How Circle could create a U.S.-backed digital currency

Crypto giant Circle has announced its intention to become a bank, fully regulated by the Federal Reserve, the Office of the Comptroller of the Currency and the FDIC.

Why it matters: We're still a very long way from this happening. But if it does, Circle's USDC stablecoin could become a de facto central bank digital currency.

How it works: Circle's dream is to become a narrow bank — one that eschews fractional-reserve banking entirely, and instead places all deposits on reserve at the central bank.

• Only banks can open accounts directly at the central bank, which credits them with pure money.
• In Circle's case, the "depositors" would be holders of USDC, and the collateral backing up USDC would be the money on deposit at the Fed. Circle would pocket for itself the interest that the Fed pays on bank reserves.

The big picture: If the dream were to become reality, then Circle would effectively be issuing a cryptocurrency backed by the Fed itself — for all intents and purposes, a central bank digital currency, or CBDC.

• If Circle was allowed to do such a thing, then presumably other banks would be, too, and they would rapidly start competing with each other to pass through most or all of the interest that the Fed pays on reserves.
• Buying those stablecoins would be tantamount to having money on deposit directly at the Fed.

Between the lines: A would-be bank called TNB has tried to do narrow banking in the U.S. and has gotten nowhere. The Fed doesn't like the idea, for reasons well-glossed by Bloomberg's Matt Levine in 2019.

• Fractional-reserve banking is the engine that powers money creation and even modern capitalism. Full-reserve banking risks messing with that model in a way that could prove dangerous.

Be smart: Circle chief strategy officer Dante Disparte tells Axios that the company hasn't yet even properly initiated the process of applying to become a bank; it's just announced its intention to do so. Disparte says they're willing to do "whatever the policymakers want."

• That might mean giving up on the dream of having 100% of assets in the form of Fed reserves — even though that's something all other banks are allowed to do.

The bottom line: Most assets at most banks are loans that can, in theory, default. That's also true of Circle's assets, right now — they're mostly commercial paper and other low-risk loans.

• Moving to a no-risk system would create a back-door CBDC. It seems unlikely the Fed would let that happen without being extremely deliberate about it.

Go deeper: Central banks are headed toward digital currencies