The explosion in stablecoins revives a debate around “free banking”

THE FAST-MOVING frontier of financial innovation can seem an intimidating place. Concepts such as decentralisation, distributed ledgers and symmetric encryption can befuddle the outsider. Scholars and regulators may therefore have been relieved to spot parallels between the burgeoning world of stablecoins—digital tokens that are pegged to an existing currency or commodity—and America’s free-banking 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 USD coin, 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 deposits 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 collapsing. 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 issued 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 particular, as a cautionary tale. Gary Gensler, the chairman of the Securities 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 clear-cut, however.

The lack of a national currency before 1863 created obvious economic inefficiencies. Dollars issued by unfamiliar banks a long way from home traded at a discount, due to the lack of information 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 arrangement led to the appearance of scam artists like Andrew Dexter, who bought up banks across north-eastern America and issued huge volumes of fraudulent notes. One bank was found to have issued around $580,000—around $13m in today’s money—while holding all of $86.48 in precious-metal specie. In another case in 1838, state officials in Michigan found that the boxes which should have contained the coins for which depositors could redeem 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 statement saying that “There is no finding that Tether tokens were not fully…