Kansas City Fed explores cost of stablecoin insurance

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Last week, the Kansas City Federal Reserve published an article exploring the potential cost of stablecoin insurance, which was found to be considerably higher than bank deposit insurance. It showed the average annual cost of insurance across four un-named stablecoins was 3.2% per year since 2019. However, for the last year the cost would have been under 1% or 100 basis points. This contrasts with FDIC insurance on banks of between 2.5 to 42 basis points. Our observation is that this level of insurance is affordable for stablecoin issuers.

In other words, the average four-year stablecoin insurance cost is almost eight times the most expensive bank deposit insurance. However, the cost has dropped considerably. So, over the past year it would have been closer to two times the most expensive FDIC insurance.

The authors employed option pricing for the calculations. For banks the three inputs are their assets, liabilities and the volatility of their assets. They used similar equivalents for stablecoins.

Stablecoin prices and the total issuance are far more volatile than those of banks. This is partly offset by the stablecoin reserves mainly comprising highly liquid, low volatility assets in the form of short dated Treasuries.

The biggest risk factor is the small capital buffers held by stablecoin issuers. The four issuers held between zero and six percent buffers averaging 0.9%. That compares with 9.5% for banks. The downward trend in the cost of insurance is partly due to higher stablecoin capital buffers and partly because they’re less volatile.

Our observations

A key goal was to understand the cost-benefit of the process. The authors didn’t draw this conclusion, but we’d observe that the cost of insurance would be easily covered by interest on the stablecoin reserves. We’d also note that one of the challenges with stablecoin insurance is there tends to be one or two very large stablecoins. So, if stablecoins had private sector insurance and one of them collapsed, that could impact the insurance providers. That’s not dissimilar to AIG, which lost almost $100 billion in the 2008 crisis and needed an $85 billion loan from the New York Fed to stay afloat.

Image Copyright: Flynt / Dreamstime, Composite LEDGER Insights

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