Stablecoins and Regulatory Arbitrage

What are the *real* advantages of a blockchain?

Imagine you’re the CEO of America’s largest bank and a lawyer walks into your office and says: 

“Hi boss, I found some legal loopholes with which the bank can offer an incredible new type of account. It’s crazy! Clients don’t need ANY documents or ID to open it – literally none at all. If they’re a business, they don’t need financial statements or legal papers or tax returns. They don’t need to tell us if they have five or 5,000 employees, if they’re selling groceries, marijuana, gambling or anything else. They can be incorporated in America or elsewhere or not incorporated at all; it doesn’t matter. We don’t ask for a single document in the opening process, not even for the name of the company!” 

You open your eyes wide, in disbelief, and gesture to the lawyer to continue.

“If the client is an individual, they can be a foreigner or a US resident. They don’t need a social security number or a passport or bills to prove a home address or a credit history; they certainly don’t have to show up in person at a branch or speak to anyone on the phone or even have a phone number! They don’t need to be screened for risk, checked against sanctions lists or if they’re related to politicians or government officials. All any new client needs to do is click a couple of buttons on the internet and the account is approved and opened instantly – from any IP address anywhere in the world.”

This all sounds absurd, but you might as well hear the lawyer out before firing them.

“It gets better, believe me! The bank doesn’t need to do any compliance checks when these accounts send or receive money, not for a $1 transfer and not for a $100 million transfer. We won’t have to file suspicious activity reports with the regulator if anything looks fishy, we won’t have to do investigations, hire investigators or “cover our asses” by freezing accounts and asking annoying questions to customers to double check everything. We won’t even have to do basic lookups against blacklists or have any compliance teams. No interactions with customers, no email, no phone calls, no paperwork or explanations EVER. All transfer and payment requests are just approved instantly and automatically, 100% of the time.”

“Right, right” you reply, wondering whether someone spiked your coffee with hallucinogens.

“Look, with this new account, the bank won’t be liable for money laundering or terrorism financing or anything else - how could we? We won’t know who our clients are, where their money comes from or what they’re doing with it. It could all be legitimate but there could also be criminals selling nukes or trafficking humans. Thanks to the legal loophole, the bank doesn’t know and it's not the bank’s problem!”

You shake your head in disbelief. This can’t be real. 

“Imagine all the new business we could get! We can bank all the mismanaged countries in the world with monetary instability – anywhere in the world where people prefer dollars over their own local currency. That’s about all of Argentina, Venezuela, Lebanon, Zimbabwe and Nigeria. That’s like most of Turkey and Iran. Literally any person or business in the world that wants a US dollar bank account but can’t get one, we can now serve. It’s an untapped market in the hundreds of billions or trillions of dollars! And by the way, we pay ZERO interest on all these deposits.”

---

This scene is obviously fiction, but I wrote it to set up important points. My points aren’t about the fake bank account but about a very real thing, stablecoins, which are tokens on blockchains (like USDC) that are linked 1:1 to a currency (like the US dollar) and are usually backed with government debt.

The first point is this:

In many important respects, stablecoins are identical to the fictional bank account I just described¹. How so?

Well firstly, wallets on public blockchains (like Ethereum or Solana) don’t require any documentation to open and don’t perform any identity, anti-money-laundering, sanctions or other checks when they’re created. Remember, this is the main selling point of blockchains, that they are “censorship resistant” and “permissionless.” Secondly, funding these wallets with USD stablecoins doesn’t require ID or checks either, as stablecoins can be purchased on decentralized exchanges (like Uniswap) for bitcoin or ethereum or on peer-to-peer markets for local currency anonymously or pseudonymously. Lastly, all transaction requests are approved automatically without ANY anti money-laundering or compliance checks because of how public blockchains work. 

Stablecoins are different to bank deposits in other respects that aren’t as important but are worth mentioning. They largely haven’t been integrated into many payment networks and aren’t as useful for buying coffee or shopping online - not yet at least. Stablecoins are also backed by government debt, whereas bank deposits are backed by the bank’s assets, deposit insurance and the implicit or explicit promise of a bailout. Lastly, banks control the private databases where deposits are tracked and recorded, and no one really controls the public blockchain database where stablecoins are recorded.

In any case, stablecoins and bank deposits are substantially similar forms of electronic money, but stablecoin issuers are held to a dramatically lower standard of compliance and face dramatically lower compliance costs than banks.

The second point is this: 

There are lots of mismanaged countries where it’s best to avoid the local currency like Argentina, Venezuela, Iran, Lebanon, and Nigeria (etc). In these places, ordinary folk are always looking for alternatives to the local currency, which is constantly taxed via inflation. Sometimes that’s investing in local real estate, local stocks or cars; sometimes it’s buying US dollars cash; sometimes it’s funding local “US dollar” accounts in local banks that always risk being expropriated or forcibly converted to local currency.

If ordinary Argentines, Venezuelans or Nigerians could access a “real” US dollar account at an American bank under their own name, they would, but they can’t. It’s not because US banks are mean or racist but because it’s bad business to open up accounts for ordinary folk in these countries.

It just isn’t profitable to take deposits from people in the developing world who are much less wealthy than Americans and have much less standardized and legible documentation. The substantial added compliance costs and risks that 99.9% people in these countries represent just aren’t worth the meager revenue and potential problems with regulators for compliance failures (big fines or worse). Compliance costs and risks make serving ordinary folk from mismanaged economies a money-losing proposition.

In the last few years, USDT and USDC ballooned to 150 billion dollars outstanding, achieving notable product-market fit in these same countries that crave inflation-resistant assets. Proponents attribute this adoption to the technological superiority of blockchains.

This argument is laughable though. What actually explains the success of stablecoins in places with monetary dysfunction is not some innovation in database architecture. It’s the loophole in the global compliance framework that allows Tether (USDT) and Circle (USDC) to ignore the rules and regulations that apply to the rest of the financial industry. 

Stablecoin issuers are not currently subject to any of the costly know-your-customer, anti money-laundering and other compliance checks that all other financial institutions face, so their economics are infinitely better². Stablecoin issuers have zero costs (compliance or otherwise), so they can bank everyone in the developing world that would be too poor and risky for a US bank, hence their growing market share in Argentina, Venezuela, etc.  

This textbook regulatory arbitrage. Stablecoins’ edge is not technological; it’s that they don’t care if anyone is laundering money or financing terrorists and don’t spend a single cent to find out . 

My third point is this: 

Inconvenient and burdensome as it can be, the global regulatory and compliance apparatus exists for a reason. Know your customer and anti money-laundering checks have been created in a coordinated attempt to exclude criminals, terrorists and bad actors from the financial system. Either everybody plays by these rules, or no one does. An in-between world with arbitrary exemptions doesn’t make sense. 

As a matter of principle, regulation should ensure fair competition between different forms of electronic money. Issuers of digital dollars should not be able to opt-out of the global compliance framework and pay dramatically lower compliance costs just because they are “on a blockchain.” 

It’s not complicated. Stablecoins should be held to the same standards as other forms of electronic money. Holding Tether (USDT) and Circle (USDC) to lower standards because of differences in database technology is both anti-competitive and incoherent.

1. To spell out the analogy explicitly, stablecoins are bank deposits, stablecoin issuers are banks, and wallets are bank accounts. 

2. Occasionally, national authorities instruct Tether, Circle and other stablecoin issuers to freeze certain accounts. Complying with these instructions is virtually costless.