Stablecoins fuel liquidity, not yet money: Mike Dolan

Treasury market bulwark or catalyst for a liquidity bubble? No one's sure whether the now government-blessed "stablecoin" explosion will juice or destabilise the economy.

When Congress passed the so-called "Genius Act" on stablecoin legislation last month with bipartisan support, it triggered another wave of speculation about just how much havoc these dollar-pegged crypto tokens might wreak, including fears of fraud, tax evasion and instability.

Those pushing back on the crypto-Cassandras have put forward much more benign forecasts, arguing that stablecoins, given their limited retail use, will remain firmly encased in the esoteric financial world, muffling any potential negative impact on the wider economy.

But these instruments are connected with arguably the most important part of the financial system: the U.S. Treasury market.

Key to the new legislation is a requirement that stablecoins - so far mostly used by crypto traders to move funds between tokens - are fully backed by liquid assets such as cash or short-term Treasury bills. Issuers are also required to disclose the composition of those reserves monthly. And with a market cap in excess of $250 billion that could explode to some $2 trillion within three years based on some estimates, stablecoins have the potential to pack a serious systemic punch.

Perhaps ironically, the link to Treasuries actually offers one of the more positive takes on the stablecoin phenomenon.

Some of its proponents argue that it will generate commensurate demand for U.S. Treasury bills as stablecoins expand and allow the U.S. government to more easily front-load its rising new debt issuance, shortening the maturity profile of its debt. In doing so, it could leave long-term debt yields relatively undisturbed even as U.S. deficits expand.

That seems like a neat twist.

As it stands, the amount of bills outstanding totals about $6 trillion, just over a fifth of outstanding Treasury debt and still below historic averages as a share of the overall market.

All else equal, if both stablecoin demand and bill issuance were to expand by $1 trillion over the next three years, then the bill share of the Treasury market would only rise back to where it was about 20 years ago - an outcome that seems fairly unexceptional.

There's a catch though. A large chunk of the cash going to stablecoins is merely redirected from elsewhere, such as bank deposits or money market funds already directly or indirectly underpinning Treasury debt. Stablecoins' effect on the Treasury market, therefore, may be far more limited than first thought.

'SHADOW BANKS' WITHOUT CREDIT

Harder to parse is the degree to which mushrooming stablecoins might impact liquidity in the broader financial system.

As analysts at Cross Border Capital point out, creating a token that can be spent instantly like a banknote but is backed by securities with average maturities of several months or more could, theoretically, have a significant impact on market liquidity.

In effect, the stablecoin transforms a basket of Treasury bills and notes into an instantaneous asset with zero duration.

Two big offsetting features apply, however.

The lack of retail use for them means the impact on real-world liquidity or consumer prices may be limited and the fast-money liquidity boost is left within the financial world - most clearly in crypto markets themselves and wider asset prices at the margins. Dangerous bubbles can blow here of course, but at least participants are there at their own risk.

The second point is that even though stablecoins might add liquidity, they, unlike banks, don't actually expand the money supply via lending and credit creation.

And if the money flowing to them is merely coming from bank deposits anyway, then there's a risk that the expansion of stablecoins could actually reduce credit expansion at banks and weigh on the velocity of money in the economy at large.

"The GENIUS Act is unlikely to unleash a 1970s-style credit boom, but it does signal a shift in who controls the supply of money from banks to a more explicit public-private hybrid system," the Cross Border report concluded. "Most action will be in financial markets, not in the high street."

Ardent critics of stablecoins fear this risks turning into a government-sanctioned return to privately issued money that could be as prone to corruption, fraud, panics and instability as when it was last in vogue in the 19th century.

And crucially, disintermediation of the regular banking system could in time undermine the Federal Reserve's ability to regulate liquidity and money in the wider economy.

But as long as this phenomenon remains largely the preserve of the esoteric financial world, those thornier issues remain largely theoretical. The size and growth of this universe is less the concern than its integration with the real world.

(The opinions expressed here are those of the author, a columnist for Reuters)

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