Stablecoin and the Fed Balance Sheet

2025 11 30

While I have been distracted by climate change policy sparked by the recent COP 30 meetings in Belem -- notwithstanding that nothing much happened there, certainly not with respect to climate change policy-- people have been Saying Things in the Internet about monetary policy. This naturally calls for my commenting.

David Beckworth in, Barbarians at the Fed’s Gate is worried about the effect of Stablecoin on the size of the Fed balance sheet? This is a counterintuitive way of raising the issue of whether Stablecoin could displace US currency for payment transactions, thereby cutting into the Fed’s seigniorage [1]. Here is Beckworth’s blow by blow of how this happens:

Consider first the case where people exchange cash for stablecoins backed by reserves, ON RRP balances, or Treasury securities. Suppose, for example, that I deposit $1,000 in cash at my bank, which returns the currency to the Fed. Currency in circulation falls by $1,000 while reserves rise by $1,000, leaving the size of the Fed’s balance sheet unchanged. I then use my new bank deposit to purchase a stablecoin, transferring reserves from my bank to the stablecoin’s bank—again, no change in total Fed assets or liabilities. Finally, the stablecoin issuer uses those reserves to purchase a Treasury bill in the secondary market, shifting reserves among banks but not altering the Fed’s overall balance sheet size. In short, the total size of the Fed’s balance sheet remains constant, but its composition shifts from currency to reserves

The shift from currency to reserves does reduce the Fed’s income, its seigniorage, but this happens when chose to hold stable coin balances (or physical tokens?) instead of currency for payments. It’s hard to see how as US currency is not much used for payments transactions and a Stablecoin token less so.

This is not the same as the possibility of stablecoin issuing institutions [SIIs] with access to “skinny reserve” accounts with the Fed making international payments more cost effectively than banks. This economic/technical prospect would be completion for one line of banks’ business. It would have no effect on the Fed as the stablecoin working balances that international payers would need to maintain with SIIs would create the same demand for reserves with the Fed as dollar working balances with banks. The no-effect equivalence would remain even if the Fed reverted to the policy of not paying interest on reserves.

Beckworth cites the experience of the Swedish Riksbank whose interest income has declined as demand for physical currency has been displaced _by digital payments_ but this is irrelevant for displacement of US currency by Stablecoin and this brings us to a second issue.

Demand for US currency does not come from its use as a means of ordinary payment. The bulk of US currency outstanding is one-hundred-dollar bills. Please raise your hand if you have a hundred-dollar bill in your wallet. You probably don’t know anyone who does. They are held mainly outside the us as a store of value and for irregular if not always illegal transactions.[2] Of course for big-time illegal transactions you have crypto but it’s of no use for storing value.

Then Beckworth turns to the size of the Fed’s balance sheet per se.

Case 1 Stablecoins Replace Currency

The shift from US currency to Stablecoin already considered with zero balance sheet effect was already considered.

Case 2 Stablecoins Replace Bank Deposits

This considers a possible shift from transactors wanting to hold balances with SII’s (with access to skinny reserve accounts [3] instead of with banks. This would in effect create a new class of banks, similar in concept to the “narrow bank” John Cochrane champions.[4] Here too Beckworth recognizes that the direct substitution would not affect the Fed’s balance sheet. It could be the case if

“… banks lose deposit funding—especially from large, uninsured balances above the $250,000 FDIC limit—the Fed may need to step in to offset disintermediation pressures, which would raise total reserves and expand the overall balance sheet.

Beckworth does not suggest, however, any reason that people would wish to make the shift unless the SIIs turn out to make international payments more cost effectively than banks. Even that, however, would be a narrow slice of bank deposits potentially subject to shift from this motive. Moreover, the “need” to offset disintermediation, if any, would be subject to the Fed’s inflation targeting, not undertaken lightly.

Case 3 Stablecoin Creates Net New Demand for Fed Liabilities

This is the crux of the argument

Now consider the case where domestic nonbank investors or foreign users outside the U.S. banking system acquire dollar stablecoins to access the dollar payment network. In this case, Stablecoin growth channels new demand into dollar-denominated safe assets, increasing the global appetite for Fed liabilities. The Fed’s balance sheet must expand to accommodate this demand if the private markets cannot fully absorb the inflows. The effect is amplified if stablecoin issuers have direct Fed access through skinny master accounts, since each new dollar of stablecoin issuance corresponds directly to a new Fed liability. In that world, the growth of stablecoins would translate mechanically into a larger Fed balance sheet, placing the central bank even closer to the center of global dollar intermediation

Note, however, what is going on. By assumption the dollar, already the world’s premier vehicle for international transactions, becomes, through SII’s improved digital payments facilities, even more desirable as the unit of account for international payments. On the margin this would be good for US financial institutions, both SII’s and non-SII who themselves are already, as Beckworth notes, counter-innovating payments and would even create a bit more seigniorage and Fed income. It would not affect the “big business” of the US financial system, however, intermediating international lending and equity transactions, which would be unaffected by the extent to which stablecoin is used for payments. [See: The Dollar Privilege or Burden? ]

So far, no cause to worry. The crowd at the gate are not “barbarians” at all; they’re venture capitalists. 😊

But wait! There is “From Barbarians to the Menger Trilemma”

Throwing aside worrywart-ism, Beckworth summaries his thesis so far. Stablecoin development will create new demand for Fed liabilities through various channels:

First, in emerging economies where dollar access remains constrained, every new stablecoin minted represents fresh demand for Fed liabilities via the safe-asset collateral backing it.

Second, strict regulations on euro-based stablecoins and an underpowered euro CBDC have left a vacuum in Europe that dollar-based stablecoins are filling. Consequently, as Luis Garicano notes, Europe’s digital future looks increasingly like a dollar-dominated one. This too will increase demand for Fed liabilities.

Third, dollar stablecoins will likely amplify the dollar’s existing global network effects by embedding it more deeply into trade, remittances, and savings as more transactions go on-chain. A bigger global dollar system, in turn, means additional demand for Fed liabilities.

Beckworth then asks

If stablecoins mean greater demand for Fed liabilities, then what kind of balance sheet expansion might this entail?

It’s unclear that the effect on the Feds balance sheet is the most interesting question to ask. Why not the effect on monetary policy? Does increasing demand for Fed liabilities affect what the Fed targets (inflation or NGDP), the level of the target (2% or ?) or the difficulty of achieving the target?

Even less clear is how Beckworth. proposes to answer:

One view—rooted in the “safe asset shortage” narrative—sees the Fed’s balance sheet expanding to meet an excess demand for safe and liquid assets, with quantitative easing (QE) functioning as a kind of public intermediation service that supplies the safety that private markets cannot.

Where does _excess_ demand for “safe assets” come from? Beckworth argues the will be an increase in demand for Fed liabilities (which ARE safe), not an _excess_ demand. Excess demand arises when supply cannot increase and prices, interest rates, cannot adjust. But the Fed CAN increase its liabilities, can expand its balance sheet. This view seems to be addressing a financial panic or some other disequilibrium event having no necessary relation to Stablecoin’s possible impact on the Fed.

The other view—anchored in concerns about fiscal dominance—sees the Fed’s balance sheet growing in response to an excess supply of safe assets, as mounting public debt pressures the central bank to absorb and manage an expanding stock of treasuries.

Yes, that’s what would happen if federal deficits became large enough that the interest rate necessary to induce the private sector to hold public debt was worse for real income than allowing the concomitant extra-target inflation. Again, a balance sheet expansion having nothing to do with Stablecoin.

And somehow stablecoin is supposed to exacerbate a “trilemma” between dollar dominance (in international payments), financial stability (Fed success at fulfilling its inflation and employment mandate), and a small Fed balance sheet. [I refuse to try to figure out how Carl Menger’s moniker got roped into this.]

The desire for dollar dominance is understandable — lots of well-paid US bankers doing international-ish things — and that can contribute to a larger Fed balance sheet. And stability — low inflation with no recessions — is also desirable and in an economy with imperfectly downwardly flexible prices subject to shocks, may entail a large Fed balance sheet. But if dominance and stability are achieved, who should care what the size of the Fed’s balance sheet is?

Beckworth does not explain.[5]

Image Prompt: The “Fed” balancing a huge object labeled “Balance Sheet on one finger.

[Standard bleg: Although my style is know-it-all-ism, I do not really think that, knowing that I can be mistaken or overstate my points. I’m also aware of the amazing range of views and experiences among readers. Bring those to bear by commenting on these posts. Both other readers and I will benefit]

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[1] When the Fed issues paper currency that is a liability on its balance sheet that costs nothing, but the counterpart asset – a liability of the Federal Government -- earns a return generating an income flow for the Fed called “seigniorage.”

[2] In the Nigerian Naira/Dolar black markets I frequented back in the day, the preference was for US twenties. The rate for twenties was better than for smaller denominations. There may have been markets that traded in hundreds but not outside the Elephant Bar in Abuja.

[3] A ”skinny reserve account” “skinny master account” is a “conceptual type of account being explored by the Federal Reserve that would provide direct access to Fed payment services like Fedwire and FedNow, but with limited functionality compared to a traditional master account. These accounts would lack benefits such as interest on balances, overdraft privileges, and access to the discount window, and they would likely be subject to balance caps. The purpose is to give eligible, but potentially lower-risk, institutions direct access to payment “rails” more quickly and efficiently.”

[4] Here is a nice, firmly anti narrow bank, explanation of the differences.

[5] Scott Sumner also has reservations about these two Beckworth posts Here