The Breakdown - Are Stablecoins Eurodollars 2.0? Long Reads Sunday

Episode Date: July 19, 2020

On this week’s Long Reads Sunday, we look at two essays about stablecoins previously published on CoinDesk.  The first is called “USD Stablecoins Are Surging, but Zero Interest Rates Complicate Business Model” by Hasu and was one of the first pieces to recognize that demand was coming not just from the crypto space but from emerging markets facing crisis time currency pressures.  The second is “Hyper-Stablecoinization: From Eurodollars to Crypto-Dollars” from Pascal Hügli. The piece argues that stablecoins are likely to play an increasingly important role in the global economy. In effect, they are a better version of the critical eurodollar system.

Welcome back to The Breakdown, an everyday analysis breaking down the most important stories in Bitcoin, Crypto, and Beyond. This episode is sponsored by BitStamp and Crypto.com. The Breakdown is produced and distributed by CoinDes. And now, here's your host, NLW. Welcome back to The Breakdown, guys. It is Sunday, July 19th, and that means that it is Long-read Sunday. One of the most common themes on the breakdown is the role of the dollar in the world. Just this week we had John Turrick talking about how the dollar might, for the time being,

be a solved problem. Well, I want to explore a dimension of this that has to do with crypto dollars, and I want to do it with a tiny little bit of recent historical context. This year has been a breakout year for USD stable coins. And so I'm going to start with an essay by Hasu from Krookin. CoinDesk that was published on March 30th about stablecoins. It was one of the first to assess what might be driving demand in a different way, and then follow it up with a new essay called Hyperstablecoinization by Pascal Hugley that just published on July 12th. I think together they

give a really good portrait of the evolution of this space over just the last three months. March 30th, 2020, USD stablecoins are surging, but zero interest rates complicate business model. The last 30 days have been historic by any meaning of the word. The coronavirus is shaking up life as we know it and has already caused unprecedented dislocations in both the traditional financial markets and the crypto market. In the center of this financial turmoil was the U.S. dollar, which saw a flight to safety from many different assets, including ones deemed safe by traditional investors. As I write this article, the S&P 500 is down 20% against the dollar in 2020, crude oil down 62%, the British pound down 9%, and both the Russian ruble and the Brazilian

Real are down 25% respectively. While the crypto markets have been insulated from the markets at large for a long time, this is no longer the case, now that public blockchains have effectively become rails for the US dollar in the form of dollar-backed stablecoins. Dollars on the blockchain represent the third largest asset in crypto after Bitcoin and Ether, ahead of XRP and Bitcoin cash. In terms of transaction volume, they are even encroaching on Bitcoin itself. And since they are backed by dollars, they are both affected by global changes in demand for the U.S. currency, as well as the monetary policy of the Federal Reserve. Since Bitcoin fell from its $9,000 range all the way below 4,000 before consolidating around 5,000 in mid-March, stable coins as a group have seen net inflows of around

2 billion, a 33% increase. This represents the largest surge in demand ever, in line with the dollars demand surge in traditional markets. Most of these inflows went to tether, with $1.55 billion added since the start of the year, but USDC and BUSD also gained $1 million and $150 million, respectively. As demand increases, investors bid up the price of a token beyond $1, that creates an incentive for arbitrage firms to step up and introduce more supply into the system until the spread closes. To give an example, a firm could deposit $10 million with Tether to buy $10 million USDT tokens for exactly $1,000. apiece. Then it sells these tokens for slightly more than $1 and pockets the difference as profit. For the last month, USDT has consistently traded above $1 as a result of this increased demand,

explaining the massive $1.55 billion inflows. Why do investors want USD stable coins now more than ever? I believe there are three main reasons for the surge in interest. First, we have seen a flight to safety from risky crypto assets as the markets tumbled. I saw people who are bullish on cryptocurrency in the long term divest for the short term as previously uncorrelated asset class. started to move down in lockstep. Second, there is big demand for USD from emerging market currencies that are weakening against the dollar, as described in the intro. Due to offshore nature, USDT in particular, has become one of the best ways to dollarize

in places like China, Indonesia, Russia, and Brazil. Finally, the physical reality of coronavirus quarantines and travel restrictions has made moving cash extremely hard for the time being, especially between countries. Dollars on the blockchain have some of the desirable properties of cash, especially in terms of permissionless access and privacy, if used correctly, and can act as a substitute at least temporarily. While dollar-backed stablecoins increasingly turn into Eurodollar's light, they are also subject to the monetary policy of the dollar. On March 15th, the Federal Open Market Committee lowered the federal funds rate by 1% to 0% to 0.25% to soften the upcoming recession caused

by the coronavirus. This reduction actually has big effects on the business model of these stablecoin issuers. To understand why, we need to only look at how they make money. So far, there are two main ways. First, by investing their reserves, usually by lending it to commercial banks or buying AAA-rated fixed-income securities like U.S. government bonds, going into 2020, the largest stable coins held a collective 5.5 billion of customer funds. At an interest rate of 1.25%, these deposits could have generated up to 68.75 million in revenue for them. Because the Fed funds rate affects all commercial interest rates, the issuer of coins like Tether and USDC now stand to make significantly less money from interest going forward.

If the rates become negative, which is the case in Europe and Japan, then they might even have to pay in order to deposit money, turning their business on its head. Due to the reduction in revenue, there are concerns that stablecoin operators could be pushed into riskier investments to pay the bills, for example, corporate bonds. This dynamic could explain why euro or yen-backed stablecoins have never taken off. As a second revenue stream, some operators like Tether already charge a fee, currently 0.1% on deposits and redemptions, while others, like USDC, don't. We might also see stablecoins explore entirely new business models to meet the new zero-rate realities. USDC seems to push into

the direction of becoming a de facto commercial bank by providing APIs for payment, including from fiat cards, wallets, marketplaces, and business accounts. For now, it seems more likely that operators will try to build and charge adjacent business models made possible by these stablecoins instead of passing on cost to retail users, e.g. via inflating the token supply relative to deposits as a form of usage tax, or implementing an additional transaction fee. The latter brings its own challenges, as users are incentivized to wrap the original tokens in a trustless contract and transact in the receipts instead, similar to W-Eath-slash-Eath. Centralized exchanges could once again be the kingmakers in this situation, as they can decide to support the wrapped tokens or not.

Even with revenue from interest drying up, I see a big future from dollar-backed stablecoins, especially now that the opportunity cost for holding stable coins has effectively gone to zero. We'll probably see even larger inflows in the future, both from places with negative interest rates in their traditional bank accounts, as well as emerging markets with currencies that rapidly lose their value against the dollar. As long as users value the service offered by stablecoins, I see good odds that operators can develop new and sustainable business models. Bit Stamp is the original global cryptocurrency exchange.

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Bitcoin is understood as money crypto while Ethereum is labeled Tech Crypto. Bitcoin is sound money that will make all other money's obsolete. Ethereum, on the other hand, is seen as better tech that will update Wall Street settlement layer. The conflict is incomprehensible to outsiders, and each community says, that the other has not understood the crypto world's actual goal and ethos. You could imagine this conflict going on for years, a sort of Game of Thrones for blockchain. But there's another more hopeful way of imagining the future. Conceivably, the future will be one where Bitcoin and Ethereum gain greater relevance alongside each other. Both money crypto and tech crypto will play their roles.

It might just not be in the pure sense envisioned by either of the two maximalist groups. Dollar Shackles We are currently under a crushing dollar yoke. Back in the 19th, In the 17th century, many parts of the world had free banking. Banks were granted unrestricted competitive issuance of currency and deposit money on a convertible basis. But gradually, the paradigm of free banking faded away and state- orchestrated fiat currency took hold. After World War II, much of the world started trading in dollars, making it into a reserve currency. To this day, U.S. Treasuries provide a safe haven in times of financial turmoil, tightening the dollar's grip

on global finance. Greater dependence on the dollar means greater dependence on the Federal Reserve. As a national bank, the Fed puts national interest first. These oftentimes contradict with other countries' concerns, leaving them in a tight spot. As the world has been dollarizing, a paradox has emerged. Although the U.S. Central Bank is often criticized for inflating its currency, global markets deem the available amount of dollar liquidity to be insufficient. This lack of liquidity has caused financial actors all around the world to start helping themselves. Euro dollars needed. The world, especially emerging market economies, really needs dollars. The emergence of the euro-dollar system in the 1960s was a direct consequence of the Fed not being able to support the world's relentless need for extra dollars.

Euro-dollars are U.S. dollar accounting entities that are used to settle cash flows between numerous players outside of the banking system supervised by the Fed. As such, Euro-Dollars are not subject to U.S. banking regulations. As the economist Milton Friedman pointed out in 1969, Eurodollars are created by the bookkeeper's pen. Corporations, banks, and other international actors are dependent on, dealer markets providing enough Eurodollar funding to uphold market liquidity and service debt. These private dealers are acting primarily through the shadow banking system. Because the dollar has ascended to become the world's number one currency with the deepest and most liquid capital market, people all around the globe have been going into dollar

debt. There is nearly $60 trillion in dollar-denominated debt globally and immense demand to service dollar debt. Euro-dollars are the world's way to grapple with recurring short squeezes on the dollar, a global dollar shortage that manifests itself each time with ever greater severity. But euro dollars are not actual dollars. They are offshore dollars or could be seen as dollar approximations. In times of crisis, this becomes evident as financial market actors strive to acquire actual dollars.

With every crisis, the Fed has to pump more dollars into the system, only to nourish the ground for a future crisis. As ongoing turbulence in the repo market and the broader shadow banking market system show, the Fed's action seems only temporarily to soothe appetite for more and more dollars. higher demand for dollars will also imply further depreciation of local currencies against the greenback, especially in emerging markets. The most current example of this is Lebanon, where the local currency has lost at least 50% of its value against the dollar this year. Greater capital controls in these types of markets could well be in store, which would make it harder for debtors to obtain dollars

or euro dollars for that matter. Enter public blockchains. In times like these, public blockchains with a liability-free native asset can act as a neutral settlement network independent of the financial system. The stage is set for Bitcoin and Ethereum to be used as vehicles to alleviate the world's global dollar shortage. For example, US dollar stablecoins, so-called crypto dollars running on Bitcoin and Ethereum, are a way to get dollar exposure or dollar proxies. As natively digital-bearer instruments, with transparent and efficient auditability capacities, crypto-dollars are easy to accept and can be traded 24-7-365 with virtually no downtime. They can also help circumvent emerging capital controls on traditional finance and euro-dollar paths. The euro-dollar approach

was an attempt by private actors to create a dollar funding system outside the U.S., but still within the traditional financial system. Cryptodollars mainly reside outside the traditional U.S.-led financial system. Because of its inherent auditability, the crypto-dollar system is more transparent than the old Eurodollar system based on shadow banking, so named for a reason. upgrade for the Eurodollar. We're beginning to see the dollarization of public blockchains. Since March, the value of USD-Peged stablecoins has passed $11 billion. Tether could surpass the market cap of Ethereum or even Bitcoin due to growing demand for synthetic

dollars in its approximations. Hyperstablecoinization will be the upgrade for Eurodollar banking. It will once again be private individuals using the innovative tools at their hands to make sure they can get the dollar exposure that they need. But this time, the tools are public blockchains and create. cryptographic tokens. The shadow banking system is a way for private actors to pledge collateral to create synthetic dollar funds and approximations. But the crypto world, in conjunction with the programmability of public blockchains, will take this one step further. Bitcoin and Eath already

serve as collateral to create dollar deposits and dollar credit instruments. A new type of free banking on public blockchain's networks is off the horizon. While crypto dollars will be its big driver, Bitcoin and Ether could play their part as well. As high-powered non-state collateral, these crypto assets could be used to back the future crypto dollars, making them even more resilient. It is very likely that we will see more of the following in the future. Crypto-backed stable-coins like Dai, Bitcoin-backed financial services like value or stable crypto dollars redeemable for Bitcoin that, for example, Chinese blockchain wallet provider Bixin is planning to launch. Also, exchanges in crypto banks issuing crypto dollars against

liability-free synthetic crypto assets seem only a matter of time until realization.