Stablecoins to the Treasury’s Rescue

What are stablecoins?

Stablecoins are a unique type of cryptocurrency designed to maintain a constant value. Unlike most cryptocurrencies, such as bitcoin — which fluctuate wildly in value — stablecoins aim for near-zero price fluctuations. Typically, stablecoin values are pegged to a currency, such as the U.S. dollar.

Because their value is nearly constant, stablecoins are much more suitable for digital transactions than other cryptocurrencies. Like the roles of money market funds and savings/checking accounts in the traditional financial ecosystem, stablecoins serve as a store of value in the digital currency ecosystem.

To achieve stability, stablecoin issuers collateralize their tokens with dollars, Treasury securities, repurchase agreements (repo), and other assets. Among the most well-known stablecoins are Tether (USDT) and USD Coin (USDC). They are widely used in decentralized finance (DeFi) and for cross-border payments due to their low volatility and compatibility with blockchain networks.

The graphic below indicates that more than 80% of the assets backing Tether consist of cash, cash equivalents, and other short-term deposits. The remaining 20% are in assets that are riskier than most money market funds can hold.

Stablecoins offer faster and cheaper transactions versus the traditional banking system. They also facilitate financial inclusion for individuals without access to conventional banking services. Lastly, they serve as a form of “cash” in the cryptocurrency world, allowing for digital transactions or simply holding funds within the digital marketplace with a minimal risk of fluctuating value.

Per TBAC’s report:

Stablecoins are digital assets designed to maintain a stable value by pegging their worth to a reserve asset, such as fiat currency (USD). The intended stability of stablecoins has made them a key enabler for payments and as a store of value in on-chain ecosystems.

The graphic below, from its report, shows that some stablecoins are incredibly secure, as they are backed by Treasuries, repo transactions, and money market funds. However, as you move down the list of types of stablecoin, others are supported by riskier assets, algorithms, and smart contracts.

Benefits to the Treasury

TBAC’s presentation discusses how stablecoins might benefit the Treasury.

According to a diagram in the report, as shown below, there is currently approximately $234 billion worth of stablecoins. TBAC believes the number could multiply to $2 trillion by 2028. It thinks that roughly $120 billion of Treasury bills collateralize stablecoins today. Furthermore, based on its $2 trillion estimate for stablecoin growth, it believes more than $1 trillion of Treasury bills could be used to support future growth.

If true, such an influx would mean that stablecoin issuers would own more Treasury securities than the U.K. ($779 billion) and China ($765 billion), the second- and third-largest sovereign holders of Treasuries. Only Japan would hold more, with $1.13 trillion.

Shifting Treasury issuance patterns

TBAC views the increased demand as a positive development for Treasury financing. In its mind, it could potentially lower yields by providing a new buyer base. Furthermore, diversifying from foreign buyers better supports U.S. fiscal stability and strengthens the dollar’s global dominance.

An additional $1 trillion demand for Treasury bills would likely require a shift in how the Treasury issues debt. An increase in the supply of Treasury bills to meet the new demand would result in less issuance of the longer-term maturities. Everything else being equal, that outcome should lead to lower, longer-term interest rates. However, shifting more issuance to shorter maturities from longer maturities introduces risk. For instance, it could be costly if the yield curve inverts and short-term rates exceed long-term rates.

The GENIUS Act

The GENIUS Act, legislation proposed in February, requires stablecoin issuers to maintain reserves on a one-for-one basis with high-quality assets. GENIUS stands for Guiding and Establishing National Innovation for U.S. Stablecoins. The act explicitly mentions U.S. Treasury bills with a maturity of less than 93 days. Moreover, the act tries to limit the ability of stablecoins to offer yields.

The following tweet from the bill’s sponsor, Senator Bill Hagerty, summarizes the benefits of the proposed GENIUS Act legislation.

Bank risks

While the Treasury may benefit from the new demand, banks may suffer as a result. If stablecoins offer competitive yields, some traditional bank customers may opt for the convenience of digital stablecoins. Thus, banks would have to increase yields to keep deposits with the bank, or risk losing a vital funding source.

Bear in mind that banks use deposits to make loans. Thus, lower levels of deposits could result in fewer long-term loans and, therefore, slower economic growth.

The Fed

The Fed is currently able to use interest rates and its balance sheet to significantly impact bank lending, which in turn directly affects the money supply. However, keep in mind that the Fed doesn’t print money. Instead, all money is lent into existence. The Fed provides reserves to banks, which incentivizes them to lend money.

If banks play a lesser role, the Fed’s ability to impact the economy through its reserve operations may be reduced. While it has less control over the money supply, it could also be more challenging for the Fed to support nonbanking crypto institutions during a crisis.

To help avoid a crisis caused by stablecoins, the government will need to enact strong requirements regarding the type of collateral and the amount of reserves backing stablecoins.

Summary

The Fed and the U.S. Treasury will do whatever is in their power to ensure the U.S. Treasury attains the lowest possible funding costs. As we wrote in our Daily Commentary in May, Bank Regulators Will Help The Treasury:

Per an article in the Financial Times titled US Poised To Dial Back Rules Imposed In Wake of 2008 Crisis, US bank regulators are preparing to reduce bank capital requirements. Of particular interest to the bond market is the supplementary leverage ratio, better known as SLR. Unlike other risk-based capital rules that banks adhere to, SLR applies a minimum capital requirement to all bank balance sheet assets. The rule was put in place in 2014 to limit excessive leverage.

Reducing leverage ratios for the largest banks will enhance their ability to hold more Treasury securities. Similarly, stablecoins, backed by U.S. Treasuries, offer another source of funding for the Treasury.

Stablecoins and the concept of digital money represent a significant shift from the current system. While there are many risks with digital money, there is also promise. Lower transaction fees and quicker transactions are two such benefits. Of course, as we mentioned earlier, a new buyer for U.S. Treasuries is another significant benefit.

Michael Lebowitz is a portfolio manager with RIA Advisors and author for Real Investment Advice. For more information, contact him at [email protected] or 301.466.1204.

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