Welcome to our new series, Node Notes, where we’re spotlighting topics from our bi-weekly research piece, The Node Ahead. If you want to read the full piece, you can check out our blog or sign up to receive The Node Ahead straight to your inbox. This edition of Node Notes is an excerpt from Node Ahead 40.
Some stablecoin background
Stablecoins are blockchain-based digital assets that are designed to maintain a constant price. Stablecoins have several of the same advantages as other cryptoassets, such as being open, global, and accessible to anyone on the internet without the need for a bank account. For most people, fast processing and low transaction fees make stablecoins a good choice for sending money across borders without having to pay exchange fees. For e-commerce, stablecoins offer the ability for merchants to accept payments without paying the 3% fee that credit card companies charge on every transaction. And for people living in countries experiencing hyperinflation, stablecoins can preserve their wealth and provide better property rights protection through self-custody. As a result, stablecoins have become an integral component of the digital asset space in recent years, acting as a primary rail through which fiat enters and exits the market.
The two biggest stablecoins in the market today are USDC which is issued by American-based Circle (hence the “C” at the end), and Tether (USDT), which is managed by Hong Kong-based iFinex. Why someone would use USDC vs. USDT is a matter of availability, liquidity, and perceived trust. Without getting into details, let’s just say Tether has a checkered history and is not necessarily known for its transparency regarding the collateralization of USDT. On average, USDT is more popular in Asia, while USDC is more popular in North America.
The most common way for stablecoins to remain stable in price is to be backed by collateral, and the most common collateral used is the dollar. Both USDT and USDC are backed by dollars (hence the “USD” in both names). When someone converts fiat to stablecoins, dollars are deposited into a bank, after which the stablecoin is issued with a 1:1 ratio against those dollars. When a person wants to convert their stablecoin back to dollars, that stablecoin is destroyed, and USD is issued back to that user.
Why the U.S. could benefit from stablecoin adoption
From a global strategic point of view, it could benefit the US to embrace dollar-backed stablecoins. As we just mentioned, all the largest stablecoins are denominated in USD meaning stablecoin issuers hold their reserves in dollars and short-term U.S. Treasuries (more on this in a minute). Most of the collateral in smart contracts and DeFi is now dollar based stablecoins, and as a result, there is more value settled in stablecoins than bitcoin or ether. Crypto essentially gives anyone in the world access to dollar-based financial services through the use of stablecoins, even if they can’t access dollars through their local financial system. Places with the highest inflation are precisely the regions that benefit the most from a stable currency which is why we see the highest adoption of crypto and stablecoins in emerging markets. The bottom line is crypto is a vector for proliferating the use of the dollar globally. This both increases demand for USD and makes dollars more accessible to buyers across the globe. The adoption of dollar-based stablecoins around the world gives the U.S. an opportunity to further entrench the dollar as the world reserve currency at precisely the time when other countries are actively exploring other currencies to transact in.
But it’s not just demand for dollars, stablecoins also increase the demand for US treasuries. The way stablecoin issuers make money is that they take in dollars, issue stablecoins, and then take a portion of those dollars and buy short-term US treasuries. Those treasuries pay out an interest rate which the stablecoin issuer profits from. This is important because, over the last 20 years, the amount of US treasuries that foreign nations hold has grown to nearly a quarter of all US debt. Stablecoins, which purchase US treasuries as a portion of the collateral they hold, could help diversify that ownership of US debt (ideally to more US-based companies such as Circle or US banks). Furthermore, embracing stablecoins would also allow the US to set requirements around USD reserves and transparency, mitigating consumer protection risks and national security risks at the same time.
Stablecoins could also solve some current problems for central banks. For one, the rise in interest rates by the Fed, which is causing problems for many banks’ balance sheets, should be good for stablecoins. When stablecoin issuers take in dollars and buy short term US treasuries, they keep all of the interest income themselves and pass none of it on to token holders. As a result, rising interest rates are pure profit for stablecoin issuers who do not have the same infrastructure costs that banks do. More importantly, due to deficit spending, the Treasury’s financing needs remain quite large. The Treasury finances its deficit spending by issuing debt, but several of the largest buyers of US debt have been pulling back from investing in treasuries in recent years. The Federal Reserve, which is the largest owner of treasury bonds, has been reducing its portfolio through Quantitative Tightening. In short, Treasury bond liquidity is deteriorating. Stablecoin issuers could possibly provide the Treasury a brand new, persistent buyer of US Treasuries precisely when it is needed most.
The potential for stablecoins to really benefit the US economy and national security will only be realized if U.S. policymakers pass reasonable regulations that provide clarity to the market. The thing is, that bill already exists. Over a year ago, a bi-partisan stablecoin bill called “The Stablecoin Transparency Act” was introduced. The bill requires stablecoins to be fully backed by a combination of U.S. dollars and “government securities with maturities less than 12 months” (ie, short-term US treasuries) as well as mandates that issuers of stablecoins regularly publish audited reports demonstrating their reserves. This bill seemed like a no-brainer and had support from both sides of the aisle as well as from the majority of the crypto community.
So why hasn’t this bill passed into law already? I’ll give you a hint, it rhymes with Harry Hensler.
Yup, the same agency that is supposed to be in charge of protecting consumers has actively lobbied against a bill that would promote the use of the dollar worldwide and increase the stabilization and transparency of stablecoins. According to reports, multiple people close to the negotiations say the SEC had constant objections and last-minute revision requests. “The stablecoins legislation was coming together over the summer, and the SEC was known to oppose it,” said a former government official familiar with the matter.
Why would the SEC oppose the bill? Because it would undermine their power. As we have covered in past issues, the lack of federal regulations over the crypto industry has allowed the SEC to step in to fill that void. Gary Gensler doesn’t want those gaps filled because it would lessen his oversight capability. He has even reiterated to reporters that he doesn’t see the need for new laws to regulate the space. “I think the true aim was to stop any stablecoin legislation,” said a former official. “It tracked with their activities now, which is essentially claiming through enforcement action that these stablecoins are securities.” The blocking of sensible regulation is causing money to flow out of the US and into offshore-based stablecoins as well as non-dollar-backed stablecoins.
Despite Tether’s long history of clashes with regulators and concerns with its collateralization, several market participants have rotated out of US-based USDC and into USDT in recent months. USDT supply has expanded back to $72.8 billion, now accounting for 57% of all stablecoins in the market. Meanwhile, the second largest stablecoin USDC has seen roughly a $15 billion decrease (-27%) in total circulating supply since its peak in July of last year.
Based on the data, it appears many market participants are more concerned about the US’s regulatory approach to crypto than Tether’s checkered history. That’s a shame because that means our regulatory agencies are driving business away from US-based companies and into foreign competitors. It could also be bad for consumer protection as most people in the industry would agree that Circle is far more transparent about what assets back USDC than USDT. But the real kicker is that it’s also potentially bad for the dollar. Last year, Tether announced that, for the first time, the company is buying government debt from countries outside the U.S. The vast majority of Tether is still backed by the dollar, but the trend of diversifying away from the dollar is growing. Other foreign issuers have already launched stablecoins in other currencies, including the Euro and the Canadian dollar. Does the US really want the number one stablecoin in the world to be based outside the US and become less reliant on the dollar? Because it appears that’s exactly what US regulators are currently promoting.
In an interview with Fortune, David Mercer, the CEO of Mercer Group, noted that although banks have invested billions in blockchain tools and are keen to trade bitcoin and other major cryptoassets, the SEC is standing in the way. “It’s not banks saying no to crypto, it is U.S. regulators,” says Mercer. It’s time our regulators stop viewing stablecoins as a potential problem and realize them for what they are, an opportunity to bolster the US economy and national security. Between the SEC’s enforcement action on Paxos and Kraken, regulators’ public comments regarding Silvergate, and the FDIC forcefully shutting down Signature Bank, the US continues to incentivize people and businesses to move their money to offshore entities that are much more opaque, far less regulated, and often times have less than a stellar track record. Just last week, Coinbase CEO Brian Armstrong came out and said he would consider moving the company out of the US if the regulatory environment for the industry does not become clearer.
The US House Committee recently published a draft of a new stablecoin bill in an effort to try to get a bill passed once again, which reportedly still has bipartisan support. It lays out a framework in which insured depository institutions (aka banks) seeking to issue stablecoins are supervised by an appropriate federal banking agency, and non-bank issuers such as Circle and Tether are overseen by the Federal Reserve. Hopefully, we will get some common sense, reasonable legislation passed in the near future, as it would benefit consumers, the crypto industry, and the US as a whole.
Disclaimer: This is not investment advice. The content is for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice. Nothing contained constitutes a solicitation, recommendation, endorsement, or offer to buy or sell any securities or other financial instruments in this or in any other jurisdiction in which such solicitation or offer would be unlawful under the securities laws of such jurisdiction. All Content is information of a general nature and does not address the circumstances of any particular individual or entity. Opinions expressed are solely that of Brett Munster and do not express the views or opinions of Blockforce Capital or Onramp Invest.