Stablecoins infiltrate shadow banking systems

Hello. Welcome to the FT Crypto Finance Newsletter.

The nightmare scenario for global financial authorities is not that they will eventually be replaced by cryptocurrencies, but that they will have to bail out the market at some point.

The closest it came was last year when Silicon Valley Bank collapsed. Circle, a stablecoin operator and SVB’s largest depositor, had deposited $3.3 billion in reserves with stricken lenders without insurance. In the panic, Circle’s “safe” stablecoin USDC lost its peg to the dollar, and crisis was only averted when the Federal Reserve guaranteed SVB deposits.

As more commercial companies issue stablecoins and U.S. politicians consider legislation to encourage the use of these tokens, the time for central banks to set the terms of their engagement with cryptocurrencies is nearing. There is a possibility that there are.

Stablecoins issued by private companies are the closest thing to digital cash, and most track the value of the U.S. dollar on a 1:1 basis. In addition, the same amount of dollars is to be prepared. These coins are receiving a lot of attention as the cryptocurrency market recovers from its 2022 lows.

The amount of stablecoins in circulation is approaching an all-time high of approximately $150 billion. In recent months, companies like PayPal and Ripple have announced plans, and many more are announcing plans. Last month, U.S. senators Cynthia Lummis and Kirsten Gillibrand proposed legislation that would create a regulatory framework for these tokens.

But what really made people sit up was the return of $65 billion Silicon Valley payments giant Stripe to crypto payments for the first time in six years.

Crypto entrepreneur Jonathan Bixby likened Stripe’s move to the arrival of the U.S. Spot Bitcoin ETF in January.

“The core of the Bitcoin ETF was an introductory exercise for traditional capital flows into ‘cryptoland,'” he said. “Stripe’s announcement is, in a sense, the same principle reversed. Instead of fiat currency appearing in a crypto rand, cryptocurrencies are being used as real-world currency.”

Taken together, this strengthens the narrative that stablecoins finally provide an answer to the fatal question: “What are cryptocurrencies for?” The argument is that these can be used for payments between consumers and businesses, meeting future payment needs and even increasing financial inclusion.

How much is used in actual trading is another matter. An eye-catching analysis by Visa suggests that there was more than $2.5 trillion in stablecoin trading volume in the past 30 days, with USDC far outpacing Tether, long considered the market leader. .

However, once Visa eliminated transactions related to pre-programmed trading algorithms, the total amount of transactions using stablecoins decreased by approximately 85-90% per day. This large discrepancy may be because USDC is widely used in decentralized finance and relies heavily on automated trading to provide market liquidity.

But what happens when Stripe and others are right, and stablecoins grow large enough to represent meaningful transactions? Then they become guardians of trillions of dollars and become the custodians of “shadow banking.” system (a generic term for financial institutions that lend, hold, and borrow money but are not regulated like banks). This includes pension funds, asset managers, clearinghouses and insurance companies.

One key question is what will happen to dollar assets held in reserves. A lockup of cash or U.S. Treasuries could significantly deplete the liquidity of the financial system on which stablecoins depend.

Currently, most stablecoin operators either park their cash in short-term U.S. Treasuries for healthy yields, leave it as cash deposits in banks, or do reverse repos in the market. The latter lend out surplus cash and receive assets such as short-term government bonds as collateral.

If the counterparty goes bankrupt, the value of the government bonds held is likely to rise, providing strong protection against the risk of counterparty bankruptcy. Clearing houses do this all the time using excess deposits from derivative margin payments.

The situation will change completely if you handle large amounts of money. Stablecoin operators have already exhausted their insurance limits on bank deposits. One answer could be for authorities to require stablecoin operators to reverse cash repo-outs.

However, as independent financial commentator Francis Coppola pointed out, locking up assets as cash or reverse repurchase transactions comes with drawbacks for operators. “They can hold on to assets for a very short period of time. . . . Their problem would be that they don’t make any money,” she said.

If a stablecoin operator chooses to earn a higher yield by purchasing government bonds, it risks constructing a balance sheet where the average life of its liabilities is shorter than the average life of its assets.

Additionally, the Fed may be concerned that stablecoins are hoarding too much U.S. Treasuries and may be looking to limit their size. However, such concerns may be overstated, especially given the projections for U.S. debt issuance in the coming years.

Some banking regulators privately see the issue of stablecoin scale as a long way off, believing these tokens need to be tied to trillions of dollars before they start worrying. .

But what shakes up the market the most are the overlooked issues, those that were initially considered unimportant, but that grow as business activities expand. And suddenly such issues are at the center of the crisis. No one notices at first because they’re looking at the money coming in through the front door, not what’s going on behind the scenes.

What do you think about the future of stablecoins? Email philip.stafford@ft.com.

Join me and my colleagues at the FT’s flagship event, the Crypto and Digital Assets Summit, in London from 8th to 9th May. Hear from key industry figures including Julia Hoggett, CEO of the London Stock Exchange, Bim Afolami, UK Government Treasurer and Cities Secretary, and Michael Sonnenshein, CEO of Grayscale Investments. Reserve your seat now at crypto.live.ft.com

weekly highlights

Roger Ver, nicknamed “Bitcoin Jesus” because he was an early cryptocurrency evangelist, has been indicted by the U.S. Department of Justice on charges of mail fraud, tax evasion, and filing false tax returns. He was arrested in Spain last weekend.

Hong Kong follows the US in approving spot Bitcoin exchange traded funds.

The new U.S. Spot Bitcoin ETF has found its crypto vault gathering dust and spitting frogs.

This week’s soundbite: Forward

Binance’s former chief executive, Qiao Changpeng (also known as “CZ”), was found guilty on Tuesday of failing to comply with money laundering regulations.

The judge was unfazed by the Justice Department’s three-year request and set a custodial sentence of just four months. Zhao has said little since pleading guilty in November, but said in court that he “deeply regrets my mistakes and is sorry,” the Associated Press reported. Later on the X social media site he said:

“I will take my time to finish this phase and focus on the next chapter of my life (education).”

Data mining: Trends are not your friend

The laziest way to explain why Bitcoin rose 72% to its all-time high in March of this year is that inflows into the new U.S. spot Bitcoin ETF created more buying. Bitcoin’s daily movements are more complex than that. Still, they can thrive and fall in stories. Wednesday was the worst day on record for US spot BTC ETFs as Bitcoin fell to $56,000. All companies, including BlackRock, recorded outflows for the first time, bringing the total outflow to $571 million, according to CoinShares. With the early momentum weakening, capital outflows are expected in the fourth week.

Crypto Finance is edited by Lawrence Fletcher. Click here to view previous editions of the newsletter.

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