78 Finance & economics The Economist December 4th 2021
Tamingwildcats
T
he fast-movingfrontier of financial innovation can seem an
intimidating place. Concepts such as decentralisation, distri
buted ledgers and symmetric encryption can befuddle the outsid
er. Scholars and regulators may therefore have been relieved to
spot parallels between the burgeoning world of stablecoins—digi
tal tokens that are pegged to an existing currency or commodity—
and America’s freebanking era of the 19th century. Indeed, recent
discussions about stablecoins have sparked a lively debate around
the history of privately issued money.
Together the dozens of stablecoins in existence, which include
Dai, Tether and usdcoin, have a market capitalisation of close to
$150bn. As they have exploded in value, their similarity to banks
has begun to exercise regulators. Like banks, they in effect take de
posits and promise immediate redemption; if many holders want
to withdraw their money at the same time, and the issuer holds
risky assets, then the digital coins could be in danger of collaps
ing. On November 30th Janet Yellen, America’s treasury secretary,
said that the tokens presented “significant risks” and pressed for
more regulation.
Before America instituted a national currency in 1863, banks is
sued their own banknotes, backed by assets and redeemable for
gold or silver. Critics of stablecoins often point to this period of
free banking, and the example of unstable “wildcat” banks in par
ticular, as a cautionary tale. Gary Gensler, the chairman of the Se
curities and Exchange Commission, America’s main markets
watchdog, and Elizabeth Warren, a Democratic senator, have both
compared stablecoins to wildcats, as has a recent paper by Gary
Gorton of Yale University and Jeffery Zhang of the Federal Reserve.
The comparison is not so clearcut, however.
The lack of a national currency before 1863 created obvious eco
nomic inefficiencies. Dollars issued by unfamiliar banks a long
way from home traded at a discount, due to the lack of informa
tion about the financial health of their issuers. For the issuing
bank, having notes circulate far away was an advantage, since the
holders were very unlikely to turn up to redeem them. This ar
rangement led to the appearance of scam artists like Andrew Dex
ter, who bought up banks across northeastern America and is
sued huge volumes of fraudulent notes. One bank was found tohaveissued around $580,000—around $13m in today’s money—
while holding all of $86.48 in preciousmetal specie. In another
case in 1838, state officials in Michigan found that the boxes which
should have contained the coins for which depositors could re
deem their notes were bulked up with lead and broken glass.
Critics argue that the comparisons with stablecoins are clear.
Tether, the largest single stablecoin issuer, with $74bn in tokens in
circulation, was fined $41m by the Commodity Futures Trading
Commission in October for misrepresenting itself as fully backed
by assets between 2016 and 2019. (Tether responded with a state
ment saying that “There is no finding that Tether tokens were not
fully backed at all times—simply that the reserves were not all in
cash and all in a bank account titled in Tether’s name, at all times,”
and that it had never failed to satisfy redemption requests.)
Yet there are also differences between stablecoins and the priv
ate money of antebellum America. Back then, anyone who needed
banking services or currency had to place their financial fate in the
hands of opaque and risky institutions. By contrast, no one in the
rich world is obliged to hold stablecoins; safer alternatives, such
as insured bank deposits and cash, are readily available.
Nor is it clear that wildcat banks are the summation of all his
torical experience of privately issued money. George Selgin of the
Cato Institute, a libertarian thinktank, has likened the use of
wildcat banking by critics of privatemoney issuance to the use of
Germany’s interwar hyperinflation by critics of centralbank
money issuance: both are extreme and negative examples, rather
than representative. Scotland’s freebanking system between 1716
and 1844, for instance, is often cited as a period of stability. Three
large banks and several smaller lenders all issued currency and re
deemed each other’s notes at their full value.
Furthermore, at least some of the problems with American free
banking may have reflected poor regulation rather than a total ab
sence of it. Banks were often not allowed to have networks of
branches and interstate banking was nearimpossible, which lim
ited the expansion of successful and trusted institutions. Many
were also made to hold volatile state bonds as collateral. Slumps in
the value of these could—and did—spark local banking crises. Policing the frontier
History alone, littered as it is with both scam artists from 19thcen
tury America and upstanding financiers from Georgianera Scot
land, cannot settle the question of how dangerous stablecoins are.
But perhaps one lessappreciated lesson from American free
banking is that, if innovation is not to be smothered, the quality of
regulation matters. A report published by America’s President’s
Working Group on Financial Markets last month recommended
treating stablecoin issuers like deposittaking institutions. Pro
viders say that this degree of supervision is stifling. Such regula
tion would offer them a prize, however: accounts at the Federal Re
serve, which would allow them to settle payments directly, rather
than piggybacking on commercial banks.
One idea, detailed by Messrs Gorton and Zhang and supported
by Mr Selgin and Dan Awrey of Cornell University, would be to
make reserve accounts easily available to any stablecoin provider,
on the condition that they hold all their assets in such an account.
That would mean that the coin is fully backed with the safest pos
sible asset: centralbank reserves that carry no risks in terms of li
quidity, maturity or credit. Scholarsmaybedivided over whether
too much or too little regulation ledtothewildcats’ demise. But
stablecoins could still avoid their fate.nFree exchange
The explosion in stablecoins revives a debate around “free banking”