Today we will be discussing stablecoins – virtual currencies tied to fiat currencies like the dollar – but we want to start with an observation about $100 bills. These are about as “real” as currency gets, and demand for C-notes remains extremely strong.
A few datapoints:
- The Federal Reserve reports that as of the end of 2020 there were $1.64 trillion (yes, with a “t”) in $100 bills in circulation. Fed research says about 80 percent of these circulate outside the US.
- 2020 saw outsized demand for $100 bills. The growth of these notes in circulation rose by 15.5 pct over 2019’s levels, twice the 20-year compounded annual growth rate of 7.6 pct.
- Demand for $100 bills is countercyclical. That 15.5 percent growth last year was a record back to 2000, with prior peak-demand periods in 2001 (10.5 pct), 2008 (10.5 pct), 2011 (11.4 pct) and 2012 (10.3 pct).
The upshot here is that periods of global financial stress create demand for stable, money-good assets like high-denomination physical dollars. Last year was a record in $100 bill issuance for a very good reason.
That soundbite is a good launch pad to discuss the growth in stablecoins, which are the most visible intersection of virtual and traditional currencies. They simply track an established sovereign currency like the dollar, but unlike either physical currency or US bank deposits stablecoins sit only in virtual currency wallets around the world.
These are the 3 largest by assets:
Tether ($62 billion). Currently under investigation by the US Justice Department for its activities several years ago, this stablecoin is tied to the dollar and used as a parking lot for capital by virtual currency traders. Its financials are opaque, but Tether executives have promised a full audit of its holdings. Oddly, Tether’s AUM has not grown since June, but it is up $41 bn since the start of the year.
USD Coin ($27 bn). Unlike Tether, USDC is audited (Grant Thornton). AUM has grown dramatically this year, by $23 bn. Here were their holdings as of May 2021:
Binance USD ($12 bn). Like USDC, BUSD is audited (WithumSmith+Brown) and has seen assets grow in 2021 (+$11 bn).
In sum, these 3 stablecoins alone have grown in assets from $26 bn to $101 bn in 2021, almost a 4-fold increase. To put that $101 bn into perspective, it is almost 3x the amount PayPal holds in global customer accounts ($36 bn, Q2 2021). Also, this year’s growth in stable coin assets ($75 bn) exceeds the amount of capital US fund investors have added to municipal bond mutual funds and ETFs ($73 bn).
All this raises 2 questions:
#1: With interest rates so low, how does a stablecoin operator make money? The simplest answer is “they don’t, or at least not very much”. In this respect they are much like money market fund managers. There’s not much left for management and operating fees when USD bank deposits pay zero and 3-month Treasuries yield 5 basis points.
The longer answer is “they can, if they operate more like a bank”. Coinbase, for example, is starting to do exactly that. At the end of June, the company started offering a 4 pct yield on USDC in return for the right to lend out that capital. No, USDC (or any other stablecoin) is not FDIC insured, which leads us to our second point.
#2: How and when will regulators get ahead of the inevitable and craft rules and regulations for the stablecoin industry? In the US, that is in the works. Secretary Yellen clearly understands the dangers of an unregulated shadow banking system. Anyone who was around in 2008 does as well …
All this reads like the classic Clayton Christensen disruption playbook combined with the “move fast and break things” ethos of Silicon Valley. Stablecoins themselves are not especially disruptive, although the last year’s global search for monetary save havens (witness the $100 bill) certainly gave them a tailwind in gaining share versus fiat currencies. Rather, it is their utility in enabling other financial transactions that is disruptive to traditional finance. In this respect, stablecoins are analogous to Amazon starting with books in the 1990s. The analogy between department stores then and traditional banks now is obvious.
We’ll close out with an observation we do not see mentioned enough regarding stablecoins: like the $100 bill, user interest is global. These are the 10 countries with the highest relative Google search volumes over the last 90 days for “usd coin” (note: volumes correlate strongly with “tether”, so these are truly queries about virtual currencies):
- North Macedonia
- United Arab Emirates
- Sri Lanka
Takeaway: USD-linked stablecoins are a global phenomenon, which is as much a reason to regulate them as concerns over shadow banking. The Federal Reserve may be undecided about a central bank digital currency, but as often happens with disruptive technologies the incumbent is always late to the party. In the meantime, dollar-linked stablecoins are happy to fill the void.