Hilary Allen on Stablecoins and Why They Matter

The Allen Framework

Hilary Allen's Driverless Finance (2022) argued that the crypto financial system was assembling the same structural vulnerabilities that produced the 2008 banking crisis, but in a regulatory environment that had not yet caught up. The most consequential of these vulnerabilities, in Allen's analysis, was the stablecoin sector. Stablecoins were performing bank-like functions without bank-like regulation, and the inevitable stress test would reveal the costs.

What Stablecoins Are

A stablecoin is a digital token whose value is pegged to a reference asset, typically the US dollar. The peg is maintained either through collateralization (the issuer holds an equivalent amount of real dollars or dollar-equivalent assets) or, in earlier designs, through algorithmic mechanisms (which have not survived empirical stress tests).

The major collateralized stablecoins as of 2024:

• USDT (Tether): roughly $120 billion in circulation, the largest single stablecoin. Reserves include Treasury bills, commercial paper, and other assets. Reserve composition has been historically opaque.
• USDC (Circle): roughly $30 billion in circulation, more transparent reserve composition, primarily Treasury bills and Federal Reserve balances since 2023.
• DAI (MakerDAO): roughly $5 billion in circulation, collateralized by other crypto assets in over-collateralized vaults.

Daily settlement volume across the major stablecoins exceeds $50 billion. The sector has produced sustained real-world utility for cross-border remittances, crypto-market settlement, and dollar access in inflation-volatile economies.

The 2023 USDC Depeg

The Silicon Valley Bank collapse in March 2023 included Circle's $3.3 billion in SVB deposits, which represented backing for the USDC stablecoin. When SVB failed and FDIC insurance covered only the first $250,000 per account, USDC's backing was at risk. The market briefly traded USDC as low as $0.87 — well below the dollar peg — before the Federal Reserve's systemic-risk exception protected the deposits and allowed Circle to recover.

The episode confirmed Allen's broader analysis. Stablecoins are not independent of the traditional banking system; they ride on it. The peg depends on banking-system access and stability in ways that the marketing did not emphasize. When the banking system experienced stress, the stablecoin pegged to dollars in that banking system also experienced stress.

The Terra-Luna Catastrophe

The May 2022 collapse of Terra/Luna was the largest single crypto-related loss of value in history — over $40 billion of market cap evaporated in a week. Terra was an algorithmic stablecoin: rather than collateralizing with real assets, it used an arbitrage mechanism involving a sister token (Luna) to maintain the peg. When market stress made the mechanism unprofitable, both tokens spiraled to near-zero.

The Terra collapse was Allen's framework playing out in real time. The algorithmic stablecoin had grown to substantial size without adequate underlying value backing. When confidence broke, the run was rapid and total. The cascading effect on related crypto firms (Three Arrows Capital, Celsius, Voyager, FTX) demonstrated that crypto-market interconnections were creating systemic-risk dynamics parallel to the 2008 bank-system contagion.

Why Bank-Style Oversight

The structural argument for bank-style oversight of stablecoin issuers rests on several propositions:

First: stablecoins perform deposit-like functions. Holders treat them as dollar-equivalent value that can be redeemed on demand. The issuer's obligation to maintain the peg is structurally similar to a bank's obligation to honor demand deposits. The Federal Reserve and banking regulators have spent a century developing the institutional framework for managing this kind of obligation; that framework should apply to comparable activity regardless of the legal form.

Second: stablecoins are vulnerable to runs. Confidence loss can trigger redemption demand that exceeds the issuer's ability to liquidate reserves. The bank-regulatory framework includes liquidity requirements, capital buffers, and lender-of-last-resort access specifically to manage this risk. Stablecoin issuers have none of these protections.

Third: stablecoins can become systemically important. The crypto ecosystem has grown to a scale where a major stablecoin failure could produce broader financial-system disruption. The 2023 USDC episode was the first warning; future episodes may not have favorable resolution.

Fourth: stablecoin issuers can engage in maturity transformation. If they invest reserves in longer-duration assets to earn yield, they take on the asset-liability mismatch that defines banking risk. Tether's substantial commercial paper holdings, before the 2023 shift toward Treasury bills, illustrated this. Without regulation, nothing prevents stablecoin issuers from creating bank-style risk positions.

The Regulatory Status Quo

The US has not adopted federal stablecoin legislation despite multiple proposals. The Clarity for Payment Stablecoins Act (multiple versions) would provide federal regulatory architecture but has not passed Congress. State-level frameworks (New York's BitLicense, Wyoming's Special Purpose Depository Institution) provide partial coverage but produce inconsistent treatment across jurisdictions.

The EU's Markets in Crypto-Assets (MiCA) framework, in force from 2024, has produced the clearest stablecoin regulatory regime in major jurisdictions. Stablecoin issuers operating in the EU must register, maintain specific reserve compositions, and meet operational requirements. The framework's interaction with non-EU stablecoin issuers is still being worked out.

The Asymmetric Politics

The political-economy obstacles to US federal stablecoin legislation are substantial. The crypto industry has substantial lobbying resources and has fought regulation that would impose bank-style costs. Some traditional banks have opposed stablecoin frameworks that would let issuers compete directly with bank deposits. Various congressional members have ideological commitments to either crypto-libertarian or anti-crypto positions that prevent compromise.

The result is regulatory stasis. Stablecoins continue to operate, continue to grow, and continue to take on risks that the existing framework cannot constrain. Allen's argument is that this status quo cannot continue without producing another crisis episode, and that the only question is timing.

The Honest Reading

Stablecoins are the one crypto product that has demonstrated sustained real-world utility. The category has survived multiple stress tests, has grown despite an unfavorable regulatory environment, and has produced clear use cases that other crypto tokens have not matched. But the structural vulnerabilities Allen identified are real, and the 2023 USDC episode confirmed that the regulatory framework has not kept up. The next major stress episode will probably test whether the systemic-risk-exception toolkit can handle stablecoin-specific failures, and the answer may not be yes without substantial Federal Reserve improvisation. Either Congress acts proactively or the next crisis forces ad-hoc improvisation; the choice has so far been the second path.

Reading List

• Hilary Allen, Driverless Finance (2022)
• Hilary Allen's stablecoin papers (multiple)
• BIS reports on stablecoin design and risks
• NY Fed staff reports on stablecoin operations
• Gary Gorton on shadow-banking parallels