Why tokenized deposits is a MUST for every bank? pt.1

“When money-market funds emerged in the 1970s as a higher-yield alternative to conventional savings accounts, Americans raced to their local banks in droves to pull their cash.

The U.S. Treasury Borrowing Advisory Committee, which advises Treasury and includes Wall Street leaders, has warned that up to $6.6T of deposits in highly liquid accounts could be pulled into stablecoins as the sector grows.” 

- Your Paycheck in Stablecoins? That’s Local Banks’ Worst Nightmare per Bloomberg

US commercial banks carry $23T in liabilities as of 2024. Of that, $17T still relies on retail/core deposits (see data from the Fed below), while wholesale funding sources like negotiable CDs and repos make up $6T.

Now imagine this: a $6.6T outflow, about 40% of retail deposits, decamping en masse to stablecoin yields or tokenized MMFs. That shift alone would reconfigure the entire wholesale funding market.

In this Weekly Research Note, I will unpack:

1. How large-scale retail deposit flight would ripple through wholesale funding

2. Which banks are most exposed

In next Weekly Research Note, I will follow up:

3. Why tokenized deposits should be a must-have product, not an optional experiment

Let’s dive in.

The rise of MMF and the Wholesale Funding Market 

MMFs exist today because of a Depression-era rule: Regulation Q, which capped the interest banks could pay on deposits. The cap was designed to stop banks from hoarding deposits and taking outsized risks—the kind of behavior that led to the collapse of 9,000 banks after the Great Depression.

For decades, the system worked. From the 1930s through 1965, the Regulation Q cap sat above market interest rates, meaning savers earned about the same return whether they parked money in a bank account or short-term Treasuries.

📌 Context: In the 1960s, before MMFs existed, US commercial bank deposits totaled just $300B—and 95% were simple checking and savings accounts. Retail deposits were the backbone of bank funding.

That changed in 1966, when inflation drove market rates above the Regulation Q cap. Banks couldn’t raise rates to compete, so savers started looking elsewhere. Wealthy investors found ways into higher-yielding instruments, but smaller investors were locked out.

In 1969, Bruce Bent and Henry Brown spotted an opening: create a mutual fund that pooled capital from small investors to buy short-term, high-quality paper (commercial paper, repos, Treasuries). By 1971, they launched The Reserve Fund—the first-ever money market mutual fund.

Growth was explosive:

• 1975: MMF had $3.7B AUM as a category. 

• 1980: MMF had $70B+ vs $1.6T in bank deposits

• 1985: MMF had $230B+ AUM vs $2.5T in bank deposits (retail deposits 60%, with large CDs and MMF making up the rest 40%)

• 2024: MMF crossed the $7T AUM mark vs $17T in bank deposits and wholesale funding at $6T.

Key shifts were taking place in the US banks funding structure: 

• banks are becoming more structurally reliant on wholesale markets, while retail deposits became less sticky

• MMF grew way faster than the bank’s retail deposit base and permanently carved away a huge slice of household savings from banks funding sources

  
  

What if another $6.6T exits retail deposits?

If $6.6T were to migrate out of bank retail deposits, US banks would be forced to lean much more heavily on wholesale funding channels such as:

• Large time CDs ($2.4T between 2024-2025) 

• Repo Market ($1.7T in 2024 on-balance-sheet funding)

• Federal Funds Market ($600B-$700B between 2024-2025)

• Federal Home Loan Bank (FHLB) Advances ($400B-$500B between 2024-2025)

• Commercial Paper (CP) ($200B-$250B between 2024-2025)

• Eurodollars (no precise figures available due to outside the Fed’s control but NY Fed estimate puts the daily flow to be around $150B, double that of the Fed Funds Market)

Here’s where MMFs come in: they are already the dominant buyers of large CDs, FHLB debt, and repos—the three biggest wholesale funding channels. If $6.6T of deposits flowed into MMFs via stablecoins and tokenized MMFs, their AUM could easily double to $12–14T. MMFs would effectively become the new “deposit base,” recycling liquidity back to banks through repos and CDs.

US Wholesale Channel Impacts

Large CDs → Big banks would issue more, but spreads would widen sharply, raising funding costs. Large regionals could still access the market, but at higher cost. Community banks risk being shut out entirely.

Repo (on-balance-sheet funding) → Could expand by 200%+ as banks pledge Treasuries/Agencies to borrow from MMFs, making repo the de facto replacement for lost deposits.

FHLB Advances → Likely to surge as regionals and community banks lean on this “agency-backed” channel. For many smaller banks, this is their only wholesale funding option. With yields just a few bps above Treasuries, FHLB notes are already highly attractive to MMFs, which are the largest single buyers of FHLB paper today.

Systemic fragility → Over-reliance on wholesale markets increases vulnerability. The Fed would likely need to expand its standing repo facilities (such as the ON RRP facility, which ballooned to $2.4T during the Covid market stress as banks pulled back on Fed Funds Market) or design new backstops to stabilize funding. A stark reminder of 2008.

Who’s Most Vulnerable to Deposit Outflows?

Here is the breakdown of retail deposits within the US banking system:

• Money center banks (JPMorgan, BofA, Wells, Citi): ~50% of retail deposits

• Large regionals (U.S. Bank, PNC, Fifth Third, Citizens, Key): ~22%

• Community & smaller banks (≈4,000 institutions): ~15–18%

While various funding channels exist for US banks, most of them are only accessible to large money center banks such as JPMorgan, Citi and Bank of America and/or gated.

Large CDs: In theory, any bank can issue them. In practice, only money-center and super-regional banks succeed. They have the credit ratings, distribution networks, and investor demand needed to compete with MMFs and Treasuries.

Repo: Requires counterparty trust, high-quality collateral, and infrastructure (clearing, settlement, tri-party platforms). Community banks generally lack the collateral scale or operational set-up.

FHLB Advances: The main backstop for smaller banks. But borrowing costs are higher (priced above repo) and advances are capped by collateral requirements (with haircuts on mortgages, Treasuries, agencies).

If deposits were to flow out at scale, with limited access to CDs or repo, reliance on more expensive FHLB borrowing, and without the balance sheet resilience of GSIBs, community and smaller banks will have the hardest time to replace their funding sources. 

So what should the banks do?

Stay tuned for the next part: Why tokenized deposits is a must, not an optional experiment, for every bank.

Disclaimer: This content is for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice.