The difficult business of stablecoins | #332
Also, Dep’t of Treasury investigates stablecoins (and tokenized deposits)
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This week:
The difficult business of stablecoins
U.S. Treasury investigates stablecoins (and tokenized deposits)
Stuff happens
1. The difficult business of stablecoins
In light of Ripple’s recent offer to buy Circle for around $5 billion, Todd Baker has published a great analysis of Circle’s stablecoin’s business. (Baker’s a managing principle at Broadmoor consulting and a senior fellow at Columbia University.)
Baker’s take? While the vibes around Circle are hot because stablecoins are in right now, the fundamental business is not nearly as desirable. (Unless, you’re Ripple, which Baker addresses later in the piece.)
First, Circle is basically just a narrow bank:
News Flash: Circle isn’t really a tech play at all. Financially, Circle is a highly levered, uninsured narrow bank with nearly all of its revenue coming from a big bucket of short-term cash investments. It makes money when rates are higher, up to a point, and makes less or loses money when rates are low.
That makes Circle a market play on — or a plaything of — volatile short-term interest rates, with another big dollop of revenue volatility tied to estimates of future crypto trading volume, beliefs about blockchain inevitability and who will be the ultimate winners if stablecoins go mainstream.
Narrow banks take in money from customers as deposits, invest that money directly in Fed Funds with zero credit risk and pay interest at a slightly lower rate to their depositors. They don’t do maturity, credit transformation or much else, so their operating costs are low.
But even in narrow bank terms, it’s not “ideal”:
But there are a few differences between Circle and the Platonic ideal of a narrow bank. Unlike a true narrow bank, its liabilities (coin-holder “deposits”) are non-interest-bearing (because otherwise fiat stablecoins are securities under US law, or at least they are until the last person left at the SEC forgets the rules.) That means that Circle is unable to use deposit costs (which at a narrow bank might equal 40-70 per cent of interest revenue) to manage towards a stable (or at least predictable) net interest margin like a bank but instead is fully exposed to the impact that changes in market interest rates have on revenue.
The biggest problem? Outside of network effects, Circle’s USDC doesn’t have much of a moat:
Does Circle have any special sauce that can’t be reproduced by new competitors, particularly those with big names in finance? History suggests not. At bottom, Circle’s business is extremely simple and easy to replicate: take money in, invest in T-bills, send money out, pay marketing partners (instead of depositors) and keep track of it all on a blockchain.
Circle has some scale advantages. Even if USDC issuance and its balance sheet increase materially over time, its fixed costs are likely to continue to be relatively stable. But scale only matters if scaling is costly. It’s relatively trivial to build a stablecoin now that the pattern has been set. If real world adoption picks up in a government regulated market, who will be likely to benefit? My guess is the big banks, big crypto trading outfits or big tech companies that dominate real world applications. Circle will get the leftovers.
2. U.S. Treasury investigates stablecoins (and tokenized deposits)
A couple of weeks ago, the Treasury Borrowing Advisory Committee (TBAC) convened a closed session to discuss a range of topics—including forms of emerging digital money including stablecoins and tokenized deposits.
From the meeting minutes:
The Committee then discussed the second charge addressing the terminal effects of interest-bearing stablecoins on demand for Treasuries, USD hegemony, the expansion of the dollar-backed payment stablecoins, and potential effects for insured depository institutions. The presenting member began by reviewing current stablecoin market dynamics and the potential for growth in adoption, noting that the current legislation in Congress provides for a prohibition on yield to holders. There was robust discussion concerning the potential implications of interest bearing stablecoins versus non-interest bearing stablecoins, and the extent to which growth in stablecoins would result in net new demand for Treasury securities rather than a reallocation of demand from banks and money market mutual funds. The Committee also discussed the potential benefits and risks for the financial system of increased adoption of stablecoins.
Along with the minutes, TPAC also published their Digital Money presentation—a worthwhile read.
Of note, they expect the stablecoin market to grow to ~$2 trillion by 2030. They also analyzed their potential impact on U.S. dollar relevancy worldwide, the Treasury market, as well as traditional bank deposits.
On the positive side (at least from the American perspective), the attractiveness of U.S.-dollar stablecoins—which represent pretty much the entire market—could drive liquidity in other currencies into the American dollar while also increasing overall demand for U.S. Treasuries.
On the other hand, the rise of stablecoins could disrupt the traditional banking system when it comes to credit creation and deposits, further exacerbated if stablecoins are allowed to be interest bearing.
From page 10 of the report, which focuses on the potential impact of stablecoins on bank deposits:
Non-Interest Bearing Stablecoins
“Potential rotation from stablecoins into tokenized MMF overnight in order to capture yield
As stablecoins are already non-interest bearing today, growth will likely be a continued function of payment utility and overall Digital Assets market activity”
Interest Bearing Stablecoins
“Potential rotation from traditional deposits into stablecoins, which may offer more usability or competitive rates
Reinforces global attractiveness of USD-pegged stablecoins, particularly for existing on-chain holders and for those utilizing USD-pegged stablecoins as a store of value”
As the presentation notes in its key takeaways:
“Stablecoins could disrupt traditional banks by drawing away deposits. However, they also present chances for banks and financial institutions to create innovative services and to benefit from the use of blockchain technology.
The ultimate design and adoption of stablecoins will drive the magnitude of impact that stablecoins have to the traditional banking system, as well as the demand for US Treasuries”
Finally, the presentation also acknowledged tokenized deposits as an alternative digital money implementation on page 4, referencing initiatives currently underway at JPMorgan Chase and Citibank, which focus on institutional use cases.
Check out the full presentation.
3. Stuff happens
The Future Of Cryptocurrency: A 10-Year Forecast | ABC Money
Bags of Cash From Drug Cartels Flood Teller Windows at U.S. Banks
An $8.4 Billion Chinese Hub for Crypto Crime Is Incorporated in Colorado
Matt Levine: Bitcoin treasury meta-company
Project Pine: central bank open market operations with smart contracts
Via Mitja Simcic—Stripe Launches Stablecoin Accounts and AI Model for Payments | PYMNTS.com
Via Jun Hiraga—Stripe Introduces Stablecoin Accounts in More Than 100 Countries