The Bank Policy Institute (BPI), a think tank supported by banks, recently published a blog post raising concerns that a proportion of the USDC stablecoin reserves could be parked at the Federal Reserve, despite the stablecoin issuer not having a central bank account.
This could potentially result in bank runs diverting cash into the USDC stablecoin in times of uncertainty, as it might be perceived as being as good as a central bank digital currency (CBDC).
BlackRock and the Circle Reserve Fund
Since November, BlackRock has been managing a large portion of the reserve assets of the USDC stablecoin on behalf of the stablecoin issuer, Circle.
To do this, BlackRock created the Circle Reserve Fund, a bespoke money market fund that invests in U.S. short-dated Treasuries and currently manages around two thirds of the assets of the $44 billion stablecoin, which keeps 80% of its reserves in Treasuries.
Using the Federal Reserve’s Reverse Repo Facility
A December research note from Barclays highlighted that money market funds like the Circle Reserve Fund can apply to use the Federal Reserve’s reverse repo (RRP) facility.
This involves the fund buying Treasuries from the Federal Reserve, which are then resold to the Fed at a future date at a slightly higher price. The net effect of the cash flows is similar to depositing the USDC reserve cash at the Federal Reserve, which the BPI has called a “backdoor CBDC”.
According to the BPI, BlackRock has applied for the RRP facility and has suggested that 20% of USDC reserves currently held at banks could be shifted to the RRP program. A Circle spokesperson stated that “in time, we expect that the Circle Reserve Fund will apply for access to the Fed’s RRP program.
If access is received, we would have the option to move USDC cash reserves inside the fund and into the RRP program. We would also continue to maintain a portion of our cash reserves inside the regulated U.S. Banking system.”
Benefits of the RRP versus a Synthetic CBDC
Using the RRP route may be a better option than a synthetic CBDC, which involves a digital currency that is backed by a stablecoin issuer’s cash held at the central bank. While a synthetic CBDC reduces counterparty risk by eliminating bank risk, the account still belongs to a private entity which means there is still some risk. On the other hand, the counterparty of the RRP is the Federal Reserve itself.
BlackRock’s Investment in Circle and the Use of USDC for Capital Market Transactions
In April, BlackRock invested in Circle as part of a $400 million funding round. At the time, the asset manager said it was interested in using USDC for capital market transactions. However, stablecoins are not typically considered risk-free settlement assets. Using the RRP would significantly improve USDC’s risk profile.
Generally, there is a strong preference for using central bank money for securities transactions. Finally, a project backed by 17 global institutions, is effectively creating a synthetic CBDC designed for capital market transactions. While some bankers not involved in the project see this as a good interim step, they would still prefer to use a CBDC.
Why the Federal Reserve Might Refuse RRP Access to the Circle Reserve Fund
There are several reasons why the Federal Reserve might refuse RRP access to the Circle Reserve Fund. For one, the fund would be able to apply before November 2023. Compliance could also be a major hurdle for the fund, as the RRP application form asks about the proportion of shareholders in high-risk sectors from an anti-money laundering (AML) perspective.
As Circle is the sole shareholder and is involved in the cryptocurrency and decentralized finance (DeFi) sectors, this would be 100%. The BPI, which argues that the RRP was originally intended to be a temporary tool introduced in 2013, wants the spread between the interest rates on reserve balances and the overnight RRP rate to be increased from the current 10 basis points (0.1%) to its previous level of 25 basis points.
In a statement, the BPI said, “The Fed should not only deny Circle’s money fund access to the ON RRP facility, but it should also take steps to hasten the winding down of the facility as an attractive nuisance.”
