Private money, public trust: The stablecoin battle

In this episode, Amit Seru, the Steven and Roberta Denning Professor of Finance at Stanford Graduate School of Business, joins host Neale Mahoney, the Trione Director of SIEPR, to explore critical questions around new cryptocurrency innovations. Stablecoins promise fast, low-cost digital payments, but Seru, a SIEPR senior fellow, explains why they function much like narrow banks — vulnerable to runs if confidence erodes. The conversation also examines the GENIUS Act’s attempt to add guardrails for this unique type of crypto, the risks of delegating core financial functions to private issuers, and why trust remains the foundation of any stable currency.

Follow along as we explore several key themes, including:

• (01:10) What’s at stake: Stablecoins and the future of money
• (05:35) The GENIUS Act: What it does, what it doesn’t
• (09:44) Run risk, backstops and regulatory gaps
• (14:34) Private innovation and public power
• (20:40) American trust in digital money

• (26:50) To buy or not to buy

  To learn more about Seru and his work on financial regulation and stablecoins, explore his bio and these recent pieces: 

• We Really Want to Trust Crypto Interests With the Future of Money? - The New York Times
• Can Markets Trust Stablecoins? - WSJ
• Raise bank equity or keep rolling the dice

Econ To Go brings Stanford economics into your everyday life — served with a side of coffee. Hosted by Neale Mahoney, the Trione Director of SIEPR and TG Wijaya Professor of Economics, the video podcast takes you on a walk across campus with leading thinkers as they unpack the ideas shaping our economy, public policy, and daily lives. Smart, curious, and conversational — it’s Stanford economics, to go. 

Explore the series

TRANSCRIPT:

Econ To Go: Episode 02

Neale Mahoney: Money runs on trust. Not just trust in what it's worth today, but in the belief that it will still be there tomorrow. And when that trust starts to crack, even just a little, the whole system can erode. From bank runs to collapsing cryptocurrencies, we've seen how quickly things fall apart when trust is shaken. Now, as private innovators and public institutions wrestle over the future of currency, a new question emerges. How can we modernize money without undermining the trust that holds it all together?

Amit Seru: What we need to do is to somehow embrace the innovation without introducing unnecessary fragility, because there are a lot of lessons about fragility which we already know and we don't wanna repeat them.

Neale Mahoney: Hi, I'm Neale Mahoney, economist and director of the Stanford Institute for Economic Policy Research. On this episode of "Econ To Go", I'm joined by Amit Seru, professor of finance at the Stanford Graduate School of Business.

Amit Seru: We're chatting about?

Neale Mahoney: Stablecoin.

Amit Seru: Yes.

Neale Mahoney: Neither stable nor a coin.

Amit Seru: Nor a coin, no.

Neale Mahoney: We talk about stablecoins, financial innovation, and how fragile things can get when guardrails don't keep up with technology. We started with what's really at stake when balancing the dual objectives of private innovation and public trust.

Amit Seru: As everybody knows, dollar is a pretty dominant currency and that has had huge effects for Americans because you end up with lower borrowing costs. It's a currency which is strong, so when you travel around the world, people envy the fact that dollar is so strong. And behind that is the public trust component to it because money doesn't get value just like that, it comes from institution, it comes from trust. So when you delegate it to the private sector, one has to worry because for many, many centuries we have learned that money gets its power from basically the trust of the institutions behind it. And once you delegate it to the private sector, you are giving that away and making the currency less stable than it really is in the hands of public institutions.

Neale Mahoney: So, you've described stablecoins as as narrow banks. Can you explain what you mean by that?

Amit Seru: So, if you think about a bank, you know, what do we do in a bank? A bunch of depositors put in their money because we don't want to keep that money lying around in our households under a mattress. What does a bank do? Bank takes that money and then puts it to use. As economists, we say that there are savers, which are us depositors, we give the bank the money and then they give it to users, could be firms, could be households. And what banks typically do is they take money from us, which is short term, it's on demand. You and I can go to a bank and want our money on any day. And bank takes that and puts it to use, which is usually long term. So when they give the money to a corporation, it's locked in for four years, five years. When they give a mortgage to a household, it's for many, many years. How do they do it? Well, they basically have to manage this so-called duration mismatch, long-term investments but funded by short-term liabilities, which is depositors. That system has inherent fragility in it and we saw that in Silicon Valley bank turmoil a couple of years ago. In came the idea of narrow banks, and the narrow banks are, okay, these things are funded short term by depositors. How do we give them something safe? Well, we will make the banks only invest in safe things like cash, like treasuries, government bonds on a short duration, so that when you fund something short term, you're also gonna invest in the short term. And that will make the structure stable. Households will get their liquidity, which is anytime I need the money, I have it. And the inherent fragility where the money is tied up now in long-term investments is taken away. Other thing that you should note is that if you want to use your money, you can take it out, you can transfer it within banks, and if you really want to use it to buy things, you have to take the money out and then use it in stores and whatever have you. Stablecoins are trying to do something similar. Whoever issues this token to you, the coin, you can basically use it for anything, to make payments, to buy things. And you can do it at any point of time and you can do it at lower transaction costs if you're trying to do these same things across different jurisdictions, different parts of the world, which is very difficult to do with the banks. So stablecoins are doing exactly the same thing, but they're trying to lever on technology to get efficiencies.

Neale Mahoney: It's like banking but it's sort of all the time everywhere as opposed to sort of nine to five on a weekday. So, there's a whole bunch of benefits, but banking also has risks. If everybody wants to withdraw their stablecoin all at once, it needs to be backed with some sort of liquid reserves, otherwise the bank runs out of money. And if people think the bank is gonna run out of money, then there's gonna be a bank run and all of these issues. So, how is the GENIUS Act trying to solve this bank run issue for stablecoins?

Amit Seru: What GENIUS Act is saying is, okay, we are gonna do this narrow banking in the crypto space using stablecoins. So private issuers can come in and issue tokens. The issue that you brought up, which is that there is inherent fragility in this kind of structure. How are we going to solve it? With narrow banks, regulators or well-designed rules would've made sure that banks are investing in liquid assets and someone would have audited that. In the case of stablecoins, someone has to do that same thing. So there are rules put in place to hopefully get everybody to invest in liquid securities or liquid assets. And then if we think that that's going to be okay, then these tokens really will have stability associated with it. But this is very big picture. If you get into the weeds, you realize that there are lots and lots of loopholes around this, which actually makes this way more fragile than a narrow bank that we would have liked to see but we never saw in the US before.

Neale Mahoney: What do you think is the North Star for this sort of regulation? Where are we? Where are the loopholes?

Amit Seru: Yeah, so look, the way you want to think about it is that if you look at what the stablecoin issuers, which is like a narrow bank, are investing in, which is all of these liquid assets like cash, or investing in treasuries and so on, who is gonna make sure that these assets are in place? So typically we have auditors looking at it, we have regulators looking at it. In the stablecoin space around GENIUS Act, because we have delegated all of this to the private sector, we are gonna have to rely on some broad and fuzzy rules. So the GENIUS Act says that, well, you can have an auditor audit this at some frequency. So that's gonna be one thing, there are the reserves in place, so you need some rule of law and someone to audit with the reputation who we can trust. The second thing is gonna be that when you are gonna issue the coin, the coin has to be used by people who are reasonable. One of the things where banks have provided a very valuable function is validating that whoever is transacting are reasonable actors. So, as everybody knows, we have to do KYC, know your customer, and AML kind of regulations that banks perform.

Neale Mahoney: And what is AML?

Amit Seru: AML is anti-money laundering. So we wanna make sure that all the reasonable actors are transacting the money that is getting transacted in the banking system. Similarly with stablecoins, when the tokens are gonna be taken, one of the things you wanna make sure is that this is not gonna be used by bad actors. So who is going to do that auditing? How are we gonna make sure that when different platforms, how are we gonna make sure that the AML and KYC are consistently followed by everyone and bad actors are not going to just find ways and loopholes to jump from one to the other while still doing nefarious stuff? So that's going to be the second thing. The third thing is gonna be there is always fragility in the banking space because money, tokens at the end of the day is all about trust, and trust is built around institutions. If enough people lose trust, you still have to make sure that because it's called a stablecoin, that means its value is stable, that when someone lines up and wants to get their token back, and a lot of people do because they have, let's say, lost trust in the system, how are we gonna make sure that things are gonna be provided to them in an orderly fashion?

Neale Mahoney: The scaffolding that supports our financial system can collapse in an instant. At a campus cafe, Amit and I reflect on the institutions that keep it standing. That money or stablecoins are fragile. You know, there's this phrase in marketing, brands take a decade to build and can be lost in a day. And I can imagine the same thing being true about financial systems, that they...

Amit Seru: Yeah, so I think fragility is inherent in the design of many, many institutions like banks. It's also true in things like stablecoins. Things can evaporate very quickly. As economists, as you know, we talk a lot about run and what leads to that kind of equilibrium where a bunch of us decide that the value of the contract is not what we thought it is. So in the case of money, we don't think it's what it is worth. As a depositor in a bank, we don't think that the bank is gonna pay us back, and then all of us line up to redeem, to get back our deposits, for example. And if a lot of us do that, these systems inherently are fragile. They are delivering a value but there is fragility associated with it. And the fragility means you have to, again, rely on institutions to make sure things happen in a reasonably calm, stable way.

Neale Mahoney: So, you know, for conventional banks, the FDIC provides insurance, right? Banks have to pay some fees. In exchange, then the FDIC steps in and insures deposits. For stablecoin, there, you know, is gonna be some auditing, but, you know, it may not be as frequent, as rigorous as some people would like. What happens if there's a bank run and there weren't the assets there?

Amit Seru: Yeah, so, if there's a bank run and there are no assets, there is no backstop, right? So at least right now there is no backstop and because it's just the private sector providing this, you are basically relying on the trust of the code to somehow make this magic happen. And what history has taught us is that during a bank run, having an institution with credibility which is monitoring is very useful to prevent many of these runs, because when runs happen there are a lot of inefficiencies created and you don't want that. So if stablecoins become big and you see a lot of investments from households and so on, you can imagine that when lots of people are gonna be in pain, as in they want their token back in terms of dollars, let's say, and there is none available, that the government will have to step in. So this is a very stealth way of saying that there is no insurance, but ultimately, if this becomes big and have a lot of households who are on the hook, that the government will have to step in. So, it's a very roundabout way of providing backstop while saying there is no backstop and private sector is going to be running the show. So that's a problem.

Neale Mahoney: There is a risk of sort of the heads we win, tails, you know, you lose sort of feature of these new stablecoins, narrow banks.

Amit Seru: Absolutely, and there is one more thing where, again, institutions play a key role, which is failures do happen even with the best intentions of FDIC and them monitoring and other regulators monitoring, we have seen runs. When runs happen, you still wanna make sure that the bank is liquidated in an orderly fashion and whoever is in the sequence of getting the money back gets the money back in a sensible way. Who does that? Again, a credible institution. In the case of stablecoins, there is no exact clarity on how this will happen. So, if you take your stablecoin and then use that coin to do transactions across different platforms, how are we gonna make sure that all of these platforms are gonna have the same kind of rules when we have got to liquidate these things? It's very difficult to synchronize this and that's why when you think about a public institution providing stablecoin, these issues of interoperability, as they're called, don't exist because it's one institution providing all of these features.

Neale Mahoney: So the US has benefited hugely sort of in the post-war era, so for almost a century, from the dollar, which is, you know, a government currency. We are now potentially moving to a world where the private sector is going to be intermediating transactions, gonna be providing the source of payments. Are we going to be eroding our financial power in doing that, or are we leaning into innovation, which has always been a core of America's success so we can lead in the 21st century?

Amit Seru: A bit of both because I think there is innovation in this technology space, having a 24/7 system, having a system which allows us to operate across jurisdictions with very less fees is a good thing. We want that. What you are getting at is we are gonna create a system where we are gonna lean on the private sector providing a lot of these things, which is where the wrinkle comes in. So, on the one hand, the GENIUS Act is great for dollar because all of the stablecoins ultimately are supposed to be issued in dollar. So that's good because it creates demand for dollar. Like you said, after the World War, dollar has been a dominant currency. It's benefited US households, it has benefited US firms because we are able to borrow cheaply effectively relative to any other country in the world. And the GENIUS Act has basically laid out the rules that if any company wants to start a stablecoin, the reserves have to be in dollars, the liquid securities have to be in dollars. So that's gonna jump up.

Neale Mahoney: Why not just a digital dollar, you know, a central bank digital currency? Why... Why are we turning our back on sort of a system that's worked so well, which is having sort of fiat money provided by the government, and, you know, moving towards sort of a fractured system with the regulatory risks?

Amit Seru: Yeah, so that's exactly the downside to this, which is we are now moving to a system where, sure, the demand for dollars goes up. We are giving the illusion that this is a stablecoin backed by dollar. So effectively, everybody thinks this is the dollar. But we are giving the execution of all of this to the private sector which has no backstop, which has no way of making sure that the rule of law is implemented in a consistent manner. Like you said, we have over the many centuries figured out that there is a technology which does trust at scale, it's called the government, and we have institutions and rule of law which back credibility around what the government does. We have decided not to do that. And once you decide not to do it, any problems that are gonna happen in stablecoins, and we talked about many that are possible, are going to actually reflect poorly on the US dollar because everybody associates stablecoins with dollars. And what does that do? Well, that basically creates a dent in people's mind on how really valuable is holding your money in dollars, which for a long time, since the Second World War, has been a great advantage for us.

Neale Mahoney: So tell me if I'm getting this right. Stablecoin has, you know, the benefits of a quick and cheap financial intermediation, but it has some risks. One is money laundering and other bad actors. The second is, you know, there will be incentives to not have as many or as liquid assets to back it up because that's how you make money. And, you know, the question becomes, are the benefits higher than the costs? And is there a way to get a benefit, these benefits, without all of those costs? And maybe a digital dollar provides a better path to that. But it seems like we have chosen the GENIUS Act or what we might call, I realize we're not in marketing, sort of the digital narrow banking regulation act.

Amit Seru: Yeah, I think you summarized it exactly right. Also, the one thing which you didn't mention is, again, what we discussed earlier, is that there's no backstop. So the fragility in the system which requires backstop and when failures happen, the orderly resolution, interoperability across different chains, is something that we know is gonna be important. National banking era tells us that when banks fail, interoperability across jurisdictions matters. And we have decided to let go of all of that when we have decided to delegate it to the private sector. And, you know, that's a mistake, in my view.

Neale Mahoney: Amit's walked us through the trade-offs here, but there's something deeper underneath it all. Sitting outside, he puts words to what money really is and why trust sits at the center of it.

Amit Seru: Money is a social contract. People think it just comes and goes and anybody can produce it. And you see these debates everywhere, right? Like right now, is dollar going to be dominant? No, you're gonna have euro and you're gonna have Chinese yuan replace it because money is money. And I think that's a big mistake that people make. And you see this also in the whole debate around stablecoins, for example.

Neale Mahoney: It's super fascinating, right? 'Cause like I have young kids, they think about money as having inherent value, right? Like here's a coin, here's a $5 bill. And your point is like the value of that rests on so many things in society. It's in fact a window into culture, into institutions, into legal systems, into geopolitics. It's a fascinating way to think about money. So, we've spoken about the role of trust here and, you know, I think ultimately whether something is trustworthy or not will be determined by the American consumer. How do Americans feel about stablecoins, about digital dollar right now? How do you see this trust progressing?

Amit Seru: I think one of the things that we've discovered in the conversation is there is a lot of technical elements behind this. So, when the conversation is kept at a very big picture level, it boils down to broad phrases. So, one way in which the American public understands this is that look, if the government comes in and does digital currency, there is gonna be surveillance on our wallet, and that's a problem. So that's the level at which Americans understand it. And now if you tell them that instead of the private sector does it, there's gonna be no surveillance and it's all gonna be good, they think it's fine, you know, like this is an innovation, what's the problem? They don't understand the fragility, they don't understand that the private sector also does a lot of surveillance. I mean, this is basically what all social media is. And in fact, you cannot provide guardrails around that. You can provide a lot of guardrails to the government itself, which is what a lot of our peer countries are doing, that when the public infrastructure is being created, there is privacy guardrails which ensure that the government doesn't get to see what individuals do but the public infrastructure is in place. So, to your point, American households, I think, think about this as a debate where we are giving them a lot of choice, they don't see a downside, and they think that the public option is actually problematic because there's gonna be surveillance, which actually is false.

Neale Mahoney: I think a sort of meta-point is this debate right now lives at the level of soundbites, and sort of deepening the debate so we can think about all of the strengths and weaknesses of different options for digital currency is hugely needed. And something that's come through for all of this is there's also a huge public interest in the United States having a strong payment system and a strong currency for our economic security, even for our geopolitical power. And so, making sure that those voices are also heard is very important in getting us to a right landing point which allows for innovation but doesn't generate too much fragility and too much risk.

Amit Seru: Yeah, and look, I think we talked about it earlier that innovation in the financial sector is strange, that many times it doesn't happen because a lot of incumbents just don't have the incentive to do it. So, if you look at US' payment system, it's actually lagging behind a lot of the parts of the world, and including countries like India and Brazil and so on, which innovated a lot. So, when you look at their payment systems, you think that, okay, we should be doing much better. And one of the strikes against the banking sector is that, well, you're not innovating, you're lazy, and private sector can do a lot of innovation. You are regulated, you can't do innovation, we can do sensible and safe innovation. And that's where the debate is. And you can see why in the public domain people think that there is some credible information here in terms of doing more innovation versus less because historically we have lagged behind in the payment space for sure.

Neale Mahoney: So, some people argue that regulation in banking stifles innovation. What do you say to that?

Amit Seru: I think there is a reasonable argument to be made that we regulated the banking space pretty heavily. Part of it comes as a legacy of the global financial crisis where we saw a wave of deregulation, we saw a lot of financial innovation in terms of derivative securities and other mortgage-backed securities and so on. But when that didn't exactly pan out the way we thought it would, with leading to a recession and so on, there was a lot of tightening of regulation. That's a typical cycle. And when that happens, it's true that innovation evaporates because we then put strong guardrails. And the right response has to be that we test those guardrails, that can we broadened as innovation coming in. And so the push and pull that happens between the private sector, like it's happening right now, and the regulated banking sector is actually a good thing. What we need to do is to somehow embrace the innovation without introducing unnecessary fragility, because there are a lot of lessons about fragility which we already know and we don't wanna repeat them. Lots of countries are trying to do it, like Singapore, for example, allows the private sector to test out innovation within the sandbox that is created where banks also cooperate with them. So you test out at a small scale, you see what works, you tweak it around, you experiment, and then when it works, you let it fly. That's the kind of thing we need more in the US, I think, rather than just this discreet let the bank do it, let the private sector do it. That just seems like not the right place to be.

Neale Mahoney: At the end of the day, money has to be backed by institutions, by trust. You can have layers of coin or layers of code, but if there isn't some trust, some institutions backing it, then there's underlying fragility.

Amit Seru: Absolutely, you can't outsource the trust to code. Trust has to remain with institutions, especially if you want to do it at scale.

Neale Mahoney: If you're a listener and you're thinking about using stablecoin in your own life, what advice do you have for them?

Amit Seru: I would say, buyers beware. Because there is gonna be some time before these coins are gonna be actually stable because of all the things that we have discussed, so even though the name sounds very safe, as in it's stable and a coin, so why wouldn't you want that? Actually it's anything but stable right now for various reasons. So let the wrinkles get sorted out and then maybe think about investing in it.

Neale Mahoney: So, I recently finished reading "1929" by Andrew Ross Sorkin, which I think is sort of a sobering reminder of history. You know, you are writing op-eds in the FT, the New York Times, the Wall Street Journal, reminding people of these trade-offs, teaching people the lessons of research and of history on how to find that middle path. And so, if there are voices that are gonna help us manage innovation without minimizing the outside risk, I think, you know, you're one of those leading voices, and so, really happy to have you here with us.

Amit Seru: The great thing about SIEPR, and Stanford in general, is that there are lots of people like us who are trying to do this, and hopefully someone will hear that history repeats itself, so let's try at least not to make the same mistakes.

Neale Mahoney: In the world of stablecoins, the only true constant is change. Financial innovation promises speed, efficiency, and access, but those benefits come hand in hand with risk. Trust, it turns out, isn't just a feature of our system. It's the foundation. A big thank you to Amit for this conversation and to all of you for listening. I'm Neale Mahoney and "Econ to Go" is where Stanford Economics meets your everyday lives. If you enjoyed this episode, follow or subscribe wherever you get your podcast. We've got more smart, curious conversations coming your way from the Stanford University campus.