In the quest to innovate within the financial sector, CERES embarked on a journey to become the first SEC-registered and patented stablecoin, navigating an intricate regulatory landscape. As CERES maneuvered through this process, addressing over 300 SEC comments, it inadvertently paralleled the foundational principles laid out by The Narrow Bank (TNB), conceived by economists Laurence Kotlikoff and James McAndrews. Both entities aimed to revolutionize financial security and stability but through different mediums: traditional banking for TNB and blockchain technology for CERES.
CERES Coin's journey was not initially aimed at replicating TNB's model but rather at solving the challenges of stability and regulatory compliance in the cryptocurrency/stablecoin space. However, through its evolution and rigorous engagement with the SEC, CERES developed a model where each coin is backed by shares in a U.S. Government Money Market Fund. This approach, much like TNB's 100% reserve banking concept, has effectively created a digital equivalent of a narrow bank:
Stability and Safety: By backing its coin with government securities, CERES offers a stable, risk-free asset akin to TNB's promise of holding all deposits at the Federal Reserve.
Interest Yielding: CERES Coin holders benefit from the interest generated by the underlying fund, paralleling how TNB intended for depositors to earn from reserves.
Cash Management and Risk Reduction: Both models provide a secure environment for institutions to manage liquidity, reducing risks associated with traditional or volatile investment practices.
Regulatory Compliance: CERES, through its SEC registration, ensures compliance much like TNB aimed for with its minimalist banking operations, though in different regulatory frameworks.
Transparency: While TNB's simplicity in operations was its transparency, CERES leverages blockchain for immutable transaction records and clarity.
This document explore show CERES, in its pursuit to be the first of its kind in the stablecoin market, has inadvertently crafted a financial product that mirrors the core objectives of The Narrow Bank. The following pages detail this comparison, showcasing how both initiatives, though born from different visions, converge towards a common goal: providing a safe, transparent, and compliant method for managing institutional funds.
Foundation: The Narrow Bank was conceptualized by Laurence Kotlikoff, an economics professor at Boston University, and James McAndrews, a former economist at the Federal Reserve Bank of New York. They aimed to create a bank that would operate on a 100% reserve model, where all customer deposits would be held in reserve at the Federal Reserve, ensuring no lending or investment with depositors' money.
Purpose: The idea was to eliminate the risks associated with traditional banking, particularly credit risk and the possibility of bank runs, by focusing solely on deposit-taking and not engaging in any lending activities. This was seen as a way to provide ultimate safety for depositors' money.
Laurence Kotlikoff: As one of the co-founders, Kotlikoff brought his academic background and advocacy for financial system reform to the table. He is known for his work in economics, especially his push for limited purpose banking, which lies at the heart of TNB's model.
James McAndrews: With his experience at the Federal Reserve, McAndrews contributed significant insight into how banking operations and regulations work, particularly in relation to reserve holdings.
TNB Team: The specific operational team included financial and legal experts who worked on the practical aspects of setting up the bank, navigating regulatory landscapes, and developing the necessary infrastructure for operations.
Regulatory Hurdles: TNB faced significant challenges in obtaining a master account at the Federal Reserve, which is essential for any bank to operate. Their application for this account was denied, and they took legal action against the Federal Reserve to force the issue, arguing that they met all the necessary criteria for such an account.
Court Battle: In 2019, TNB sued the Federal Reserve in the U.S. District Court for the District of Columbia, claiming that the refusal of their application was arbitrary and capricious. The legal battle was aimed at securing their right to operate as intended.
Outcome: The lawsuit was not immediately successful; in2021, the judge dismissed TNB's claims, ruling that the Federal Reserve Bank of New York had discretion in deciding whether to grant a master account. This effectively stalled TNB's operations as they could not proceed without such an account.
Academic and Economic Discourse: The concept of The Narrow Bank reignited discussions on banking reform, particularly about the nature of risk in banking, the role of reserves, and the potential for narrow banking to stabilize financial systems.
Innovation in Banking: TNB's model was seen as an innovative approach to banking that could potentially reduce systemic risk. Despite not achieving operational success, it contributed to the conversation around banking regulations and the safety of financial institutions.
Influence: The idea of narrow banking, even if not realized through TNB, has influenced other initiatives and discussions on how to make banking safer, including discussions on stablecoins and digital currencies that aim to be fully backed by reserves.
The Narrow Bank (TNB) pitched to institutions by offering a unique banking model focused on safety and simplicity. Here's a summary of their pitch based on available information:
1. 100% Reserves:
TNB proposed holding all deposits in reserve at the Federal Reserve, essentially operating as a 100% reserve bank. This means that every dollar deposited would be backed 100% by reserves, making it one of the safest banks possible since there would be no lending out of depositors' money.
2. Elimination of Credit Risk:
By not engaging in lending or investment activities, TNB would eliminate credit risk entirely. This was a significant selling point, particularly after financial crises where traditional banks' lending practices led to significant losses.
3. Interest on Reserves:
They would earn interest directly from the Federal Reserve on these reserves, which could be passed on to depositors or used to cover operational costs. This was an attractive feature for institutions looking for a stable return on their cash holdings without the risk associated with traditional banking activities.
4. Regulatory Compliance and Safety:
The model was inherently compliant with banking regulations since it would not engage in maturity transformation or risk-taking activities, which are often sources of bank failures. This was pitched as a way for institutions to park their money in an environment with negligible regulatory risk.
5. Simplicity and Transparency:
The straight forward business model would be easy to understand and audit, offering maximum transparency for depositors. This simplicity was meant to appeal to institutions that value clarity in financial dealings.
6. Reduction of Systemic Risk:
TNB positioned itself as contributing to the stability of the financial system by not participating in risky banking practices that could lead to systemic crises. This was framed as a benefit not just for individual depositors but for the broader financial ecosystem.
7. Efficiency in Cash Management:
For institutions with large cash reserves, TNB offered an efficient way to manage liquidity. Money could be moved in and out without the complexities of traditional banking operations.
Despite the compelling pitch, TNB faced significant challenges in getting a Federal Reserve master account, which is essential for their operations. They even went to court over this issue, highlighting the regulatory hurdles they encountered.
The idea of a narrow bank was not new, but TNB's approach was to be the first in modern times to implement it on a significant scale. However, banking regulators and the Federal Reserve were cautious about endorsing this model, citing concerns about monetary policy implementation and the overall functioning of the financial system.
In essence The Narrow Bank was an ambitious project aimed at providing a risk-free banking experience through a 100% reserve model. Despite its theoretical appeal and the intellectual support from key players like Kotlikoff and McAndrews, the practical execution faced significant barriers, primarily from regulatory bodies, leaving its vision unrealized in practice but influential in theory.
The Narrow Bank pitched itself as the ultimate safe harbor for institutions' cash, with a promise of no risk, high transparency, and regulatory compliance, but faced substantial operational and regulatory obstacles in realizing this vision.
Here's how CERES Coin has essentially created a similar model to The Narrow Bank, focusing on its structure with shares backed by a U.S. Government Money Market Fund:
CERES Coin: Each CERES Coin is backed by shares in a U.S. Government Money Market Fund, which holds U.S. government securities, ensuring a stable value. This structure aims to provide a risk-free or near risk-free asset, similar to how The Narrow Bank (TNB) intended to hold all deposits in reserve at the Federal Reserve.
The Narrow Bank: TNB's concept was to maintain 100% reserves, with all customer deposits held directly at the Federal Reserve, thereby eliminating credit risk.
CERES Coin: Holders of CERES Coin benefit from receiving interest income from the underlying Money Market Fund. This is analogous to depositors at TNB potentially earning interest from reserves held at the Federal Reserve.
The Narrow Bank: The interest on reserves at the Federal Reserve would be passed on to depositors, providing them with a return on their cash holdings.
CERES Coin: Offers institutions away to manage cash or liquidity in a stable manner within the digital asset space, akin to how TNB would provide a safe place for institutions to park funds without engaging in risky banking activities.
The Narrow Bank: Aimed to attract institutions looking for a secure place to hold cash with no exposure to lending risks.
CERES Coin: By being backed by U.S. government securities, CERES Coin reduces the volatility risk associated with cryptocurrencies, providing a stable digital asset for institutions.
The Narrow Bank: Its model was to eliminate credit and liquidity risks by not lending out depositors' money, ensuring all funds were safely held.
CERES Coin: As an SEC-registered security, CERES Coin operates within a framework that ensures regulatory compliance, which is attractive for institutions concerned with regulatory adherence.
The Narrow Bank: Focused on being fully compliant with banking regulations by not engaging in activities that could lead to regulatory issues, although it faced challenges in obtaining necessary banking infrastructure like a Federal Reserve master account.
CERES Coin: Utilizes blockchain technology for transparent, immutable transaction records, providing clear visibility into the backing and operations of the coin.
The Narrow Bank: Emphasized simplicity and transparency in its banking operations, where the funds' use was straightforward, i.e. deposits held at the Federal Reserve.
While CERES Coin and The Narrow Bank operate in different contexts—one in the digital asset space and the other in traditional banking—they both aim to provide a stable, low-risk environment for holding cash or cash equivalents. CERES Coin achieves this through its backing by U.S. Government Money Market Fund shares, offering stability, interest, and compliance in a digital format, similar to how TNB proposed to do with physical deposits in the Federal Reserve. Both models focus on reducing financial risk, ensuring regulatory compliance, and offering an interest yield, thereby serving as modern equivalents of safe deposit havens for institutions.
