Neha Narula, Anders Brownworth, and Daniel Aronoff on Understanding Stablecoins in the GENIUS Era

Neha Narula is the director of the Digital Currency Initiative which is based out of the Media Lab at MIT. Anders Brownworth is veteran software engineer in the crypto space and is a Senior Research Advisor at DCI. Daniel Aronoff is Research Affiliate in the MIT Department of Economics and a Collaborator at DCI. Neha, Anders, and Daniel join the show to discuss their work at DCI, the current state of stablecoins, their paper on the hidden plumbing of stablecoins, the basic mechanics of stablecoins, the technical and operational risks of stablecoins, the implications for the treasury market, interoperability between blockchains, and much more.  

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Read the full episode transcript:

This episode was recorded on February 27th, 2026

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected]. 

David Beckworth: Hi Macro Musings listeners, this is your host David Beckworth with some very exciting news. We recently announced that Macro Musings has full-length video of each episode going forward. The full-length videos are posted on our YouTube channel @MacroMusingsDavidBeckworth. There is a link to that channel in the show notes, and it would mean the world to me if you subscribed and shared it with others. Not only will that channel have full length videos, but it will also have some fun behind the scenes content. Additionally, the full-length video from each episode will also be posted on our X account @Macro_Musings. So, make sure you are following that account as well. We are so happy to give you even more macro bang for your buck. Now on to the show. 

Welcome to Macro Musings, where each week we pull back the curtain and take a closer look at the most important macroeconomic issues of the past, present, and future. I am your host, David Beckworth, a senior research fellow with the Mercatus Center at George Mason University, and I’m glad you decided to join us. 

Our guests today are Daniel Aronoff, Anders Brownworth, and Neha Narula. Dan, Anders, and Neha are from MIT’s Digital Currency Initiative [DCI] and published an interesting, timely, and important paper titled, “The Hidden Plumbing of Stablecoins: Financial and Technological Risks in the GENIUS Act Era.” They join us today to discuss it and the future of stablecoins. Welcome to everyone.

Neha Narula: Great to be here.

Daniel Aronoff: Thank you.

Anders Brownworth: Thank you.

Background of the Group

Beckworth: Let’s begin maybe by having each of you share your background, your connection to this policy space. Let’s start with you, Neha.

Narula: Yes. My name is Neha Narula. I am the director of the Digital Currency Initiative, which is based out of the Media Lab at MIT. I’m a computer scientist by background. I’ve been working in the cryptocurrency space for about 10 years now. We work with a lot of central banks. We work with a lot of traditional financial institutions, but we also do a lot of work in open-source development, particularly on the Bitcoin network.

Brownworth: I guess I can jump in. Sure. I’m Anders Brownworth, and I am an engineer. My background is as a software engineer. I was lucky enough to be an early employee at Circle and had a hand in helping USDC start up. From there, I went over to the Federal Reserve where we did additional work on a digital dollar, and now I’m over at the Digital Currency Initiative with Neha and Dan.

Daniel Aronoff: I’m Dan Aronoff. I’m in the economics department at MIT, an economist by background. I collaborate with the DCI, and have become quite involved in the cryptocurrency space and cryptography and economics in general.

Beckworth: Well, thanks to all of you again for joining the show. This is such an exciting time to be discussing this issue. So much going on. I imagine you guys are super busy responding to inquiries like mine and just doing the work in this policy space. 

Digital Currency Initiative

We are recording this February 27. Just this week, there’s been a lot of news in this policy space. We learned that Crypto.com secured a conditional approval from the Office of the Comptroller of the Currency for a special trust bank charter. Now we have Ripple, Circle, Paxos, Bridge, and Fidelity. They all have these charters that allow them to tap into the banking system and maybe even one day into the Fed’s balance sheet. We’ll talk about that later.

Also, we see that Stripe now is in talks to acquire PayPal. Maybe one of the biggest news items from this week, which I’m sure you have talked about, is Facebook or Meta getting back into the stablecoin space. As you all recall, 2019 was a pretty interesting year when Libra was introduced. That triggered a lot of excitement among central banks, so they’ve pushed forward with a CBDC. It seems like we’re coming back full circle now. We have the GENIUS Act, and now we have all these players in this space.

Tell us a little bit more about your work and how you’re engaging these issues.

Narula: Yes, absolutely. Like I said, I lead a group called the Digital Currency Initiative, which is based out of the Media Lab at MIT. We’ve been doing this for about 10 years now. We just had our 10-year anniversary in 2025. 

Maybe we could go back to 2015 and remember how things were then. Bitcoin had been around for a while. The network had been running for about six years. I think Ethereum had just launched. I remember the tenor at the time being very blockchain, not Bitcoin. People were very excited about the data structure and about the technology, but they were maybe a little bit less interested in getting into the changes in money and our monetary system.

Fast-forward 10 years, and I think we’ve finally gotten over that, and we realize, no, this is about money. This is about finance. Yes, it will have broader implications than just money and finance; it will affect the entire economy, it will affect the entire internet, but that’s really where it’s coming from. That’s where the change is being driven from. Everything that’s happened since then, I think, has made a lot of sense.

You’re speaking to repetition. History, maybe it doesn’t repeat, but it rhymes, is what we’re seeing. People are trying to do stablecoins again, and they’re trying to do them in a slightly different way. As we bring our regulatory regime, our political regime along with us, as these large institutions come into the future, we’re seeing that progress. It’s just happening really slowly.

State of Stablecoins

Beckworth: We’re going to get to your paper in just a minute because it addresses some of the challenges that stablecoins still face and hurdles that need to be cleared to really make them reach their full potential. Just stepping back and based on your experience and looking at stablecoins, is it fair to say the horse is out of the barn? This is something that’s going to happen no matter what? There may be challenges along the way, but given the GENIUS Act and other developments, this is something we need to embrace as opposed to pretend it’s not fair or to fight against? What do you think?

Narula: Yes, 100%. Everyone I talk to seems like they are on board with at least a 10 times growth in stablecoins coming up. The horse is definitely out of the barn. At the same time, it’s up to the industry to show the real value and show the real use cases. I don’t know if you want to get into use cases now. We can talk about where stablecoins come from and where they’re going. I do think that now is a really critical time because the industry needs to prove out the use cases, show that there are new use cases that are going to drive that growth. That’s what we’re in the middle of right now, but everyone is very optimistic about this happening. I don’t think you can ignore it any longer.

Beckworth: Yes, it definitely seems to be an important part of the financial landscape, the payment landscape going forward. Let me ask one question before I get into your paper. I think it’s fair to say we’ve been in a crypto winter. Am I exaggerating? In general, most of the crypto assets have been down, along with other risk assets. The stablecoins have held their own. They’ve maintained their value. That’s what they’re designed to do. However, one thing I have noticed is the market cap has peaked for the time being. We’re around $300 billion. What do you attribute that to? Is it tied to the crypto market itself writ large or just some other factor driving the momentum here?

Brownworth: Yes, I would say, stablecoins, their first use case was really for traders to get into and out of digital assets, different cryptocurrencies, and escape or enter volatility in different places, move money around. That was the first use case for stablecoins.

Since then, there’s always been the idea that at some point maybe I’m going to buy my cup of coffee with a stablecoin. We’re not there, but it’s trending toward that direction. When you look at back in the day when stablecoins were new, it very much tracked crypto prices because there was this whipsawing back and forth. That’s not so true anymore as stablecoins become much more commonly held. I don’t know. That’s my opinion. I don’t exactly know why they’ve leveled, but I don’t think it’ll stay where it is.

Beckworth: Well, let me share a story with you. I recently gave a presentation at a conference for Bitcoiners. Of course, I was there to talk about stablecoins. I wasn’t very popular. They didn’t like the fact that I was presenting something that to them was not very pure. It wasn’t a true blockchain asset. There’s big players. There’s choke points, as they’ve told me. They weren’t as sympathetic to the idea, but what I was making the case is this is something that has traction, that it’s what people want to use for payments. People want a stable medium of exchange. They don’t want something that goes up and down like Bitcoin and other crypto assets.

On the flip side, I made a presentation to a bunch of federal regulators in the banking system, and they weren’t pleased either. They didn’t like what stablecoins may or may not do to their business. They have to look over banks and other entities. It’s interesting that we see this movement forward with stablecoins, but there are some parties who aren’t as excited about it as we see it. What do you see there?

Aronoff: To me, it’s sort of explicable by the fact that stablecoins are the new entrant. The incumbents are naturally going to be resistant unless they can find a way to adapt and profit.

Narula: I think there’s also something to be said from having both sides be mad at you. It means you’re probably doing the right thing. This is something we also have a lot of experience with at the DCI, which is we work with developers who work on the Bitcoin network 24/7. They’re developing code, they’re working in open source, they consider themselves cypherpunks. Then we turn around and we’ll go talk to the BIS, or the Federal Reserve, or more traditional financial institutions. Bridging those two worlds, some people look at us and they’re like, how can you believe in both of these things?

I really see it as, pun intended, two sides of the same coin. We want to bring money into the future. You can’t do that by completely ignoring the currencies that 8 billion people across the world are using and the currency systems that 8 billion people across the world are using. You have to work on those and bring those into the future at the same time that you are developing something new and cutting edge and quite different to see how that works out. You have to place multiple bets, and it’s all going to move forward together.

Hidden Plumbing of Stablecoins

Beckworth: Okay, so the horse is out of the barn. We need to embrace and think about stablecoins. You guys have written a wonderful paper that helps us do that. Listeners, it’s time to jump into this amazing paper. It’s titled, “The Hidden Plumbing of Stablecoins: Financial and Technological Risks in the GENIUS Act Era.” Why don’t you maybe summarize it for us, give us the executive summary, and then we can jump into certain sections and go along from there.

Narula: Yes, so I think I’ll give the summary, and then Dan and Anders will chime in on more specific parts of it. First, I want to set the context of what we’re looking at. We’re looking at dollar-based stablecoins under the GENIUS Act. That means something really specific. We’re talking about stablecoins that are fully backed by Treasuries or bank accounts.

We are not talking about algorithmic stablecoins, and we’re not talking about cryptocurrencies like Bitcoin or Ethereum. I know a lot of people get very confused about that, but just to really narrow that scope, the goal of a stablecoin is to maintain what we call par value; that you can exchange one coin for $1. We’re talking about the reliability of being able to do that.

Also, importantly, in this paper, we are not talking about why you might want to use stablecoins. We’re not pontificating on the use cases. We’re not trying to make a prediction as to how big they’re going to get, or if they’re a good investment. What we are trying to do is very specifically answer the question: If stablecoins become widely used as payment and settlement instruments, what might go wrong with this guarantee of par? What are the risks, and what regulatory, institutional, operational, or technical mechanisms might help prevent destabilizing outcomes?

Just to dive into that a little bit: We are saying, assume stablecoins become really big. Assume they become widely used. In that context, what are the risks that we should be looking at and how might we mitigate those risks? We’re looking at three important areas. We’re looking at the backing assets, so the banking system, the Treasury securities markets. We’re looking at the technology rails that stablecoins run on. We’re looking at the regulatory frameworks that govern these issuers, these institutions.

In order to do that, we had to, I think, really dive into how stablecoins work, and so we talk about how to situate them in the hierarchy of money. We talk about how they work practically, how you get one, how you move one, how you redeem one. We have to talk about the actors who are involved and the physics of stablecoin movement. We reached, just to summarize, three high-level conclusions, which we’re going to dive much further into detail into these conclusions on this call.

First, there’s been a lot of focus on what we call asset quality. Is the stablecoin fully backed? Is it backed by high-quality assets? The assumption has been Treasuries. Treasuries are great. Treasuries are the highest-quality asset. This is sufficient. Asset quality and asset backing alone is not sufficient to guarantee par value stability if redeeming, getting in and out of stablecoins, depends on both intermediated markets that are subject to capacity constraints and also blockchain-based rails, which introduce very different operational risks than our traditional financial rails.

Just to be clear, I’m not saying this to say that blockchain-based rails are bad or that we shouldn’t use them. Just that we need to understand that we can’t abstract them away and pretend like they operate exactly like our existing financial system, and we can just assume that they’re going to have the same risks and roughly stay up the same and work the same. No, they’re really fundamentally different. We’ll dive into how they’re different in this call. Interestingly enough, those operational and technical risks can actually amplify financial stress.

Then third, last high-level conclusion of the paper is that the GENIUS framework is a strong foundation, but it leaves a lot of stuff open and unresolved. We had a nice little blog post about this, and the image in the blog post was a picture of Swiss cheese; there’s a lot of holes in the GENIUS Act. There’s a lot of unresolved policy dilemmas, which a lot of agencies are trying to figure out right now, and we’re starting to see them come out with that. I think the OCC just very recently came out with some guidance on yield this week.

Also, GENIUS doesn’t say anything about redemption mechanics, how strictly we need to maintain par value, and how we should think about stablecoin issuers operating these rails, and whether we should demand anything of them when it comes to how they communicate with their users. That’s high-level. And excited to dive in.

Basic Mechanics of Stablecoins

Beckworth: Yes, let’s do that. Let’s begin by maybe going through the basic mechanics you were talking about of a stablecoin. How does a stablecoin operate? What’s the step-by-step issuance, transfer, redemption mechanics?

Narula: Yes, so I think there’s two parts to this. One is technically how stablecoins move, like the physics of it. What does it mean? What are the messages that are passed? Who are the actors involved? Then there’s looking at it from the financial side. Maybe Anders and I will talk about the technical part, and then Dan will jump in on the financial part, how bank account balances move, and who are the actors involved.

Let’s say that you have a person who wants to buy a stablecoin. You’ve got the person, the user, let’s call them, and they’ve got some money in a bank account. Then you’ve got what we’ll call the stablecoin issuer. In the case of USDC, that is Circle. In the case of USDT, that’s Tether, and so on and so forth. Then you’ve got the blockchain-based network on which the stablecoin operates, and something that people might not realize is that there’s many of these. USDC is on over a dozen different blockchains.

Just in terms of the basic mechanics, and I’m very much oversimplifying here, when a person buys a stablecoin, what happens is that there’s a smart contract that was created by the stablecoin issuer running on a specific blockchain. The user gets a stablecoin by making a transfer to the stablecoin, usually through an intermediary, but ultimately, once it goes through all those hops, the stablecoin issuer smart contract issues a stablecoin to that user. It creates one in the smart contract. It does something we call minting.

Then that user has control of that stablecoin on that blockchain through that smart contract. They can transfer that stablecoin, which all happens through the smart contract. Then at some point, they can redeem the stablecoin. At that point, the stablecoin issuer and the smart contract will take an action we call burning the stablecoin; removing it from circulation on the blockchain. That’s the basic overview of how that works. Anders, how did I do? Anything you want to chime in with on the mechanics?

Brownworth: No, you did great. I think the difference here, like Neha definitely said, that it’s a lot more complicated than this simple overview. There’s obviously a primary market. There’s a secondary market for this. If you are just a person walking around buying a stablecoin, you’re probably buying it from a secondary market player. Then this mint operation has already happened, and they’re just giving you some of their supply. 

Beckworth: Quick question on the mechanics here. I mentioned earlier, one of the critiques I got from Bitcoin people is there’s these choke points. This isn’t truly a public ledger blockchain. Can you speak to that difference?

Narula: Yes, this is super important. Stablecoins, ultimately, the type that we’re talking about under GENIUS, there is a stablecoin issuer who has a tremendous amount of control over the stablecoin. They operate on top of what we call decentralized blockchain networks like Ethereum or Solana. These are the networks that operate the smart contract, and those are decentralized. Though, when you start to get into the details, there are different levels of decentralization, and there’s different risks with all of these different blockchain networks. They’re not all the same. We like to pretend they are, but they’re not. They’re very different.

The underlying blockchain might be decentralized, but the blockchain is just accounting. It is storing the ledger of who owns what stablecoin. The stablecoin smart contract is the smart contract that is maintaining that ledger on the blockchain, and it is under the control of the stablecoin issuer. Anders will get into this later, but there’s certain upgrade mechanics. It’s very auditable. Everyone can see what’s happening. The code does constrain the stablecoin issuer in some ways, but they can upgrade the contract, just to be clear.

Then most importantly, the stablecoin issuer has all of the assets backing that stablecoin off-chain: the Treasuries, the bank account balances, whatever other assets are behind that. Maybe they rely on a third party to manage those assets, like BlackRock does for Circle, or Cantor Fitzgerald does for Tether. That’s all off-chain. That’s all very centralized. The fundamental backing assets that give the stablecoin its value, that’s not decentralized. When you are using USDC, when you are transacting in this token, you’re going through a smart contract that’s ultimately controlled by Circle, and you are relying on backing assets that are ultimately controlled by Circle or whoever is custodying those assets for Circle.

Beckworth: I think this is a big deal when we talk about Know Your Customer or anti-money laundering laws. Stablecoins do provide a way in for governments to have some influence on this issue, right?

Aronoff: I think the issue there is that at the point of entry and exit, there’s KYC. In fact, it shouldn’t have to require the stablecoin issuer doing anything—I don’t actually know what GENIUS talks about—because the stablecoin issuer, at the point of minting and redemption, is interacting with bank accounts held at other banks. The banks are doing the KYC. The issue is that on-chain, there’s no regulation, so that transactions that are taking place in stablecoin world are completely unregulated.

Narula: There is some regulation, and GENIUS does indicate that there does need to be some AML and KYC. I think that exactly where that happens is very much still up for debate and is being formed. Dan, maybe you can talk a little bit about the bank mechanics of how stablecoins move from one bank account to another. Specifically, I think that there’s this broad misunderstanding that stablecoins somehow move money out of the banking system. When you actually look at the creation and destruction of a stablecoin, that’s not exactly what’s happening.

Aronoff: That’s correct. What a stablecoin issuer is doing, one way of conceptualizing it is that it’s monetizing Treasury. A bank deposit does not leave the banking system. In other words, if Alice wants to purchase a newly minted stablecoin, Alice transmits a bank deposit to the stablecoin issuer, and the stablecoin issuer gives Alice a minted stablecoin or assigns her a minted stablecoin. The deposit hasn’t left the banking system. If that stablecoin issuer is then investing in Treasuries, well, it’s paying for the Treasuries by transmitting its bank deposit somewhere else.

Fundamentally, I think the misconception is rooted in a larger misconception about the relation of bank deposits to bank lending. There’s a popular misconception that your deposit base is the fund for lending. It’s exactly the opposite. The bank assets, the asset side of the balance sheet, determines what the deposits are. The reserves set by the central bank, that the banks are required to hold, is one portion of assets, and the other are the loans that the banking system is making.

I think this idea that somehow you will drain deposits from the banking system, or even that if there is a drop in demand for deposits because people are using stablecoins for transactions, that cannot express itself as a reduction in deposits. It can express itself as a shift in velocity or turnover. In other words, you might have a reduction in the turnover of bank deposits and an increase in the turnover of stablecoins, but you aren’t draining deposits from the system. If you go through the steps, you can see that.

Beckworth: Yes, you did a great job in the paper illustrating this. You have a lot of flow charts, diagrams. Very, very helpful. I encourage listeners and watchers of the video to go out and check it out. Dan, the total or aggregate amount of banking deposits does not change, but maybe the banks that actually service those deposits could change. In other words, you might want to be a bank who is a custodial bank. Maybe it’s in bankers’ interest to make sure they’re a part of this activity.

Aronoff: Yes. We haven’t really gotten into this in the paper, so we shouldn’t go too far afield here. If there was a shift in velocity in transactions from the banking system to stablecoin world, that could have an impact on bank earnings because there’d be less transaction-related fees that banks are earning, but it wouldn’t fundamentally change in either direction, either minting or redeeming.

Beckworth: Let me ask this question, and it’s related to what we’re talking about here, because this is the critique that comes up is that stablecoins will take business away from the banks. That’s what I heard from these regulators. I felt like I was in O.K. Corral shooting all these objections down as they came my way. I wish I’d had your paper beforehand. It would have been very helpful.

Dan, tell us more about this par value, this minting risk idea that you bring up in the paper.

Aronoff: There’s been a focus, understandably, on redemptions; on the reliability of the stablecoin issuer to be able to convert a stablecoin or to take a stablecoin and issue bank deposit with a stablecoin holder. There has not been focus on that par value requires some adjustment on the other end. That is, when there’s demand for stablecoins, which would put upward pressure on the price of stablecoin, will the issuer respond by minting stablecoin? The answer to that question probably is related to the profitability of issuing the stablecoin.

In a low-interest rate environment, and particularly Treasury rates because that’s what the issuers are investing in, you could see a point at which it is unprofitable to issue. Therefore, there would be an increase in demand without a supply adjustment. In both cases, that’s the dynamic. In either direction, you’re looking at, whether it’s minting or redeeming, there being a demand to convert in one direction. The question is, can the stablecoin issuer make the supply responsive. The only point is that issue exists on both sides, not just on redemptions.

Technical and Operational Risks of Stablecoins

Beckworth: All right. I have an issue for us to continue to think through. Let me move on to technical and operational risk. Anders, it’s great to have you here. You were in the trenches with Circle. You have probably some war wounds from those experiences. Tell us, what are the real technical and operational risks we should be thinking about?

Brownworth: Yes. What we go through in the paper, there’s a technical risk matrix and pretty much, I think, boils down what you need to know. There’s a most likely to least likely, and a high systemic risk to a low systemic risk. The stuff that’s in the upper left quadrant of that is probably the most important to talk about. That would be smart contract logic flaws and bridge failures, things like that.

As we were mentioning, blockchains, they seek to be immutable. If you write something onto the chain, you would expect that it not be changed. As Neha was saying, in order to supply a stablecoin, what you do is you create a smart contract that implements it, and then you start using that. What happens if there’s a bug in that smart contract? There’s this decision—talking about war wounds; I remember when this happened at—it’s not a war wound, but I remember when this happened at Circle, when we were talking about this. Should we just put it out there so you cannot change it and if it works, there’s confidence, or should we deploy something that can be upgraded? All the major stablecoins are upgradable, but that leaves this possibility that there is a way for bugs to then creep in later in an update and things like that.

The implementation of your smart contract—obviously, there are things you do. You audit that very well, et cetera. You test it heavily. Once you put it out there are, there are keys that exist that can upgrade that contract. There is a way for changes to be made, both good and bad. Obviously, if there’s a problem with that, it would be a systemic problem. It could potentially impact that entire stablecoin on that blockchain.

There’s many other risks that we go through: how do you bridge between different implementations of the same stablecoin across different networks, and stuff like that as well. There’s a matrix that we pose.

Beckworth: Just to be clear, a solvent stablecoin, one that has assets fully backing it, could be able to operate if it had some of these technical challenges emerge.

Brownworth: It could. I think the important thing to remember is the money is still in the bank, presumably. If there’s simply a technical problem, it’s not like the money disappears from the bank. The ledger or who owns how much of what might have a problem. One of the problems it might have, it could just cease to be live. You can’t update it, and you can’t trade the stablecoin. That might impact its par value because you can’t use it anymore. You can’t send it back to the issuer to get a redemption. The issuer can’t mint new coin. All of these three things—issuance, transfer, and burning of the stablecoin—all those things require on-chain actions. Yes.

Beckworth: Let me ask a question that was asked of me by the bankers. I’ll give you my answer. It probably wasn’t adequate. You guys are MIT. You are the engineers. You are the folks who really know these technical details. Someone brings up this question: What about quantum computing? What if these blockchains get hacked? My response is, well, look, you got bigger fish to fry because if you can hack a blockchain, you probably can hack your antiquated computer system that runs the bank.

I probably should put things in perspective, but what would be your response to this question that sometimes comes up about quantum computing and being able to hack through the encryption?

Brownworth: Well, I would argue that we don’t know whether or not that’s practical yet. I think it is not. Like you say, it would be a systemic issue that would impact traditional financial networks and pretty much anything on the internet, HTTPS, anything in a secure web browser. These would be hugely systemic problems not only focused on the cryptocurrency world. However, there are efforts afoot to address this and to come up with quantum-safe cryptography and implement it in all the different blockchains. It’s a known problem, and it’s something that people are working on.

Aronoff: There is something to it that relates to concerns that Anders has raised. One difference would be that if there’s a hack, let’s say, of a commercial bank, you do have legal recourse. There’s a legal structure. Anders, you can talk about this more, but that is not necessarily the case with an equivalent attack to…

Narula: I think maybe the thing that I would add to what Anders said is that I think quantum computing and its risks are very misunderstood. For example, a lot of people don’t even seem to realize we know how to build quantum computer-resistant cryptography. This isn’t an unknown. We know how to build it. We know how to use it. The issue is that we need to upgrade our existing systems to use it.

Another issue is that it doesn’t perform as well as our current cryptography from the point of view of it’s slower, it’s larger, it’s a little bit more clunky, but we know what it is. NIST is working on standardizing quantum-resistant signature schemes and hash functions and things like that. We have a path forward.

The issue is really this upgrade question. With centralized systems, it’s relatively straightforward to upgrade them. Google decides to upgrade Chrome. Microsoft decides to upgrade Windows. They move forward. They roll it out. They tell everybody, “You got to upgrade. You’ve got to get on this new version. Here’s how it’s going to work.” They can coordinate that. Much, much harder to coordinate the upgrade of decentralized systems. Easier on some blockchains than others. Most challenging on the most decentralized blockchains like Bitcoin. I think that’s where the concern arises.

Also, the fact that these blockchains fundamentally rely on cryptography to determine who owns what asset. There’s no other way. No one’s storing a list of all the Bitcoin owners and their ID numbers next to them so that if they lose their private keys, they can figure out how to give them their Bitcoins back. That doesn’t work. The way that you show that you own Bitcoin is you produce a cryptographic signature. If the fundamental of that cryptographic signature breaks, then you don’t know who owns what Bitcoin. That’s why this is a little bit more challenging.

In addition to that, there’s what Dan says, which is that if you can’t access your bank account or if someone steals it because they break the cryptography behind it, you could call Chase. You could get on the phone. The regulators are going to be monitoring this very carefully. They can probably figure out how to make you whole again and how to make things work. There’s no one like that for Ethereum. It’s a bit of a different situation if things actually do break. How do you recover? Do you have any recourse? That’s why it’s a little bit different than the existing system, but maybe not quite in the ways people traditionally think so.

Beckworth: That is so interesting. Thanks for sharing that. When I was at that Bitcoin event, this did come up. There were people there who admitted that, yes, we could upgrade, but the culture doesn’t want to do it because we’re Bitcoiners. We like to stick to the original, and we’re very decentralized. There are advantages to centralized finance. This is one of them, for sure.

Let’s go on to one more question related to this technical side. This is the question of scaling. Right now, as I mentioned earlier, we have just over $300 billion market cap in stablecoins. What happens if we reach these amazing projections of $3 trillion to $4 trillion by the end of the decade, maybe even more than that over the next few decades? Can the stablecoin infrastructure handle this added capacity?

Narula: Yes, so I think this is something, again, where if you just assume the blockchain works, you might not understand some of the nuance and the detail here. I think there’s two components to this question. One is, can you just handle a large number of users, a large number of transactions, if they all want to transact on the blockchain?

The simple fact of the matter is that decentralized systems are less efficient than centralized systems. You can’t do as many transactions per second. If there’s, for example, a run on a stablecoin or something like that, you could end up having a very high backlog of transactions of a lot of people trying to get through. You literally can’t fit all of the transactions that people want to make onto the blockchain. That could happen. Blockchains are limited in capacity. I think that’s one component that’s important to understand.

The other component that’s important to understand is the fundamental security of these blockchains and what it’s based on. The idea behind decentralized blockchains is that they are open, and they are permissionless, and this is part of the value. This is part of the power. This is why they’re interesting. This is why we’re all building in this space. Anybody can access them. When anybody can access them, that means that hackers can access them. Attackers can access them.

They’re built very carefully to try to be secure, even though they are operating in very adversarial environments; the open internet. The way they do that is using cryptography, but also a field that we now call cryptoeconomics. What does that mean? What that means is that the reason these blockchains are secure, the reason that we have a ledger, that we know there’s one ledger, everybody sees the same copy of the ledger, and people only can add to it according to certain rules, is based on cryptoeconomic security.

There’s a set of validators, or there’s a set of miners that are producing the blockchain, and we make certain assumptions about them. We make assumptions that the majority of them are honest, that they are following the protocol, that a majority of them don’t collude to try to create advantages for themselves. We design the protocols in such a way to encourage this. One of the mechanisms that does this is called slashing.

In proof-of-stake blockchains, where most stablecoins run, the idea is that if you misbehave as a validator, then you might get your stake, which is in the native cryptocurrency, slashed. You might actually lose money if there’s evidence of your misbehavior. These protocols are complicated, and all the blockchains use slightly different protocols. You have this really interesting, very dynamic set of protocols. They’re also updating them constantly. Ethereum switched from proof-of-work to proof-of-stake a few years ago—that was a very big change—and did so mostly successfully, I want to be clear.

I think that a lot of people who are building with stablecoins, a lot of traditional financial institutions that are operating on top of these networks, maybe aren’t as fully aware of what’s going on under the hood. Who’s making these upgrades? What are the dynamics of the cryptoeconomic algorithms that are powering these protocols? What are the risks? Where are the validators? What are their incentives? A really interesting thing that I think people might not understand is that the game theory of the cryptoeconomics behind the security of the blockchains changes when you have a very large asset like a stablecoin, that is not denominated in the underlying cryptoeconomic token.

If we look at, for example, Ethereum, if you misbehave in the Ethereum protocol, you get slashed in Ether. Your stake is in Ether. Your stake is not in USDC. If the value of USDC becomes very large on the Ethereum blockchain such that it dwarfs the market cap of Ethereum, then the balance of incentives changes. It might be in an attacker’s interest to attack the underlying blockchain, incur that slash in Ethereum if they can get a large gain in USDC. That’s an example.

Now, it’s not as simple as I make it sound because, as we were just talking about, USDC is very centralized. Circle is still controlling the underlying backing assets. As we have DeFi, as we have decentralized exchanges, as we have automated market makers, there are all kinds of attacks that attackers can engage in that might be very hard to undo, might be very hard to really prevent an attacker from running away with an advantage.

Beckworth: Wow, so much there on the technical side. You guys will be busy for some time dealing with these technical issues. This is what industry does. It responds to challenges. Hopefully, there’s enough profit motive there to drive them to solve some of these things, but also folks like you providing solutions. 

Implications for the Treasury Market

Let’s move on to another issue you bring up in the paper, and this relates to Treasury market fragility. I know, Dan, this is your specialty. This is actually something that came up when I had this presentation with these federal regulators. They were worried about what the implications for the Treasury market would be from stablecoins holding a bunch of Treasury bills. Maybe walk us through the questions and issues there, Dan.

Aronoff: The mechanics of redeeming a stablecoin when the stablecoin issuer is holding a Treasury security, outright Treasury or repo involves ultimately a liquidation, a sale of a Treasury. The issue is the capacity of the Treasury market to process that sale. This isn’t a new issue in general in the Treasury markets. The fragility of Treasury markets has led to such initiatives as the central clearing mandate, as the recent relaxation of the SLR lower bound, as the introduction of the standing repo facility. All of those are in place, but if you go back to the March 2020 run on the Treasury market, the net sales that were processed, that is, when you take out the movement through the intermediation, was around $100 billion.

Now, this is in a $25 trillion market, and that caused a meltdown. That’s rather fragile. As you mentioned earlier, the capitalization of stablecoins today is $300 billion. If the projections made by City and by Treasury of it being a $2 trillion market, that’s both a nontrivial percentage of the total Treasury. The $25 trillion is Treasuries held by the public. I guess there’s an additional amount held by the Fed. That’s a nontrivial portion. $100 billion is a very small percent. That would be a minor blip in terms of a stablecoin run. It’s there. The choke point—again, nothing new here—is the intermediation chain, the capacity of broker-dealers to process those transactions because they’re running into their SLR limits.

As an aside, I did a back-of-envelope calculation of the increase in capacity that the recent revision to the SLR rule would provide among the largest five broker-dealers. Roughly speaking, it works out as follows. That for each of the bank’s affiliates of those broker-dealers, it would give them about $1 trillion additional capacity for assets on their balance sheet. On average, they have 10% of their assets in repo. That’s like a $500 billion increase in repo transaction capacity in a $12 trillion market, and a market that’s supporting Treasuries that are increasing. That gives some relief. I don’t think it solves the problem.

Another thing that’s been addressed is the standing repo facility, which gives broker-dealers essentially unlimited access to reserves so that they can carry out their transactions. Surprisingly, in an abundant reserve regime, in these crisis points, it is generally that the key broker-dealers were short of reserves to process transactions. That’s been solved. It doesn’t solve the balance sheet problem. Let me go back to that. It’s abundant reserves, but the problem is that, as you know, one of the consequences of the abundant reserve regime is the interbank lending market and the whole trading desk and so on have almost completely closed down.

The only way you can transfer reserves in the banking system are for those banks that are active in the repo market. If all the banks in the repo market are running short of reserves, they have no way of transacting with banks outside of the repo market system that might have excess reserves. That’s solved by the standing repo facility. A standing repo is a repo-borrowing transaction that all goes on the asset side of the balance sheet, so you run into the SLR constraint. In addition to that, the Fed cannot participate in a central clearing platform, so you don’t get the benefit if a broker-dealer has repo lending on the other side. They can’t net those in the standing repo transaction.

The bottlenecks remain, and that’s the issue is all this has to funnel through the Treasury market to handle. The other thing is that, looking at it on the other side, is that a small disruption in the Treasury market could trigger a stablecoin run. Stablecoins are a very runnable asset. 

There’s an interesting paper I would refer listeners to by Aldasoro, Mehrling, and Neilson, a BIS paper, where they compare the stablecoin system to euro money. They talk about the fact that in the eurodollar market, there are all sorts of institutions that are built up to absorb pressure of movement in one direction or the other between the dollar system and the eurodollar system that create frictions or stem the tide of what could otherwise be a run. They point out that none of that exists among stablecoins now. It’s a very runnable asset. 

One of the things we address in the paper is an idea developed by Bengt Holmström about assets that you basically assume are safe and people don’t question, and so they can transact on that basis. The idea is that bank assets would be like that. When a bank has trouble, if there’s just a slight release of information about it, that can cause a panic, as, for example, happened with SVB Bank in 2023 or banks in 2008. The point here is that while the Treasury market’s stable, while people may not question the US government’s ability to pay, that market’s intermediated by banks. If there’s a slight disruption in intermediation, that could cause concern and a panic. Then that interacts with the stablecoin market, that’s a runnable asset that has no natural buffers. That can also be an explosive situation. There’s a mouthful there, but that’s the picture of it that I have.

Beckworth: Those are legitimate concerns. Of course, you guys talk about this in the paper. I’ve talked about it on the podcast. I’ve written about it myself. The Fed has proposed one possible valve to release pressure, so to speak. That is the skinny Fed master account, having limited access to the Fed’s balance sheet. Dan, do you think that would be something that would help, or do we need something more than just access to the Fed’s balance sheet here?

Aronoff: Well, let’s make a differentiation between the skinny Fed account proposal and full access to the Fed balance sheet. As I understand it, the skinny Fed proposal would not provide a buffer for a run. It would just facilitate daily transactions, and there would be limits so that the stablecoin issuers could send and receive reserves. That probably would help grease the wheels of commerce in a way, in a normal situation. In other words, you’d need for the stablecoin issuer to be able to go to the Fed discount window and borrow against its Treasury securities to be able to meet redemptions. That would solve the problem.

That would make the Fed the insurer, but it would potentially raise another problem. One that applies to the stablecoin issuer itself is that if a stablecoin issuer gets that kind of access, one presumes that they would be subject to banking regulations and the costs associated with those regulations. That would then increase an operating cost of the stablecoin issuer, and it would create a risk that if Treasury interest rates fell, let’s say below some threshold amount, it could bankrupt the stablecoin issuer. Remember, the stablecoin issuers do not control their margins under GENIUS. They pay no interest on the stablecoin, but they have only one asset that they can invest in, Treasuries, in a market. They have absolutely no margin control, and that’s a differentiation from a bank. That’s one risk. 

The other is a general observation, and something I’m not in a position to trace out the details, but clearly, it alters the monetary transmission mechanism. If stablecoin issuers have access to Fed balance sheets, it creates another channel of transmission and thereby complicates the conduct of monetary policy. I don’t have any conclusion about what those complications are, other than to make the statement it’s there, and it needs to be studied because it’s a slightly different situation than what we have today when you go and make that move.

Business Model of Stablecoins

Beckworth: Let me speak to what you’ve just addressed, and that is the business model of stablecoins. This has come up several times before in other podcasts and other conversations I’ve had. You touched on it, that if the yield on their assets were to go down, imagine we return to a world with zero lower bound interest rates like we were in the 2010s, could stablecoins still survive? Could their business model adapt and earn revenue some other way? Can someone speak to that?

Narula: I think that’s definitely possible. We’re just at the beginning of exploring different business models for stablecoins, whether that’s transaction fees, minting fees, redemption fees. Stablecoin issuers and the whole cryptocurrency market they’re working to figure out how to provide value to users. If they can figure out how to provide value to users, then they will figure out how to charge for that value. It might be the case that we’re in a blip right now where most of the ways that stablecoin issuers make profit is through this interest arbitrage. That could change in the future, but they’re going to have to figure it out. It’s not clear or obvious exactly where that new business model is going to come from.

Interoperability Between Blockchains

Beckworth: Going back to the technical questions, a big overarching theme of what I’m hearing is this lack of interoperability between these different blockchains, different stablecoins. Do you see hope, progress there that at some point I might have Tether, you have Circle, and we can somehow interact with each other without having to go through our intermediaries?

Brownworth: I think there are probably technical ways to do that. There’s also a market that is really emerging to be able to supply that liquidity across chains. I think it’s a problem that certainly is a problem, but it’s something that’s being solved right now.

Narula: I think one of your previous guests, Austin Campbell, seemed to think that the fungibility between stablecoins was less of an issue than the fungibility between bank accounts. I completely disagree with that position because in the bank account regime, we have things like FDIC insurance. During the failure of SVB, the Fed basically indicated that they’d be willing to backstop the entire banking system. There is a lot of apparatus that is, for better or worse, dedicated toward maintaining the illusion that a deposit at one bank is equivalent to a deposit at another bank. There is absolutely zero of that apparatus at play for stablecoins today, other than the fact that they are mostly backed by US Treasuries.

They are backed by Treasuries and under different regulatory regimes in completely different jurisdictions, different companies that operate in different ways. Even under GENIUS, I do not think it’s the case that level of faith in the fungibility between stablecoins is at 100%. All of that is going to have to be developed, all of that. It is not just a technical issue. It is a regulatory issue. It is an economic issue. There’s going to need to be a lot that is created, and it will probably have a cost.

Will it look exactly like what we have for banks? Probably not. It’s going to be interesting to see how that develops. That’s part of what’s exciting about this whole space. It’s giving us the opportunity to invent a new structure and not be stuck with the ways of the past. If you think about when banking regulation was written in the 1930s, a lot has changed since then. It’s worth taking a step back and trying to reinvent how we do things from first principles.

Beckworth: You mentioned the Austin Campbell podcast. You probably also heard the Dan Awrey podcast. He shares your view, almost identical, that there’s a lot of work to be done in order to get to the place where we do have that fungibility between different stablecoins. Of course, one of his proposals was to allow stablecoins to have complete access to Fed master accounts, which would go a long way. Dan, as you said, there’s added costs. There’s a lot of learning to do. As I look around the world, for example, the Bank of England, they are more open to stablecoins on the balance sheet. The ECB, on the other hand, they’re making it almost impossible. You’ve got to go through a bank, which is a competitor, which then gives you access to the balance sheet. 

There are a lot of different models being explored. It is exciting to see which one will work the best. It does seem, though, like in the US, we do have this wonderful opportunity, I daresay advantage. Our horse is out of the barn. I think we gave it a little slap in the rear, and it’s out running. We’ll be excited to see what happens. 

What’s the Deal with Tether?

This is a nice way to maybe segue to my final question here, as time is nearing an end. That is, we have the largest dollar-based stablecoin outside the US, outside the GENIUS Act. Anders, you’re a former employer. Circle, it’s wonderful, it’s in the US. But there is this beast called Tether. What do you see the implication of this? On one hand, you might be worried. They’re outside the regulatory umbrella of the US government. On the other hand, maybe they’ll try some things that we wouldn’t try in the US. Maybe they’ll make some mistakes, and maybe we’ll learn from it. How do you see this dynamism playing out? Is it a good thing that we got experiments inside and outside the US when it comes to dollar-based stablecoins?

Brownworth: I have no crystal ball. I can’t tell the future with that disclaimer. Tether, maybe at one point, some would say that was a feature, that people are looking for a way to not be observed,. Since the founding of Circle, it was very much regulatory first, very much build it in the United States. Let’s do things right and properly. It took a long time. It wasn’t immediately clear that was the right strategy. I think it certainly was in the long run, but that game’s not over yet. I understand Tether has a US project that they’re spinning up. I don’t know. We’ll see. Competition is good generally for consumers.

Beckworth: Absolutely.

Narula: I also think it’s important to note that the Tether of 10 years ago is not the Tether of today. It is a very different organization. Cantor Fitzgerald is located in the United States. I think a lot of people come to Tether with a lot of assumptions about how it used to work, and it’s not clear to me that it still works that way. It’s very different. I also think it’s really interesting because Tether is very much focused on the extra US, and in particular, Latin America, Africa, Asia, all of these environments where payment systems are very different, access to dollars is very different, and there is a real demand for dollars that is not being met by the traditional financial system.

Tether is one of the organizations that is meeting that demand. We’re seeing it in countries with very high inflation, like Turkey, Argentina, Nigeria. There’s high usage for stablecoins. I think this is a really interesting data point that we need to examine more carefully. We need to understand what’s happening in these places. I’m glad Tether exists so that we can see this demand, and we can try to understand it better. I think we need more competition, not less.

Beckworth: Absolutely. Our guests today have been Neha, Anders, and Dan. Thank you so much for joining us. Their paper is titled “The Hidden Plumbing of Stablecoins: Financial and Technological Risk in the GENIUS Act Era.” Where can people find you online?

Narula: I think we all have X accounts. I’m @Neha, so N-E-H-A. The website for the DCI is dci.mit.edu.

Brownworth: I’m @Anders94 on X, A-N-D-E-R-S 94.

Aronoff: I’m Daniel Aronoff. I don’t know exactly what the handles are.

Beckworth: Well, thanks to each of you for coming on the program. Listeners, be sure to check out their paper.

Narula: Thanks.

Brownworth: Thanks.

Beckworth: Macro Musings is produced by the Mercatus Center at George Mason University. Dive deeper into our research at mercatus.org/monetarypolicy. You can subscribe to the show on Apple Podcasts, Spotify, or your favorite podcast app. If you like this podcast, please consider giving us a rating and leaving a review. This helps other thoughtful people like you find the show. Find me on Twitter @DavidBeckworth, and follow the show @Macro_Musings.