Stablecoins and US Treasuries: More Turbulence Than Lift?

Summary

• Stablecoins (SCs) expansion is likely to accelerate with Congress’ adoption of the GENIUS Act, which will provide a much-needed regulatory framework.
• SCs are unlikely to reach a scale where they would displace traditional money as SCs are a niche means of payments and cannot pay interest.
• Medium term, traditional money is likely to be tokenised and could become competition for SCs.
• Even if SCs displaced traditional money, this would increase demand for T-bills and lower demand for coupons.
• SCs are adding to money market volatility, reflecting the industry’s immaturity and its linkages to cryptocurrencies.

Market Implications

• SC expansion could lead to curve steepening and further money market volatility.

Stablecoins: a Special Type of Cryptocurrencies

Here, I argue SCs are poised for fast growth over the next few years but longer term are unlikely to lift demand for US Treasuries. This is because SCs are likely to remain niche money and could be made obsolete by the forthcoming tokenisation of bank deposits and money market funds (MMFs).

However, SCs have already become a significant source of money market volatility, largely because their demand is tied to cryptocurrencies performance and because SC issuers are still figuring out how to best manage liquidity.

Key Concepts

SCs are a special type of cryptocurrency. Cryptocurrencies in turn are tokenised money that operate on decentralised ledgers.

Tokenisation is the electronic representation of an asset on a programmable ledger. It allows the integration of messaging, reconciliation and asset transfer into a single, seamless operation. As a result, multistep transactions that settle sequentially, for instance RP, cross-border transfers, or MBS issuance, are settled instantaneously (‘atomic settlement’) and much more cheaply. In short, tokenisation will revolutionise the financial sector.

Beyond cryptocurrencies, tokenisation has already started with bank deposits, MMFs, stocks, and central bank reserves. For instance, the BIS’s Agora pilot for cross-border settlements involves tokenisation of central bank money and commercial bank deposits. Agora participants are seven of the largest global central banks and 41 of the largest global commercial banks.

A decentralised ledger is a record of all transactions in a network that is shared by all network participants. Every transaction is validated by the network participants using an agreed upon consensus algorithm. Once a transaction has been validated, it is added to the ledger and linked to the previous transaction in a way that makes it immutable (through cryptography). By contrast, a centralised ledger is controlled by a single entity and therefore more exposed to failure or manipulation.

Blockchain is the most common form of decentralised ledger technology (DLT), where data are stored in blocks and chained chronologically. Blockchain has been used mainly with cryptocurrencies but has applications in a variety of fields including supply chain management, healthcare, digital identity management and real estate.

Because of the cost involved with consensus validation of transactions, the blockchain can be subject to congestion and fragmentation, which undermines its scalability. Whether blockchain is less efficient than a centralised ledger is debated, with the BIS arguing a centralised ledger is more efficient over time.

Bitcoin (BTC) is the main cryptocurrency and accounts for 60% of market capitalisation of all cryptocurrencies. Other significant cryptocurrencies include Ethereum (ETH), XRP and Binance (BNB).

The key difference between SCs and cryptocurrencies is that the latter are not backed by any asset. Rather, their value fluctuates based on demand and supply with supply driven by an agreed rule. For instance, BTC and XRP have supply limits of 21mn and 100bn coins, respectively. ETH has a variable issuance rate. BNB ‘burns’ a set portion of its profits and of validators fees (fees collected by network participants when validating transactions).

By contrast, SCs are pegged to the value of an asset such as fiat currencies, cryptocurrencies or commodities. Most SCs are backed by actual reserves of the asset they are pegged to but some use algorithms to maintain their peg. The most common form of SC is pegged to the US dollar and backed by short-term USD assets. The main SCs are Tether (USDT), Coin (USDC) and DAI. USDT accounts for about 75% of SC market capitalisation.

SCs represent less than 10% of cryptocurrencies market capitalisation (Chart 1). They are more stable but strongly correlated to cryptocurrencies. This is because SCs are mainly used to settle cryptocurrency transactions.

Table 1: SCs Are Cryptocurrencies Pegged to an Asset Value

Chart 1: SC Demand Correlated to Cryptocurrencies Demand

GENIUS Act to Bolster SC Issuance

The US Senate has just passed the GENIUS Act that provides a regulatory framework for SCs (Table 2). Senate passage was secured with bipartisan support and House passage is expected shortly.

The Act defines who can issue SCs, mandates that SCs be backed 1:1 by liquid and safe assets, prohibits the payment of interest, and establishes the basis of a supervisory and regulatory regime.

The Act is likely to see a large expansion of SCs. This is mainly because it increases the safety and reliability of SCs. Regulatory clarity makes them investible for institutional investors, and it encourages responsible innovation by reducing regulatory uncertainty.

Table 2: GENIUS Act Provides Much-Needed Support to SCs

But SCs are unlikely to take much market share from traditional forms of money.

SCs Unlikely to Displace Traditional Money

Neither cryptocurrencies nor SCs growth have seen a decline in traditional money, namely cash, bank deposits of MMFs (Chart 2).

Since 2022, MMF assets have increased and banks assets flatlined relative to GDP largely due to banks not paying market rates on deposits, by contrast with MMFs. Therefore, the FFR increase of 2022-23 has seen a widening of the interest difference between bank deposits and MMF share and an increase in MMF assets. These changes have been gradual and orderly.

Traditional money is 116 times larger than all SCs outstanding. This leaves much room for fast SC growth. Also, I do not expect SC to displace traditional money largely because SCs lack a key property of money, singleness (Table 3).

Singleness refers to the property of money to maintain a 1:1 value with central bank money. This property exists with cash, which is already central bank money. It also exists with onshore bank deposits (i.e., dollar deposits in US-based banks) that are commercial banks issued money. This is because of three features:

• Interbank transactions are settled on the central bank balance sheet using central bank money (through Fedwire, a high value RTGS system the Fed provides).
• Deposit insurance.
• Lender of last resort.

Eurodollar deposits and MMFs have less money singleness than onshore bank deposits:

• They do not directly settle on Fedwire.
• They are not insured.
• Access to a LLR facility is limited:

• • For Eurodollar deposits, it consists of the Fed’s global central banks swaps administered by the central banks of the countries where eurodollar deposits are located.
  • For MMFs, the LLR consists of ad-hoc liquidity facilities the Fed typically establishes during periods of stress. For example, the MMF lending facility in 2020 and the AMLF and MMIFF facilities in 2008.

SCs have even less singleness than MMFs. Like MMFs, they do not have direct access to Fedwire. However, unlike MMFs, SCs are too small to pose a systemic risk and therefore would be unlikely to elicit Fed support at times of market stress. Lack of SC singleness is shown through the very frequent deviation from par of USDT and USDC (Chart 3).

In short, SCs are too risky to compete with bank deposits. The main advantage of SCs relative to bank deposits is their atomic settlement and their access to decentralised finance platforms. That is, SCs are likely to remain a niche form of money.

As the SC industry matures over the next few years, it may better maintain par with USD. However, traditional finance (tradfi) is unlikely to sit still. For instance, tokenisation of bank deposits or of MMFs is likely to gather pace. Bank deposit tokenisation would allow them to settle atomically and be used on Defi (DLT-based finance) platforms. For instance, to settle cryptocurrencies transactions.

SCs can be thought of as tokenised MMFs. SCs and MMFs have similar balance sheets (Chart 4). Since SCs cannot pay interest, it is unclear whether they could withstand competition from tokenised MMFs.

Chart 2: So Far Traditional Money Has Held Its Own

Table 3: SCs Lack Money Singleness of Onshore Banks Deposits

Chart 3: SCs Lack Money Singleness

Chart 4: SCs Are Form of Tokenised MMFs

Even if I am wrong and SCs take market share from Tradfi, they are more likely to add to T-bill rather than coupon demand.

SC Success Could Steepen Yield Curve

A liquidity shift away from bank deposits and into SCs would steepen the yield curve. This is because the assets of SC issuers consist mainly of T-bills while banks assets consist mainly of loans. Treasury securities account for only about 8% of banks assets and most are in long-dated coupons rather than T-bills (Chart 5).

Similarly, should holders of USD cash shift into SCs, this would raise the demand for T-bills but lower demand for coupons as the Fed’s Treasury holdings consist mainly of long-dated securities (Charts 6).

Because SCs cannot be easily used for everyday retail transactions, onshore holders of cash are unlikely to switch to SCs. By contrast, foreign holders, who typically hold USD cash to avoid local currency and/or the local banking system, would be more likely SC adopters, assuming they had access to a trusted SC issuer. About 75% of dollar bills or about $1.5tn are held abroad.

That said, it is unclear whether SC issuance would add to the attractiveness of USD assets. Ultimately, demand for USD-based SCs is based on demand for dollars and is driven by factors such as expectations, relative rates of returns and risk, with tokenisation and DLT having only a limited impact.

Chart 5: Banks and Fed Hold Mainly Treasury Coupons

(Balance Sheets, $bn)

Chart 6: Maturity Distribution of Fed Held Treasuries ($bn)

It is unclear if SC issuance will lift T-bill prices. But it is adding to money market volatility.

SC Issuers Adding to Money Market Volatility

A BIS study shows SC issuers already have a marked footprint in money markets. In 2024, they bought as many T-bills as China and more than Fidelity’s government MMF (Chart 7). The study showed a $3.5bn increase in SC market capitalisation lowered T-bill rates by 2.5 to 5bp but increased them by two-three times as much during redemption episodes. I think this asymmetry could reflect SC difficulties in managing liquidity. GENIUS Act rules together with industry maturation could reduce these effects.

Furthermore, by contrast with MMF whose assets expand steadily during periods of monetary tightening, SC assets shrink during these periods. This likely reflects that SCs are used mainly to settle cryptocurrencies and that those fall in value during periods of monetary tightening. If so, even with more efficient regulation and balance sheet management, SCs could continue adding to money market volatility.

Chart 7: SCs Adding to Money Market Volatility

Source: BIS, Macro Hive

Market Consequences

SCs have much room to grow but are unlikely to displace traditional forms of money. Even if they did, this would steepen the yield curve rather than add to coupon demand. In addition, SCs could keep adding to money market volatility.

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