Now that Silvergate Capital Corp. owns the technology and intellectual property underpinning the blockchain and stablecoin originally developed by Facebook (now called Meta), it hopes to issue the new digital currency by the end of the year.
When Silvergate Capital, the holding company for Silvergate Bank, bought the technology assets of Diem, the stablecoin originally developed by Facebook engineers, on Jan. 31 for $182 million, it further distanced the stablecoin from its giant creator, which now calls itself Meta. This puts the token firmly under the control of a regulated bank,
The $16 billion-asset bank, based in La Jolla, California, hopes to create a new and commonly accepted way of moving money for the masses, not just the crypto enthusiasts who use stablecoins today to buy and sell digital currency. It could build partnerships with large retailers that want to make it easier for consumers to buy things. Along the way, it will have to resolve any lingering doubts about the safety and soundness of stablecoins, create and promote a technology consumers will want to use, and figure out how to handle reserves and security for the new stablecoin.
Diem’s history
Facebook announced in June 2019 that it was developing a blockchain and a digital currency called Libra for all Facebook users. The social media tech company would run the network, issue the Libra token and use the token, which it positioned as a way for underbanked people to access the financial system.
Regulators around the world and the U.S. Congress balked at the idea of a U.S. technology company controlling a digital currency. Facebook tried to distance itself from the concept by creating a consortium to run it and by rebranding it with the name Diem. In May 2021, Silvergate Bank partnered with the Diem Association to launch a permissioned, dollar-pegged stablecoin, with Silvergate acting as the token’s issuer and reserve manager while the Diem Association running the underlying blockchain and network in test mode.
But Meta’s steps to distance itself from Diem weren't enough to appease regulators. Last week, in announcing the sale of Diem’s assets to Silvergate, Diem Networks US CEO Stuart Levey said, “Despite giving us positive substantive feedback on the design of the network, it nevertheless became clear from our dialogue with federal regulators that the project could not move ahead.” The report on stablecoins issued by the President's Working Group in November had already made it clear that U.S. regulators wanted to see stablecoin activities brought inside the banking framework.
Now Silvergate will manage the stablecoin and the blockchain itself.
Why another stablecoin?
Since Facebook floated its Libra idea, many dollar stablecoins, such as U.S. Dollar Coin and the Pax Dollar, have become popular in cryptocurrency trading and decentralized finance, where people want to buy and sell instantly, rather than waiting for ACH transactions to clear and settle.
There’s also an emerging class of bank-issued stablecoins within closed networks. For instance,
Silvergate’s new stablecoin — CEO Alan Lane says he will come up with a new name for it and that he’s open to ideas — could be a payment mechanism for digital-first retail platforms like Uber, Lyft and Spotify. Those platforms today use credit cards, debit cards and mobile wallets that contain debit cards and credit cards.
“Where we see the opportunity, and many members of the Diem Association agree, is to get outside of the credit realm and outside of the specific ACH rails and just use a tokenized dollar on the internet,” Lane said. “In all the conversations we've had with the regulators, they understand all of this and they just want to make sure that it's not being co-opted by large tech companies.”
A person using the future Silvergate-issued stablecoin wouldn't have a relationship directly with Silvergate. The bank would issue stablecoin to retail providers, which would allow their customers to use it.
“The vision is that you would be able to use that across all these different platforms,” Lane said. “So right now you have to have your credit card linked to your Uber app, your Starbucks app, your Dunkin Donuts app, your Lyft app and every other app that you use on your phone. And the idea is, you should just be able to use a tokenized dollar and you should be able to push those dollars to these platforms.”
The money would originally come from the user’s bank account or wherever the person has their paycheck deposited.
Challenges ahead
The future of any new coin “is uncertain since it is hard to predict its usefulness or its adoption,” said Bryan Routledge, associate professor of finance at Carnegie Mellon University. “So trying to peg the value of something that is uncertain can be hard.”
Regulation is also an ongoing challenge. Congress has dozens of bills before it that would affect the future of stablecoins. Bank regulators and Securities and Exchange Commission leader Gary Gensler have all said stablecoins should be regulated, but have not yet issued specific rules.
The question of how issuers should reserve against stablecoins has been raised many times by policymakers. Some stablecoins have been criticized for not backing their digital dollars fully with fiat dollars.
“Backing the stablecoin with less than 100% backing will worry a regulator,” Routledge said.
Silvergate and the Diem Association have developed a framework for reserves that the bank is discussing with regulators now. The plan involves purchasing Treasury notes to back up the stablecoins.
These Treasury notes would be held at a trust company subsidiary of Silvergate. In December, Silvergate renewed its application with the New York Department of Financial Services for a trust company charter.
“That would mean that if you had purchased Silvergate-issued dollar tokens from one of the apps on your phone, the company running that app would have purchased the tokens from us,” Lane said. “And we would have taken those dollars, bought Treasuries and put them in trust on your behalf at our trust company subsidiary. So they would be backed one for one, but not with dollars in a vault per se, but rather with U.S Treasuries sitting at the trust company.”
Regulatory concern is one of the reasons Silvergate has been moving cautiously, he said.
“We move pretty fast for a bank, but we don't move as fast as tech companies,” Lane said. “That old adage in technology — move fast and break things — doesn't work in banking. We're very patient as is evidenced by the fact that we've been working on this for a long time.”
Lane said he is “relieved” that regulators are thinking about all the potential risks of stablecoins now, rather than after the next incarnation of Diem launches.
There are also security issues involved with generating a stablecoin that works across blockchains, Routledge pointed out.
In a few recent breaches, such as the
On the positive side, Wedbush Securities analysts said in a recent note that Silvergate could benefit from having worked with all the retail and tech company members of the Diem Association. These include Uber, Lyft, Spotify and Square.
The bank’s control could also allow Silvergate to charge higher fees on transactions and give its stablecoin an advantage over others because the bank is heavily regulated, the analysts said.
Stanford Graduate School of Business Professor Darrell Duffie, who studies banking and financial markets, also takes a hopeful view of Silvergate’s purchase of Diem.
“Silvergate has the intellectual property waiting for the day when U.S. regulation of stablecoins is sufficiently clear that they can go ahead with the original business plan, or perhaps modify as needed,” he said. “With good compliance safeguards, stablecoins do have strong potential uses in the real economy. Remittances and cross-border business-to-business payments, for example, are potentially great use cases.”
Lane, naturally, agrees.
“We just have a strong conviction that this technology is not going away,” Lane said. “It’s a way to use modern technology to move value around the world without borders and it never sleeps. Eventually, I think all of the banking systems in the world are going to be using this technology. We're just going to keep chipping away at it and I think we're in a really good spot.”
