Forward the Original Title‘May 2024: Stablecoins are helping create a buyer of second-to-last resort for US Treasurys’

A long time ago I was a junior bond and FX trader, and a conversation I remember happening every few months during US Treasury Auctions was (paraphrasing)

“Whats the China bid”

Basically, was the People’s Bank of China (PBOC) going to be a buyer in this particular auction or not. In hindsight I can’t even remember if it ever mattered for any auctions I observed, but the theme I took away was that one day maybe the PBOC wouldn’t buy in an auction and the Treasury would be in trouble.

Didn’t think about this again until I saw this chart recently:

Source here

You don’t have to squint that hard to see where this is headed. The crypto world has (probably) unintentionally designed a system that will likely strengthen USD as a reserve currency. Here’s why.

A frequent talking point of bitcoin maximalists is

1. US government (and most governments) borrow too much and print a lot of money
2. This is stealing wealth from the future
3. Eventually this behavior will drive hyper inflation and debase the dollar.
4. When this happens the dollar will go into freefall
5. So owning bitcoin is a hedge against #1 - #4

I personally think dollars behave weird relative to other currencies because of reserve status and a bunch of other things (eg there are just not that many things that are as liquid as dollar markets so if you operate at a certain scale, dollars are hard to avoid), but I’m genuinely not particularly informed, thoughtful or up to date about the dynamics. In addition, a second macro take (just what I absorb from the business press) is:

1. The world gets more multipolar/less integrated every day
2. For this reason (and others bunch of other reasons) China (and probably a bunch of other governments) are less interested in owning US Treasurys (and are thus buying more gold), which partially explains why Gold spot prices are at all time highs while ETF holdings of Gold are cratering. Story for another day [3]

I don’t have a good argument for why this macro theme is happening, but lots of data points to it being true. However I think cryptocurrency enables another interesting thing to happen, that really is a counterweight. Under the hood, there’s insane demand for dollars relative to supply, from non-US individuals and businesses. For non-US individuals, USD is often a more stable way to save than their home currency, and local banks make it hard to get[4]. For non-US businesses, lots of crossborder trade (about 40%) still settles in dollars. Wealthy individuals in most developing countries will often move their excess savings to the US/UK/Europe. Cities like London, Vancouver and New York all have real estate markets that reflect this demand for dollar denominated assets. Non-wealthy individuals in developing countries really struggle to access USD, and have for decades, and as a result there’s pent up demand for it. I’ve talked about this a bit before.

Stablecoins for Emerging Markets

The “digital gold” pitch for cryptocurrency (ie, that it is a hedge for inflation and its permissionless [2] nature enables consumers to protect themselves from a wealth seizure by their local government) is far more true for stablecoins (a cryptocurrency pegged to a reserve currency like the US Dollar), than it is for bitcoin. In addition, given the largest proportion of fiat backed stablecoins are backed by USD, stablecoins are not really THAT useful as an inflation hedge for US citizens.

A person in a country with a mismanaged currency might theoretically want to own bitcoin at some stage for speculative purposes. However, the volatility so far makes it atrocious as a store of value, because you have no confidence about how much value will be available to you when you actually need to use it. Said another way, in emerging markets, the average citizen does not have sufficient excess savings necessary to stomach bitcoin volatility for savings they might need on a rainy day. It makes bitcoin a very expensive and inefficient store of value in the short term. In contrast, prior to the existence of cryptocurrency, it was (and still is) fairly common for wealthy individuals in poor countries to hold foreign currency (typically USD, GBP or EUR) as a mechanism for savings. As a market maker, I used to think (and I still think) that a good heuristic for a country’s economic trajectory is “where do the country’s rich put their wealth?”. Wherever wealth is exported (eg if the move in your country when you get rich is to immediately buy New York or London real estate) is a signal that citizens are afraid of wealth seizure, either explicitly by taking it away, or implicitly by printing it away.

Governments hate this because it creates natural selling pressure for their home currency and puts assets somewhat beyond their reach. However, a fiat-backed stablecoin pegged to the US Dollar or Euro (with real assets under management) that is permissionless and effectively beyond the ability of the local government government to stop you from buying, is simply a digital asset substitute for a real use case that already exists. Before stablecoins, you had to buy dollars from a bank and keep it in a bank account (which has its merits) but the bank could also a) just refuse to sell them to you, b) charge you a ton of fees to buy or hold it or c) be forced by the government to transact at a fake exchange rate or limit how much you could buy or own. Even in today’s environment, if you’re in the US you should try going to your local Bank of America or logging into your Chase mobile app and try to buy some euros, and it will become blindingly obvious how unsupported this is.

Basically, everyone around the world wants access to a relatively stable currency to denominate their savings in, one that has a predictable exchange rate vs. the goods and services they purchase every day. For most humans today (in 2024), dollars and euros are more stable than their home currency. A stablecoin backed by the dollar (or GBP, EUR, take your pick), is a permissionless way to do that. The loudest voices in crypto aren’t incented to tell you this because USDC doesn’t make them rich. Ironically, stablecoins actually help solve the runaway hyperinflation use case, while bitcoin merely enables a user to swap hyperinflation in their home currency for volatility in crypto. That doesn’t mean it has no utility; just that it’s a crappy way to save if you might actually need to access your savings at a time you couldn’t anticipate.

The weirdest unintended consequence

Stablecoins are turning retail investors/citizens/savers around the world into implicit buyers of US Treasurys. Here’s why:

1. Stable coins make it possible for people outside of the US to hold dollars and (in certain cases) earn interest in USD in a permissionless way that their governments can’t control and that their banks would never make easy. The poorer you are, the harder it is to access USD. And this is only just starting - stablecoins have only started being utilized for non-crypto use cases, eg replacing SWIFT transactions and other crossborder SMB payments (this is what Bridge [1] does). I can only imagine that as the offline utilization of stablecoins expands, demand will continue to rise.
2. Well managed stables basically have to hold the stablest + most liquid securities, which are basically US Treasurys. For example as of February 2024, most of USDC was held in US Treasurys + repo + cash:

1. So stablecoin driven demand for Treasurys will grow pretty linearly with underlying demand for stablecoins themselves.
2. This basically means something like 90% of stablecoin demand will result in demand for Treasurys in some way.

In a weird way it’s almost easier to buy stables which are a layer on treasurys, than the underlying treasury itself. 3x growth in stablecoins will make them a top 5 holder of USTs. So it isn’t crazy that growth in crypto will help support dollars as a reserve currency for another generation.

Source

Implications if these trends hold or accelerate

A few potential effects come to mind if these trends hold. First, given stablecoins are largely backed by Treasurys - there are a few interesting contagion scenarios we haven’t experienced before. For example, the very hyperinflation event that crypto evangelists fear, could destabilize stablecoins and infect the broader crypto markets, if retail holders attempt to redeem en masse. Similarly, we could encounter a “break the buck” event where the redemptions accelerate over a weekend or outside of market hours as stablecoins are tradeable 24/7, but the stablecoin manager cannot produce the real USD quickly enough because the underlying Treasurys do not trade 24/7 (this could manifest as a de-peg where the stablecoin trades at a discount in a panic such as when USDC was trading at 85c during the SVB crisis). This type of event could not only infect cryptocurrency markets, it could also infect money market funds as a class. It’s hard to tell how this plays out - as stablecoin adoption grows generally, and institutional adoption of crypto grows specifically, the transmission mechanisms between assets also change. In crisis, assets tend to be far more correlated than we believe them to be in peacetime, and at their current scale, by the time we find out how it plays out, it will be playing out . ..

Second, treasurys held in stablecoins that are broadly distributed to retail, with some sliver of margin monetized by the “managers” of the stables, are far less usable in a weaponized way, versus their foreign central bank held counterparts. As stablecoins grow and hold more USTs, they’re less likely to be sold en masse in times of conflict and negatively impact the US Government’s ability to fund itself, both because retail investors/savers everywhere are less likely to express their preferences (even if they’re anti-USD) by selling stables because their currencies are just as likely to be volatile, and also because for the managers of stablecoins, earning yield is how they make money (for example Tether earned $1b on Treasury yields in 2023), so they’re not inherently incented to sell unless there are redemptions.

Said slightly differently, the decoupling of U.S.-China and associated restructuring of capital flows, is often thought to be bad for USD dominance. However, the emergence of stablecoins bucks this trend and can end up reinforcing USD and treasurys dominance. Purely for liquidity and network effect reasons - as fiat-backed stablecoins grow they’re more liquid (and dollars are more liquid by extension) and as more unique individuals hold dollars (or dollar biosimilars) dollars become harder to destabilize.

Third, “flight to quality” trades in times of conflict tend to favor the reserve currency (and in recent decades this is mostly USD), but historically that shift is most pronounced by institutional investors (partly because most market activity is institutions, and partly because retail has terrible access to bonds). In a world where retail investors around the world have easy access to USD (via USDC/USDT) it’s not crazy to expect a retail “flight to quality” trade to emerge with retail investors round the world shifting out of a) crypto and b) their own currencies into USDC, because for the first time ever, they can.

Last, there’s some risk that emerging economies cede monetary policy/destiny to individual savers in their countries. Capital controls are a tool often used by governments to combat currency devaluation - this is much harder to do when your citizens can just buy USDC/USDT. Which implies that eventually, if fiat-backed stablecoins continue to grow in adoption, governments will begin to build tools in their toolkit to at least track their citizens’ adoption and usage of stablecoins, in order for their capital controls to remain as effective.

Thanks to Brandon Carl, Amias Gerety, Justin Overdorff, Zach Abrams, Ranjan Roy, Saira Rahman & Temi Omojola for reading this in draft form.

[1] In full disclosure I’m an investor in Bridge.

[2] I’ve seen “permissionless” used a few different ways, including to mean not requiring KYC or AML on transactions. By using permissionless here, all I mean is; if you live in a country that’s experiencing hyperinflation, that country’s government cannot stop you from buying USDC, in the same way they basically can stop you from opening a bank account that can access USD. Or at a minimum, even if the government doesn’t care, your local bank no longer stands in the way.

[3] The most plausible synopsis I’ve seen so far for the UST < > Gold effect over the past couple of years goes like this (h/t Brandon Carl) ;

• The West largely reappropriated Russia’s money following the Ukraine war
• China and other countries obviously took notice - lots of data shows that they are now investing in gold instead of Treasuries.
• They are largely purchasing gold from people in the United States (ie ETFs selling gold)
• That provides cash to US investors.

[4] To be very clear, I’m referring to savings in the sense of a rainy day pool of money you might need at some unpredictable time in the future in normal course of business. This is in contrast to censorship resistance which you need if your government is coming after you.

Disclaimer：

1. This article is reprinted from[kunle]. Forward the Original Title‘May 2024: Stablecoins are helping create a buyer of second-to-last resort for US Treasurys’. All copyrights belong to the original author [KUNLE]. If there are objections to this reprint, please contact the Gate Learn team, and they will handle it promptly.
2. Liability Disclaimer: The views and opinions expressed in this article are solely those of the author and do not constitute any investment advice.
3. Translations of the article into other languages are done by the Gate Learn team. Unless mentioned, copying, distributing, or plagiarizing the translated articles is prohibited.