to 1880s Canada. In addition to having a set of noteholders, the Banque d’Hochelaga also had bondholders and shareholders. These investors, often prominent members of the community, would have had plenty to lose if Banque D’Hochelaga failed—not just money, but community standing. And so prior to investing in the bank they would have carefully scanned its financial statements, investigated its managers and directors, and verified the quality of its biggest customers. If these well-known and sophisticated stock & bond investors thought it was safe to buy Banque d’Hochelaga securities, then noteholders—without having to do any sophisticated analysis of their own—could assume that it was safe to hold its banknotes too.   

Likewise, in modern times should Warren Buffet decide to invest in Tether or PayPal securities, then users of these platforms could be assured that the firm's financials have been thoroughly vetted, and thus by transitivity Tether stablecoins and/or PayPal balances should also be safe. 

But Warren Buffett owns some isn't fool-proof. Even Warren Buffett can be tricked. Alternatively, shareholders may have been in on the scam from the start.

A third way for outsiders to gauge the quality of a dollar is the JP Morgan trusts them approach. Like the previous two methods, this one piggy-backs off of other people's due diligence, but in this case it relies on banks & other dollar issuers. In theory, no one should be a better judge of the quality of a dollar issuer than a competing dollar issuer.

In 19th century Canada, for instance, banking giants the Bank of Montreal, Royal Bank, and Dominion Bank all allowed their customers to bring Banque d’Hochelaga notes in for deposit. These bigger banks would have then redeposited said notes the very next day at the Banque d’Hochelaga for conversion into gold/silver. Until the banknotes had been converted, however, the Bank of Montreal, Royal Bank, and Dominion Bank were effectively creditors, or lenders, to the Banque D’Hochelaga. That's a dangerous position to be in. So prior to adopting a policy of accepting deposits of Banque D'Hochelaga notes, these big banks would have audited the smaller bank's books.

Thus a 19th century consumer could trust that Banque D’Hochelaga notes were solid. Competing banking behemoths had already vetted the bank.   

The JP Morgan trusts them route to trust formation doesn't quite work with stablecoins or PayPal balances. The issuer of USDC, the Centre consortium, doesn't accept Tether deposits, or vice versa. Nor do PayPal and Cash App interchange deposits with each other. And so unlike Canada's 19th century banks, none of these dollar-issuing platforms operate in an environment in which they are constantly auditing each other's credit worthiness.

Other banks do enter into the picture, but it is in a different, less effective, way. PayPal, Tether and USDC have reserves that they use to secure their dollars. They deposit these reserves at an underlying bank. That bank doesn't act as a creditor to the platform (it acts as the debtor), and so it needn't worry about its customers' credit risk. But it does have to worry about a customer being fraudulent, since this could damage the bank's reputation. Thus we can take some comfort from the fact that Wells Fargo, PayPal's bank, is keeping an eye on PayPal, and that Tether's bank, Deltec, is watching Tether. But this is weak medicine compared to the assurances that Banque d'Hochelaga noteholders enjoyed.

JP Morgan trusts them is a pretty good rule of thumb, but it isn't fool proof. Even bankers can be fooled. Or maybe the bank and its shareholders are themselves in on the scam.

Luckily, a dollar user has yet another way of forging trust in various types of dollars, one that doesn't piggy-back off of others. Let's call it the show us the money approach. Just take a look at the firm's financial statements. The Banque d'Hochelega made it easy for the public to get this information, going so far as to flaunt its capital on its banknotes. See below, where it advertises having $1 million in capital.

1898 $10 note. Source: Bank of Canada

It also bragged about its financial strength on its bank passbooks, those little books that account holders had to bring to the bank when they made deposits or withdrawals:

Source

Finally, the Banque D'Hochelaga even took out full page advertisements in newspapers and other publications showcasing its capital and reserves. Below is an ad from a 1910 tourist guide published for visitors to the 21st International Eucharistic Congress, hosted in Montreal:

Source

Show us the money also works in the 21st century. Don't trust PayPal's reserves? Scan its audited balance sheet. PayPal is a publicly-traded company, and so it is obliged to post quarterly audited financial statements. As for USDC, each month it voluntarily attests to how many reserves it holds. Grant Thornton, an accountancy, verifies its numbers.

In many cases, however, the public can't rely on show us the money. Tether, for instance, doesn't publish audited financial statements or attestations.

Which leads us to our final rule of thumb. Consumers can build trust in dollars via the big brother is watching approach, i.e. government regulation. Banque d'Hochelaga operated at a moment in history when government regulation of banks was very light. This lack of regulation worked fine. The Canadian public trusted private banknotes and only rarely did they suffer from bank failures.

But today, regulation is far more pervasive. PayPal and USDC are regulated in the U.S. on a state-by-state level as money transmitters. Each state has different money transmitter legislation, but in general all states require transmitters to limit their investments to a range of permissible securities, to post a surety bond or letter of credit with the regulator as security, and/or to maintain minimum net worth requirements. Transmitters must also provide their state banking regulator with yearly audited financial statements and submit to examinations. 

These rules are by no means homogeneous. Dan Awrey, Lev Menand, and James McAndrews have published an interesting comment that gets into some of the nuances of state-by-state money transmitter regulation. The map below, for instance, shows how net worth requirements differ across states.

Source

Even though the U.S. lacks standardized rules, a base level of regulation exists, and so owners of USDC stablecoins and PayPal balances can muster an additional layer of confidence in the safety of their dollars.

But big brother is watching doesn't always apply. 

Tether, for instance, doesn't serve U.S. customers, presumably to avoid having to secure state money transmission licenses. Thus it needn't submit itself to state-by-state permissible investment lists, net worth requirements, security deposits, audits, examinations, etc. One might assume that Tether is regulated elsewhere and thus must abide by a different set of strict rules. But that's not necessarily true. Many nations do not have regulatory frameworks for money transmitters. (Canada, my home country, doesn't). Since Tether is likely domiciled in one of these light touch jurisdictions, Tether users cannot rely on big brother is watching to build trust in Tether's dollars.

Indeed, Tether has admitted that a large chunk of its reserves are in the form of a multi-year loan to an affiliate, Bitfinex. The Bitfinex loan would probably not be a permissible asset under most U.S. state money transmitter laws. Put differently, I doubt either USDC or PayPal—which are obliged to follow state law—could have done what Tether did.

I can see why Tether might prefer to avoid US money transmitter licensing requirements. Tether's reserves include receivables from loans to third parties, but if you look through state MSB law (i.e. Florida https://t.co/z8kjGkIoBZ) this sort of investment is not permitted. pic.twitter.com/3mcTq1VO7C

— John Paul Koning (@jp_koning) January 21, 2021

Having worked through the rules of thumb that the public uses to establish trust in various types of dollars, let me end with the Tether situation in particular.

Social media is filled with Tether critics. Some of their criticism is weak, and Tether's many supporters on social media are quick to point this out. But the counter-criticisms that Tether's supporters provide are just as shoddy.  Apart from their reliance on everyone's using it and a pale version of JP Morgan trusts them, supporters can't give much good evidence for why Tether should be trusted.

And that's because Tether hasn't provided much solid footing for its protectors to stand on. By contrast, there are very few rumours in social media about the solidity of PayPal or USDC. That's because both of these platforms have gone to great lengths to remove all the raw tinder that might cause innuendo to spark and spread in the first place. 

If Tether wants to stop public criticism, it need only need copy what its competitors have done and provide something other than everyone's using it as the basis for fabricating trust. It can pick and choose from any of the following: provide the public with audited financial statements or verified attestations; bank at a higher profile bank than Deltec; secure a well-known and highly respected investor; go public; or get licensed as a money transmitter in a few U.S. states. Any of these would help asphyxiate the rumours.

It could be that Tether doesn't have solid enough finances to do any of the things I've listed. Or maybe it does, but it doesn't actually care about rumours. After all, even after years of criticism, Tether continues to grow and dominate the stablecoin sector. The community of stablecoin users seem quite content to rely on everyone's using it. For now, at least.

The unbanked, the post office, and fintech in the 1880s

"A large population of people are excluded from the financial system because they don't have bank accounts. Fintechs compete to connect them and parallel plans emanate from the government to reach the unbanked, including postal banking."

What year am I describing in the above paragraph? 

It could be 2021. But it also describes 1870s. 

It's 2021 and the U.S. still has a large population of unbanked, those who have so little money that banks would rather not serve them. An astonishing 5.4% of Americans—that's 7.1 million households—do not have bank accounts.

Financial technology companies (aka fintechs) like PayPal and Facebook's Libra have well-meaning plans to connect the American unbanked population. Government-run proposals abound too. Postal banking is probably the most popular option, but more exotic solutions like central bank digital currency (CBDC) have also been floated. But many economists are wary that these government efforts will cripple the private sector.

None of this is new. Concerns over the unbanked, fintech, and a government participation in the payment system were all present back in England in the 1880s. Since I enjoy when the past resurfaces in the present, I'll tell the story.

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Britain in the 1870s had a very sophisticated chequing system. Because banks were the only way for people to access cheques, and banks preferred to limit accounts to rich people and wealthy merchants, the poor and middle class were often left out. 

Luckily, the 1870s version of fintech came to the rescue. The PayPal of the day was something called the Cheque Bank. Established in 1873, the Cheque Bank—like PayPal today—was a bank-on-top-of-a- bank. What do I mean by this?

PayPal is a customer of Wells Fargo, a large commercial bank. Wells Fargo provides PayPal with banking and payments services. PayPal in turn passes these services on to PayPal account holders, folks who might not otherwise qualify as customers of Wells Fargo or, if they could, prefer the way PayPal rebundles underlying Wells Fargo services.

Stock certificate for the Cheque Bank, Limited

The Cheque Bank operated on the same principles. It opened accounts at bank branches all across United Kingdom and overseas. Like PayPal, it passed through underlying banking services to its unbanked customers. The Cheque Bank's main product was cheques, which today might seem quaint. But back then they were cutting edge.

Anyone could buy a book of Cheque Bank cheques at a stationer or cigar store, the Cheque Bank redepositing the cash it received with its bankers. The customer could then spend those cheques at stores, send them to family via the mail, or hold them as a form of saving in lieu of cash (which was always at risk of being stolen). People who accepted a Cheque Bank cheque as payment could promptly take the document to any bank and cash it.

Much like PayPal does today, the Cheque Bank held 100% reserves. That is, for every $1 in cheques it issued, it kept $1 locked up with its bankers. And so its cheques were considered to be as safe as cash. Put differently, regular banks engage in both lending and payments. But fintechs like PayPal and the Cheque Bank don't lend at all. They deposit all of their assets at an underlying bank and focus on offering the payments side of the banking business to their customers.

The Cheque Bank attracted the attention of William Stanley Jevons, one of the most important economists of the day and still very much a household name among economists today. Jevons was one of three economists (along with Carl Menger and Leon Walras) to discover the principle of marginal utility, a key economic principal which had eluded even Adam Smith. 

In his 1875 book Money and the Mechanism of Exchange, Jevons devotes a full chapter to the Cheque Bank, describing it as a "very ingenious attempt" to "extend the area of banking to the masses." Here is what one of the Cheque Bank's cheques looks like:

1899 cheque issued by the Cheque Bank [source]

The cheques could only be filled to an amount printed on the document, writes Jevons. So the above cheque, which had been purchased for £5, could be written out for anything up to £5, although in this particular case the cheque writer (H.L. Stevens) chose the sum of 3 pounds 3 shillings. 

Jevons isn't the only notable economist to write about the Cheque Bank. It also pops up over a hundred years later in economist Edward S. Prescott's work, who describes it as a "highly interesting experiment in extending the use of checks to the lower and middle classes." Prescott suggests that the ability to write a specific amount on the face of one of these cheques would have greatly facilitated payments through the postal service since there was no need for change. Unlike a regular cheque, which also offered this flexibility, the recipient of one of the Cheque Bank's cheques needn't worry about it bouncing.

Jevons was excited by the Cheque Bank. But he was not a fan of a subsequent competing payments innovation, the postal order.

The British Post Office, owned by the government, had long been engaged in the business of transmitting money orders, unofficially since 1792 and officially since 1838. A customer would walk into any money order office, put down, say, £2 and 2 shillings, and get a £2 2s money order. The recipient's name was then written on the order. It could then be sent via post to a distant office, upon which the recipient could take the money order to the counter to be cashed. The officer would first confirm the payment by referring to a separate letter of advice. This letter, sent from post office to post office, served an an extra layer of security against fraud. Only then would the £2 and 2 shillings be paid out.

The problem, according to then Postmaster General Henry Fawcett, is that the money order wasn't very useful to people who only wanted to send small amounts. "If a boy wanted to send his mother the first shilling he had saved, he would have to pay twopence for the order and a penny for postage," wrote Fawcett. In other words, to send a 12 penny (i.e. one shilling) money order, three pennies—a massive 25%—had to be sacrificed in fees. (A shilling in 1880 was worth around US$8 today.) And so it would have been an expensive payments option for the poor.

Prior to his appointment as Postmaster General in 1880, Fawcett had been both parliamentarian and the first professor of political economy at Cambridge. And while he wasn't as illustrious an economist as Jevons (he hasn't left us any bits of economic theory), Fawcett did write what was one of the popular textbooks of the day.

But if Fawcett wasn't going to change the study of economics, he did intend to change the payments system. As Postmaster General, Fawcett proposed complementing the money order with a new product called a postal note, or postal order. (The postal order had been earlier conceived of by George Chetwynd, the Receiver and Accountant General of the Post office). Like the cheques issued by the Cheque Bank founded just seven years before, postal orders would have a fixed denomination printed on them. These increments were to start at 1 shilling and go up to 20 shillings (US$8 to US$160 in 2019 dollars).

By contrast the post office's traditional payment product, the money order, was open-faced and had no denomination. Because postal orders would be issued in smaller amounts, the Post Office needn't bother sending separate letters of advice as a security measure, which meant that they would be far cheaper to process. And so the fees could be lower for postal orders than money orders, broadening the pool of customers.

In an 1880 essay, William Stanley Jevons blasted the idea of postal orders, which hadn't yet received legislative assent. Singling out Fawcett, Jevons wrote:

"The fact of course is that not only from the time of Adam Smith, but from a much earlier date, it has always been recognized that a Government is not really a suitable body to enter upon the business of banking. It is with regret that we must see in this year 1880 the names of so great a financier as Mr. Gladstone, and so sound an economist as Professor Fawcett, given to schemes which are radically vicious and opposed to the teachings of economic science and economic experience."

So that lays out the cast of characters in 1880. It includes exclusionary banks, hoards of unbanked, a set of opposed economists in Jevons and Fawcett, fintechs like the Cheque Bank, and a post office on the verge of issuing a novel product; postal orders.

2020 seems very much like 1880. To help connect the large population of American unbanked to the financial system, a number of modern day Fawcetts (Morgan Ricks, Mehrsa Baradaran, Rohan Grey) have floated public payments solutions including a return of postal banking, central bank digital currency (CBDC), or central bank-accounts-for-all.

Our modern day equivalents to the Cheque Bank includes non-banks such as prepaid debit card issuers Walmart and Netspend, both of which are trying to reach unbanked Americans. Online wallet companies like PayPal and Chime are also in the mix. And stablecoin issuers such as Facebook's upcoming Libra project talk a big game when it comes to financial inclusion. To round things out you've got your modern day Jevonses; economists who don't buy the idea that the government should get into banking (Larry White, George Selgin, Diego Zuluaga).

So how did things end up in 1880? Despite opposition from Jevons and the Economist, Fawcett's postal order dream came to fruition. After receiving legislative approval, the world's first postal orders were issued in 1881:

The world's first postal order was issued in 1881 by the British Post Office. The fee of a halfpenny on a one shilling postal order (~4%) was less than two pennies for a regular money order, which meant the not-so-wealthy could finally afford to make small remote payments. pic.twitter.com/KpbyoY0uHj

— John Paul Koning (@jp_koning) December 30, 2020

Postal orders would go on to become very popular. They largely displaced money orders, except for large amounts. Other postal systems including that of New Zealand, Canada, Australia, and the U.S. would go on to copy the idea. The UK's modern day incarnation of the post, the Post Office, still offers a version of the product.

And what about the Cheque Bank? Digging through old documents, Edward Prescott discovered that the Cheque Bank failed in the late 1890s. According to liquidation proceedings reported in the Banker’s Magazine, it was plagued by forgery problems and increased competition for less wealthy depositors from banks. Perhaps the emergence of the postal order also played a part.

I'm not invoking the 1880s as a prediction of what will occur in the 2020s. Rather, it fascinates me because it reveals how old these payments dilemmas are. The same tensions between public and private payments were present then as they are now. And it's also interesting to see how economists have always been engaged in questions of financial inclusion. Not just Fawcett but Jevons too, who we know primarily for his work on monetary theory. 

And over a hundred years later, Edward Prescott delved into the topic, too. In a 1999 paper (which mentions the Cheque Bank), Prescott discusses the idea of opening up an inexpensive type of bank account called an Electronic Transfer Account (ETA) so that all Americans, particularly the unbanked, might receive Federal benefit payments digitally. (Prescott was skeptical that ETAs might work out. The program, introduced in 1999, was discontinued in 2018 and has been replaced with a prepaid debit card program.)

In closing, the topic of how to help the unbanked is a complicated one with many moving parts. Which is why we should explore how things played out in different times. Perhaps history can get us to see the debate in a new light.

Merry Christmas and a Happy New Year!

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P.S. If you're interested in learning more about Jevons's thinking on payments, he was a big champion of the idea of creating an international coin standard. I wrote about it here. Think of it as a proto-version of the Euro. Jevons came up with a "tidy English solution" for fitting Britain into this proposed international coin union. The project never came to fruition.

Dolphin Safe Tuna and Fair Trade bank accounts?

The Royal Bank, Canada's largest bank, says that it won’t lend to clients that get more than 60% of their revenue from thermal coal or coal-fired power generation. Should a bank be able to avoid providing services to businesses just because they don't engage in the sorts of activities the bank, or its depositors, approve of? 

Put differently, should the Royal Bank be able to avoid "dirty" loans so that it can offer its depositors the semblance a Fair Trade, or green, bank account?

Critics would say that the Royal Bank shouldn't be allowed to avoid banking coal-fire dependent companies because it operates within a “regime of privilege.” That is, the Royal Bank benefits from a system of government regulation, central bank lender of last resort benefits, Federal deposit insurance, and direct access to core public payments systems. Given how deeply it is fused with public infrastructure, the Royal Bank is sort of like a utility, and like any utility it has a public duty to consider all customers, even coal energy guzzlers.

A related argument is that because banks must obtain a charter in order to operate, and this is difficult, there are not enough banks competing with each other. And thus it would be unfair for Royal Bank to avoid doing business with coal-fired power generators; financial banishment could doom these businesses to failure.

I draw the above arguments from a recent paper by Brian Knight and Trace Mitchell. Hopefully I have accurately captured their views. Given their specialness, banks should not be permitted to act as "de facto regulators," say the authors.

Now for the counterargument. People should be free to enter whatever contracts they see fit, including avoiding ones they find distasteful or against their beliefs. This freedom shouldn't be available to some people but not others. For instance, say that Sarah and Tom are both worried about global warming and sustainability. Tom is a skilled cook and decides to set up a sustainable restaurant that serves only ethically sourced ingredients. Sarah, for her part, is trained in finance and wants to set up a sustainable bank. Her source material for creating 100% green bank deposits is ethical loans to green businesses.

A law disallowing banks from choosing their customers means that Tom can self-actuate his beliefs by only dealing with green food suppliers, but Sarah cannot do the same by only lending to green borrowers. That hardly seem fair.

So there are two conflicting ideals at play here: the right to receive core services vs the freedom of association.

In the U.S., the Office of the Comptroller of the Currency (OCC), a key U.S. bank regulator, is choosing a side in this conflict. In an effort to stop banks from “politically driven discrimination,” the OCC is proposing a rule that would prevent bankers from using anything other than regular credit and operational criteria for evaluating a company seeking financial services. Were the OCC's "no discrimination rule" to be applied in Canada, it would require Royal Bank to lend to companies hooked on coal-fire energy.

In proposing this rule, the OCC has adopted the same rational as Knight & Mitchell. In an op-ed for the Wall Street Journal, OCC head Brian Brooks and Chief Economist Charles Calomiris argue that government chartering and direct access to the Federal Reserve obligate banks to provide services to all companies.

I recently wrote about this "no discrimination" rule for Coindesk. In that article I took the pro-Royal Bank side, arguing in favour of fair trade bank accounts. The 21st century consumer wants to know more about the provenance of the things they buy. We don’t just want tuna, we want dolphin-friendly tuna. We don’t want our T-shirts to be made in sweatshops with Xinjiang-grown cotton. We want ethical T-shirts. So why shouldn't we get clean bank accounts?

I want to explore this tension a bit more.

If we are going to apply a no discrimination rule to any segment of the banking and payments market, I think it should be placed on the card networks, Visa and MasterCard. The card networks have the power to exercise far more de facto regulation over the economy than any bank. If a bank disconnects a business, that'll certainly a hassle for the debanked business. But at least there are dozens of other banks in Canada to turn to, and thousands in the U.S. Even if no bank is willing to step forward, there is a whole host of non-bank financial institutions that can provide a business with financing or payments services.

Not so if the two card networks disconnect a retailer. Since there is no good alternative to Visa and MasterCard (especially online), a banned business could be in very real jeopardy. For instance, the card companies currently allow gun and porn purchases across their networks. But were they to ban gun and porn sales because they deem them unsavoury, Visa and MasterCard would be doing incredible damage to both industries, far more than if two large banks were to cease providing services to gun retailers or porn sites.

For a demonstration of this power, look at Pornhub's recent reaction to the threat of being deplatformed by Visa and MasterCard. After being accused of hosting child porn, Pornhub completely redesigned its platform to try and keep the two card networks on side (it failed.) 

By the way, I wrote about this incident for the Sound Money Project. Porn is legal, but child porn is illegal. Any financial institution that knowingly allows illegal transactions to cross its platform could be accused of money laundering. So Pornhub's deplatforming wasn't a case of the card networks acting as de facto regulators of content. Rather, they were doing what the actual regulators, i.e. the law, dictate. (That doesn't mean we shouldn't be worried that card networks can engage in de facto regulation. It just means that in this case, they didn't exercise that power).

So to reiterate, card networks have more power than banks. But unlike banks, card networks don't operate within a “regime of privilege” as described by Knight & Mitchell or in Brooks & Calomiris's op-ed. They don't have lender of last resort benefits, Federal deposit insurance, or direct access to core public payments systems. Nor do they have to get to get a bank charter. 

Visa and MasterCard are powerful because they are networks. Once everyone is connected to a network, there is very little reason for any one to leave to a competing network since only the incumbent can offer a large number of connections. (A bank is not a network, it is a member of a network.) 

And so Visa and MasterCard evade—unjustifiably so, in my opinion—all of the criteria for being targeted by the OCC's no discrimination rule. Instead, it is less powerful banks that would be handicapped by it on the basis of their proximity to government infrastructure and their obligation to get a charter.

Which gets me to my final point. The OCC and Knight & Mitchell have proposed that the criteria for triggering a no discrimination rule should be the existence of a "regime of privilege" and chartering. But doesn't a wide swath of the economy operate within a "regime of privilege" and chartering? 

A restaurant, for instance, must get a restaurant license before opening its doors. It also needs to secure building, ventilation, and signage permits. It is encumbered by zoning requirements and needs to secure a license to sell alcohol. Restaurants benefit from a government-funded system of food inspection. The ingredients that a restaurateur purchases has passed through some sort of a food safety regulatory process.

In sum, I do agree that we may need some sort of no discrimination rule for financial institutions. I'm just not sure that the OCC and Knight & Mitchell have found the right criteria for applying this rule. Let's choose whatever criteria get us to a situation that the card network Visa and MasterCard are the prime candidates for a "no discrimination" rule, not banks (or restaurants).

Judy Shelton at the Bank of Canada? No thanks

How would I feel if Judy Shelton was a candidate for Governor of the Bank of Canada? Here are my thoughts.

A bit of background first. Judy Shelton was a Trump appointee to a key spot on the Federal Reserve board, the U.S.'s central bank. A President's appointees must be confirmed by Congress, and this was probably the most heated confirmation process I've ever followed. Shelton has espoused several controversial view points, including a return to the gold standard. 

The reason this appointment is so important is because Federal Reserve board members determine American monetary policy. That is, they decide whether to pluck interest rates up or down in order to ensure that the central bank is hitting its mandated targets.

That's a pretty important job! Not only would Shelton have been in the monetary policy hot-seat, she would have been on track to become the next head of the Federal Reserve. But it was all for naught. Shelton narrowly lost the spot as several Republican senators, including Mitt Romney, dissented.

So Shelton for Bank of Canada? Here's a simple set of guidelines I'd suggest Canadian voters adopt when they consider what sorts of people should be at the helm of the Bank of Canada. 

First, I'd suggest that anyone being considered for the Canadian monetary policy cockpit have a PhD in economics, preferably one in macroeconomics. And second, they should have administrative experience. (I'd be willing to accept a master's degree in economics as a substitute, with sufficient time spent working up the rungs of a central bank. The administrative experience is important because candidates will be in a management position.) Once they've passed those two hurdles, the finer points of their candidacy can be discussed.

A quick scan of Shelton's background reveals that she has a PhD in an unrelated discipline and no prior central banking experience. So if she was being floated for the job of Bank of Canada governor she wouldn't have passed through my filter. (Current Fed governor Jerome Powell, who is a lawyer, wouldn't have got through either.) 

Some readers may think I'm only stating the obvious. "Of course the most important people at a nation's central bank should have high-level economics degrees." But other readers will be disappointed in my criteria. I mean, here I am, an independent blogger—one who doesn't have a graduate degree—advocating an elitist sclerotic filtering mechanism.

Note that I'm not criticizing Shelton for her controversial stance on the gold standard. If she was a trained economist whose gold standard views had survived through years of rigorous training, she'd pass through my basic filter. Nor am I criticizing Shelton because she was a Trump appointee. Christopher Waller, another recent Trump appointee, would have easily passed through my filter.

Here's why I think my filter makes sense for Canadian voters. Monetary policy is complicated. Luckily we have an institution that teaches it: economics departments. Once someone has attained a PhD (or Masters + experience) in macroeconomics, odds are they'll be better than most at understanding how to operate the levers of a central bank. 

Why not draw central banking talent from other venues like the media, activism, think tanks, law, finance, business, or the blogosphere (ahem)? These venues don't attack the problems of central banking in as disciplined a manner as an economics department does. And so the average quality of these talent pools will not be as high.

In particular, I want to comment on the idea of drawing central bankers from the business/finance community. Many voters may think that Canadian business personalities like Kevin O'Leary, investor Prem Watsa, or banker David McKay would be uniquely qualified to run the Bank of Canada. I disagree. Sure, these titans of business will have good administrative experience (although no better than anyone else at the top of their field). 

But running monetary policy has little in common with running a business. Like the litre, second, and meter, the Canadian dollar is one of Canada's most important weights & measures. We put well-trained physicists at the National Research Council (NRC) in charge of maintaining our key physical measurements, not business people. (In fact, NRC scientists recently guided us onto a new standard for the kilogram.) Likewise, we need people with proper scientific training to manage our key economic measuring unit, the $.

Will my filtering system leave out a lot of good candidates? Yes. Will it bring in some bad ones? Certainly. Economics departments have tons of problems. Trust me, I've heard stories from insiders.

But even if it's not a great filtering system, it's still the best filtering systems we've got. Imagine that the plane you're on has lost its pilot in mid-air and needs a replacement. If one of the passengers has been to flight school, that person is probably going to be the best pick for flying the plane.

The WSJ marketed Shelton's candidacy on the basis of diversity. Yes, diversity of opinion is important. We want the co-pilot on our plane to criticize the pilot when one sees him/her make a mistake. But we still want both to be trained pilots with solid skills. They need to know exactly what that little red button above and to the left of their heads does when pressed. We wouldn't put a cake decorator, a plumber, and psychologist in the cockpit, just for the sake of diversity.

It's interesting to contrast U.S. and Canadian central banks on my very simple filter. Going back to 1970 the U.S. has missed twice: Jerome Powell and William Miller. The hits include Janet Yellen, Ben Bernanke, Alan Greenspan, Arthur Burns, and Paul Volcker.

Canada hasn't missed once. Everyone from Louis Rasminsky and James Coyne to Mark Carney, Stephen Poloz, and Tiff Macklem qualify.  

Stablecoins as a route into Venezuela?

Over the last decade, few nations have experienced as much monetary and payments chaos as Venezuela has. Fans of bitcoin, Dash, and other cryptocurrencies have all tried to help by introducing Venezuelans to their preferred coin. But even with Venezuela's bolivar currency entering hyperinflation stage, cryptocurrency adoption never happened. 

Circle, a U.S.-based company that issues the stablecoin USDC, is the latest to join the Venezuelan crusade. Last week it belatedly announced that it had partnered with the opposition Guaidó government  to deliver financial aid to Venezuelan health care workers. Here is Circle's CEO, Jeremy Allaire:

Breakthrough use-case for $USDC -- with US Govt permission, we partnered with the exiled govt of Venezuela (@jgauido) and Airtm @theairtm to distribute aid to people and healthcare workers in Venezuela. Stablecoins now a tool of US foreign policy -- https://t.co/50NoXNMJCz

— Jeremy Allaire (@jerallaire) November 20, 2020

In its blog post, Circle says it helped to get million of dollars to Venezuelans by leveraging "the power of USDC...to bypass the controls imposed by Maduro over the domestic financial system." Allaire suggests that in his tweet that stablecoins have now become a "tool of US foreign policy."

Did stablecoins play a vital role? I'm skeptical. If you pick through the transaction chain carefully, USDC's role was trivial. Nor does the wider claim made in Circle's post, that stablecoins have somehow arrived on the world stage as a foundational infrastructure in the future of the international monetary system, hold much water. 

For those who don't know, stablecoins are sort of like bank accounts with U.S. dollars in them, the difference being that they are hosted on a blockchain like Ethereum. Yes, they are a new and rapidly growing segment of the payments ecosystem. But if any payments instrument has helped Venezuela over the last few years, it's not stablecoins. Rather, it's the twin combination of old fashioned U.S. paper money and regular U.S. dollar bank accounts. More on that later.

A bit of background. The U.S. has declared the Maduro-led government to be illegitimate and thrown its support behind the Venezuelan opposition government led by Juan Guaidó. In 2019, U.S. officials cut off Maduro's access to Venezuela's U.S.-based bank accounts and put Guaidó in control. To give credence to the Guaidó opposition, an idea was hatched to take $19 million from these U.S. bank accounts and somehow airdrop it into the pockets of poorly paid Venezuelan health care workers. Each health care worker was to get $100 a month for three months.

Airtm, a money services business that offers U.S. dollar accounts, was recruited by the U.S. government to be the distribution agent for this $19 million airdrop. Airtm is a traditional e-wallet, much like PayPal or Skrill. People can get an Airtm account after going through a know-your-customer process, submitting ID and such. Having been approved, they can then transfer funds between their bank account or other wallets like Neteller. The money can also be spent using a virtual MasterCard debit card.

The first step in the Venezuelan campaign: move Guaidó's $19 million from his U.S. bank account to Airtm's U.S. bank account so that Airtm could distribute the funds. 

This is an easy step, right? It's just a US-to-US transfer, after all. Guaidó's bank simply initiates a wire transfer via Fedwire, the Federal Reserve's large value payment system, upon which the $19 million arrives in Airtm's U.S. bank account. It shouldn't take more than a few minutes. With that step out of the way, Airtm can now create $19 million in Airtm deposits for distribution to Venezuelan health care workers.

Instead, USDC stablecoins were substituted (either fully or partially) for Fedwire. Guaidó's bank bought $19 million in USDC stablecoin tokens (or maybe just a portion of that), and then sent these tokens to Airtm. Now Airtm could create $19 million in Airtm deposits for distribution.

By inserting itself into the US-leg of a transaction, Circle gets to make the claim that it was part of a stirring effort to bypass "censorship by the Maduro regime." But really, all it did was take the place of a very plain vanilla Federal Reserve transaction, one that never faced any obstacle anyways. The tough part isn't state-side, it's getting the fund to Venezuelans, In effect, USDC's role in this chain of transactions is superfluous (a point that Cas Piancey also makes here). Mind you, it certainly does make for good marketing.

Once Airtm had received the $19 million (via Fedwire or USDC), it could now embark on the tricky Venezuelan leg of the campaign. This involved signing up Venezuelan health care workers for Airtm accounts and then crediting their new account with U.S. dollar balances. (Nope, it didn't credit the workers with USDC. Airtm created internal database entries representing U.S. dollars for distribution to health care workers). From the sounds of it, this process didn't always go smoothly. The Maduro regime blocked Airtm's website, which meant that Venezuelans would have to use a VPN to connect. After talking to a number of medical workers, José Rafael Peña Gholam described the payouts as "somewhat chaotic."

I suspect this is why PayPal, which has much wider usage in Venezuela, probably opted out of the airdrop and let Airtm conduct it. PayPal didn't want to put its existing business at risk of being sanctioned or blocked by the Maduro government.  

If Airtm is to be the deployment vehicle for future Guaidó airdrops, it will have to refine its process. This isn't Airtm's first attempt to airdrop funds into Venezuela. Leigh Cuen chronicled an earlier attempt by Airtm to airdrop cryptocurrencies to Venezuelans for charity purposes. Only 57% of recipients ever engaged with the funds.

Now for my second criticism. The Circle press release describes Airtm's U.S. dollar accounts, or AirUSD, as a stablecoin-backed dollar token. And thus it can boldly claim that thanks to the combination of AirUSD and USDC, the world has just witnessed a "global first with use of stablecoins for foreign aid."

But Airtm's so-called stablecoins are not stablecoins. That is, U.S. dollars held at Airtm are not U.S. dollars held on a blockchain. Rather, they are very much like U.S. dollars held at PayPal or Skrill or Neteller. You know, good ol' fashioned centralized money. So for each Venezuelan that did succeed in connecting to Airtm to claim their dollars, they were getting non-blockchainy stuff.

So much for a "historic moment" in which "economic and political leaders have turned to stablecoins." USDC played a bit role, and AirUSD aren't stablecoins. 

That being said, stablecoins like USDC could be part of future relief programs. We'll have to see. One problem with using stablecoins for these sorts of airdrops is the massive customer due diligence requirements. The airdrop required vetting 60,000 Venezuelans to determine that each one was indeed who they claimed to be. But compared to e-wallets like PayPal and Airtm, stablecoins issuers have incredibly lax know-your-customer standards. Circle probably just doesn't have the staff to pull a carefully targeted airdrop off.

For now, no payments product has been more helpful for Venezuelans than classic U.S. paper dollars. So much U.S. currency has flooded into the country that it has effectively dollarized. An honourable mention goes to Arizona-based Zelle, a network that allows for instant transfers between U.S. bank accounts. Venezuelan retailers have adopted Zelle as an electronic payments method, although this surely goes against Zelle's terms of service:

For a modern blueprint of how people try to cope with hyperinflation, look to Venezuela. Locals have adopted Zelle, an Arizona-based app that facilitates instant US$ bank transfers.

"Supermarkets have dedicated lines for customers paying with Zelle." ⬇️https://t.co/XacNlZ5KNl pic.twitter.com/V4PXyCasww

— John Paul Koning (@jp_koning) November 16, 2020

I've written about Zelle usage in Venezuela before. Just as there is nothing blockchainy about paper dollars, there is nothing blockchainy about Zelle either.