By Byron Gilliam, Markets Strategist at Blockworks.
“The Eurodollar market is the latest example of the mystifying quality of money creation to even the most sophisticated bankers.”
— Milton Friedman
Are stablecoins tokenized Eurodollars?
I’ve asked a lot of people what a Eurodollar is and the two most common responses I get are “no idea” and blank stares.
(Yes, I am available for your next dinner party.)
The third most common response I get is that Eurodollars are “US dollars held in a non-US bank account.”
I’ve always found that confusing.
For starters, how did they get there?
If you send $1,000 from your Chase account to my Citi account (account number available upon request), Chase settles that transaction by moving $1,000 from their Fed master account to Citi’s Fed master account.
So, how do you send dollars to a non-US bank (which, by definition, doesn’t have a Fed master account)?
You don’t.
US dollars can’t leave the US banking system to become Eurodollars (with the possible exception of physical cash physically leaving the country, as in the Wolf of Wall Street photo above) — and Eurodollars can’t enter the US banking system to become US dollars.
Where, then, do Eurodollars come from?
“Their major source is a bookkeeper's pen,” according to Milton Friedman’s 1971 paper on the subject.
Eurodollars, he says, are “printed” by non-US banks in the same way that US dollars are printed by US banks.
I find this even more confusing.
Because surely, if anyone could print US dollars, everyone would.
Why, for example, would North Korea bother to steal all our crypto if they could just order the National Bank of Pyongyang to print a gazillion US dollars for them?
If you find this as bewildering as I do, we’re in good company, per the Friedman quote at the top.
I know what you’re thinking. You’ve made it this far in life without knowing how these mystifying Eurodollars work (or even knowing they were a thing), so why bother now?
Normally, I’d agree with you. If it’s that hard to understand, it’s probably not worth understanding.
But if you’re reading this newsletter, you probably do want to understand stablecoins — and Nic Carter has unofficially rebranded stablecoins as “tokenized Eurodollars.”
So, if we want to understand stablecoins, we now have to understand Eurodollars, too.
Sorry, I don’t make the rules.
But here’s the good news: If you understand stablecoins, you’re already halfway there to understanding Eurodollars (which makes you halfway ahead of nearly everyone else).
Let’s see if we can get the rest of the way, too.
Tokenized IOUs
You can’t buy much with stablecoins.
To purchase anything other than crypto with the USDC in your digital wallet, for example, you will almost always have to send the USDC to a centralized exchange where you can swap it for US dollars.
That’s because USDC is a liability (an IOU) of its issuer, Circle, and not everyone is willing to accept Circle IOUs as money.
So, to spend your USDC, you first have to find someone who knows Circle is a good credit and will therefore trade you US dollars 1:1 for your USDC.
Same goes for Eurodollars.
Just as stablecoins are a liability of the issuer that creates them, Eurodollars are liabilities of the bank that creates them.
They, too, are IOUs and IOUs only have value to the extent that people are confident the issuer is good for the money.
The “money,” in this case, is US dollars — Eurodollars are ultimately a promise, if asked, to deliver US dollars to a US bank account in the US banking system.
(“Payments settle to the US banking system, ultimately,” according to Joseph Wang.)
That’s different from the US dollars you keep in your pocket or the ones that banks keep in a Fed master account, both of which are liabilities of the Fed and therefore carry no credit risk.
When non-US banks print Eurodollars, then they are not creating money so much as they're creating credit.
EuroIOUs
So here’s a better explanation of where Eurodollars come from: “Eurodollars are created when a banker abroad decides to assume a dollar-denominated deposit liability,” as explained in a paper from Vanderbilt Law.
No banker would accept a liability of the Bank of Pyongyang. So North Korea can print all the Eurodollars they want, they just won’t be worth anything.
Eurodollars, like stablecoins (and unlike US dollars), are not all created equal.
This distinction is more obvious in stablecoins.
Stablecoins all have different names — USDC, USDT, etc. — so, it’s obvious that you’re trusting the issuer of the particular coin you hold.
My shorthand way of understanding Eurodollars is therefore imagining that they all have different names.
The Royal Bank of Canada’s RBCeurodollars would always trade 1:1 with US dollars.
But the Royal Bank of North Korea’s RNKeurodollars would trade about like the Terra Luna stablecoin (i.e., at zero).
This isn’t an exact analogy because I don’t think there is much of a market to trade one bank’s Eurodollars against another’s like there is with stablecoins. (Maybe you can OTC, though?)
Instead, Eurodollars generally move freely from one bank to another, creating long chains of liabilities.
This makes the Eurodollar system “an interlinked set of balance sheets,” according to the Eurodollar expert Robert McCauley.
That’s a lot more complicated than the US banking system where all interbank liabilities are settled at the end of the day in Fed master accounts.
Yes, the money in your bank account is also an IOU from your bank, but the Fed has de facto guaranteed those IOUs, which makes US dollar deposits practically indistinguishable from the base money held at the Fed.
So, yes, Eurodollars are “US dollars in a non-US bank account.”
But not all US dollars are created equal.
Mystery solved?
Are stablecoins really “tokenized Eurodollars” then?
Sort of.
They are, like Eurodollars, dollar-denominated liabilities created outside of the Fed’s jurisdiction.
But the second-largest stablecoin issuer is based in the US, so I don’t think you’d consider USDC a Eurodollar any more than you consider your account balance with PayPal or Venmo to be Eurodollars.
More importantly, I can’t see how stablecoins will ever scale like Eurodollars have done.
Stablecoins are better than Eurodollars in many ways: anyone can hold them, the credit risk is obvious, and there’s no “interlinked” system of balance sheets.
But as long as they are fully reserved, they won’t be able to scale as fractionally-reserved Eurodollars have done.
So, however much stablecoins are or are not tokenized Eurodollars, I don’t think they will ever be used as such.
Either way, though, we now at least understand this mysterious form of money.
(I think.)
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Our-gentina? The Prospect of a U.S. Debt Crisis and Possible Implications for Investing Today
There is evidence that inflation is fading while growth solidifies and hopes for the longed-for "soft landing" are high. But even if these short-term concerns are managed, there is still the medium-term to consider: the mounting national debt causes optimists to worry and pessimists to see inevitable doom. They will discuss the interaction of primary deficits, real interest rates, and growth to examine where current policies are likely to take us. They will also look at the ways the problem could be addressed and assess the barriers those approaches might encounter.
About the Author:
Byron Gilliam traded international equities for investment banks and brokers in Frankfurt, London, Paris and New York before becoming the Markets Strategist at Blockworks.
“The Eurodollar market is the latest example of the mystifying quality of money creation to even the most sophisticated bankers.”
— Milton Friedman