The US Treasury needs Stablecoins. Stablecoins need Bitcoin.
Last week, the US Treasury announced its intent to expand purchases of 10- to 30-year bonds as interest rates rise. Bitcoin and gold rallied, and this rally structurally changed the perception of the asset.
A few weeks prior, Tether published its quarterly financials showing a $1.5B operating profit while losing $4B in excess capital over the same period. It gained operating profit while losing capital because it holds bitcoin and gold as reserves.
Tether holds bitcoin and gold for a reason. The Treasury announcement caused bitcoin and gold to rally for a reason. There is a structural shift happening in markets that can be a major driver of bitcoin adoption.
The Consensus View
Put bitcoin aside for a moment.
The conventional belief is that the US can’t manage its deficit; people sold its bonds; the Fed didn’t take action, so the Treasury stepped in to buy long-term bonds with short-term bills or general account reserves.
Long-term bond rates are basically the last bastion holding the US government accountable, and the actions they took are simply kicking the can down the road. The end result is either the debasement of the currency or a new vector of demand for US Treasuries.
Stablecoins are generally considered this vector, and the US Treasury is publicly aligned with their adoption for this reason. The inefficiencies of the global banking system inhibit the ability for individuals to access dollars. Stablecoins, by using digital signatures for payments, provide superior dollar access to the underbanked, unbanked, and inflation-hindered populations worldwide. As this adoption expands, more people hold stablecoins, ultimately driving demand for US Treasury securities. Today, this amount is in the hundreds of billions, and projections suggest that this market could grow into the trillions by 2030.
So by 2030, stablecoins are projected to reach $3 trillion, and it follows that within a decade, stablecoin demand could reach $10 trillion. Assuming a range of $1T-$10T in demand for stablecoins within the next 5-10 years is reasonable, and that any amount in that range represents substantial demand for the ~$30 trillion in US Treasury debt. The US Treasury is fiscally aligned with demand and will surely lean into its growth.
What most people are missing is that bitcoin has a major role to play in this development.
The Stablecoin Carry Trade
Carry is broadly defined as the expected return on an asset by holding its price fixed, and carry trades attempt to exploit opportunities in this. Currency carry trades are the most popularized; commodity carry trade returns have been the most volatile over time, and equity returns have been the highest performing.
Source: Ralph Koijen
Equity carry trades capture the spread between a funding cost and a dividend. This trade has produced the highest cumulative spread historically. Remember that.
Stablecoin issuers, primarily Tether and Circle (~85% of the market), exist as a carry trade. Their business model takes in zero-cost funding, places it in securities, and captures the difference (for Tether at least; Circle gives most of its margins to Coinbase).
Through this lens, stablecoins basically have two jobs: (1) maintain zero-cost funding and (2) maximize their return on that funding without undermining the funding itself. Whatever can be done to maximize return from reserves while growing adoption for the stablecoin is the primary incentive of any issuer, and this game will become increasingly complicated from an adoption, regulatory, and economic lens.
This structure of incentives could create a major vector of bitcoin adoption. Let me explain.
The Mechanism
Maximizing the economic yield of the reserve assets is a competitive advantage. As more stablecoins enter the market, there will emerge competition, not over yield but over distribution. Issuers will need to pass along the interest earned on their reserve assets to distribution partners or more directly to their users. Today, this is how Circle operates with Coinbase, passing along 60% of the float to Coinbase, which is then paid to customers in some proportion (the Clarity is primarily a battle over this workaround for the Genius Act in the US). Internationally, I expect to see a more favorable environment in which stablecoins pay interest directly to customers and distribution begins to take shape with the issuers themselves.
So we know this is already happening; the question becomes: how does it evolve? Money market funds (“MMFs”) emerged in the 70s as a workaround to regulations that limited the rates that banks were allowed to pay. There are several key insights from this period:
Banks influenced regulators to allow them to provide their own money market accounts to depositors with insurance, while MMFs survived as uninsured
MMFs continued to rise in number because they were easy to launch — there were 649 MMFs by 1990, up from about 75 funds in the 70s.
The 1990s MMFs grew significantly as bank deposit rates were less compelling in the low-interest-rate environment following the 1991 recession — people were able to earn more in money market, bond, and equity funds.
Banks started acting as distribution partners to MMFs
Ultimately, both banks and MMFs have continued to grow since. There was initial fragmentation of MMFs, followed by subsequent consolidation. The lessons learned from this period applied to stablecoins are:
They’re most valuable when official money is worst
The industry will continue to fragment
The scarce asset is distribution
What’s different about stablecoins is that you can also conduct payments in them.
Money funds said:
If the bank can’t pay the market rate on cash, we will wrap T-bills and pay it.
Stablecoins say:
If the bank cannot give you a portable dollar, we will wrap T-bills in it.
It’s at the intersection of the rate and portability that things get interesting. This is novel, and globally we have never seen a product with implications like this.
As the stablecoins continue to fragment, they will compete on yield and portability. Issuers will increasingly seek novel ways to offer higher yields, whether to their distribution partners or directly to customers, to gain market share.
Bitcoin Reserves
The largest stablecoin issuer, Tether, holds reserves not just in US Treasuries but also in corporate bonds, precious metals, public equities, and bitcoin.
Source: Tether
Today, these reserves are boosting Tether’s operating profits, making it one of the most profitable companies in the world. As competition emerges, they may have to pass these profits along to customers as yield paid on their stablecoin. What’s important to understand is:
they hold bitcoin as a reserve, not just as an excess reserve
almost a quarter of their reserves are not in US Treasuries, and they haven’t broken the buck in any meaningful sense to date — the lowest it’s traded was at $0.85 in 2018
Bitcoin has been the best-performing asset of the past decade and, since inception, is arguably the best-performing in history. Bitcoin bulls believe this will continue as the asset continues to monetize for an extended period. If you believe that bitcoin even achieves a 30% CAGR over the coming decade, holding it as a reserve will either be a competitive advantage for gaining market share, more revenue towards your distribution partners, or increase the profits you would capture as an issuer. Recall the historical performance of equity carry trades from earlier — stablecoin issuers will view the no-cost-stablecoin-to-bitcoin carry trade from the same lens. Further, bitcoin has even more enticing qualitative characteristics as the largest digital collateral trading 24/7 over a permissionless network.
Bitcoin’s return potential and superior digital characteristics are strong incentives for its expansion as a reserve asset. Its biggest problem is only that it is small and young, which will be solved with time.
The Case Against
This all sounds well and good, but if the reserves ultimately cause the stablecoin to lose its peg, then the issuer’s carry trade is over, as its zero-cost funding is eliminated. The advantage that was once used for growth can undermine the entire value proposition of a stablecoin in the first place.
Agreed. That’s why it starts gradually. Bitcoin is 3% of Tether’s reserves today, and I anticipate it will increase as the asset grows and the market becomes more accepting of it. This goes back to the beginning of this writing — the 54% drawdown in bitcoin of this cycle; if it persists, it is the precise market signaling that allows stablecoins to hold more bitcoin reserves. The market becomes more comfortable that bitcoin won’t suffer 80% drawdowns anymore and that it is growing up. This is the type of signaling that makes bitcoin more likely to serve as a countercyclical hedge against currency debasement (exactly what it did), ultimately making bitcoin the precise asset you want to hold alongside US Treasuries as demand for them declines globally.
This is why the recent market developments are so important for bitcoin. The US is going to continue to push for stablecoin adoption because it is a new vector of demand for its unmanageable debt. Stablecoins will continue to adopt gold and bitcoin as a countercyclical hedge.
Do we have any precedent for this other than Tether owning 3% of it’s reserves in bitcoin?
Strategy’s STRC preferred equity product is like a proto-bitcoin-backed, somewhat stablecoin. Legally and economically, it is a preferred equity ownership, but it is also a significantly overcollateralized position paying a variable dividend that depends on bitcoin’s capital returns. Strategy issued it for the product to act as an MMF by trading at par, which ultimately broke about 30% to the downside this year. Since then, Strategy has made more conservative decisions in hopes of returning it to par (it trades at $0.97 as I write these words). What STRC shows is that bitcoin-backed MMF economics are being pursued at scale and are somewhat achievable even today, with bitcoin still in its infancy. The differences between STRC and stablecoins are legion, but they illustrate the idea at its most extreme in economic terms. The thesis I’m proposing is that a more granular blend of these economics will continue to emerge.
The most compelling aspect of this idea is that as bitcoin grows, it becomes more of a self-fulfilling prophecy. Growth increases size, which increases liquidity, making it an even more compelling reserve asset fundamentally. Bitcoin’s biggest problem is that it remains small compared to alternative reserve assets, and, historically, it has been the best asset at eliminating that problem. Bitcoin’s value as a reserve asset is recursive.
Now you might be thinking, sure, but the GENIUS Act doesn’t allow for this, and it will never take hold. What’s missing is that stablecoins primarily exist in a global marketplace, and the US will primarily push for their international adoption because that is where the unaddressed market for the US dollar lies. In the US, this thesis isn’t going to play out in the near term, but globally it already is, and we’re witnessing it in real time.
Even so, I expect we will see this thesis play out to some degree in the “excess reserves” of US-compliant stablecoins where the residual between assets and liabilities grows from the float spread. Whether that economic benefit may be passed on to consumers is the primary tension in the Clarity Act. Still, Circle is a public company that holds no bitcoin in surplus.
Lastly, no sovereign has dollarized yet, despite stablecoin demand. The ultimate alignment of the US government here remains to be seen. If stablecoins fail to expand globally across the long tail of currencies, the US Treasury may have a change of heart.
Ultimately, I would abandon this thesis if Tether’s dominance fell below 40% and no compliant issuer accumulated hard assets in its surplus, nor did any global issuer accumulate hard assets in general.
Let me know what you think on X. Depending on feedback I might expand on this at the next issue in two weeks.
About Me
I’m a freedom and bitcoin enthusiast who runs a venture capital fund focused on fintech and bitcoin adoption. This is a biweekly newsletter where I write about finance, technology, economics, bitcoin, and how to make decisions. Tweet things at me and I’ll respond to them.
Originally published on Substack.