Stablecoins Are on the Rise. Bond Investors Should Pay Attention. — Barrons.com

By Nate WolfStablecoins, with their roots in the buzzy, freewheeling world of cryptocurrencies, may have an outsize impact on one of America's most staid yet critical asset classes: Treasury bonds.Wall Street is still trying to suss out how stablecoins — tokens pegged to assets like the U.S. dollar — will affect industries such as banking, payments, and retail. It matters because the consensus is that the currencies will proliferate rapidly over the coming years.That growth could trigger corresponding demand for U.S. government debt, according to a brief research note Friday from Torsten Sløk, chief economist at Apollo Global Management. In fact, major inflows of money in the stablecoin market already appear to be lowering short-term yields.In June, the Senate advanced legislation to establish a regulatory framework for stablecoins, a move that has already made companies more comfortable dabbling in the asset class. The so-called Genius Act, which the House will now deliberate, also requires stablecoin issuers to back their tokens with safe, liquid assets, and Treasury bills are the reserve of choice.The bottom line is that the more stablecoins are issued, the more Treasury bills are needed.Circle Internet Group, which issues the USDC coin and went public in a blockbuster IPO last month, held $55.2 billion worth of short-dated Treasuries and overnight Treasury repurchase agreements as of the end of May. More than 99% of the company's 2024 revenue was interest income on its Treasury holdings.Circle's main competitor, Tether, held a combined $113.6 billion in Treasury bills and overnight repurchase agreements as of the end of March. Tether issues USDT, the largest dollar-pegged stablecoin by circulation.If we put cash holdings aside, the equation is simple: For every $1 in stablecoin issued, companies must snap up $1 in Treasuries. And plenty of stablecoin will be headed out the door soon. The global supply has the potential to reach $4 trillion by 2035, according to forecasts from Bernstein analyst Gautam Chhugani, up from roughly $225 billion today. (Other, shorter-term projections have been all over the map.)Even at current circulation levels, stablecoins are moving the bond market at least a little bit.In a May working paper for the Bank for International Settlements, researchers Rashad Ahmed and Iñaki Aldasoro found that a stablecoin inflow of $3.5 billion in any five-day period lowers three-month Treasury yields by two to 2.5 basis points, or hundredths of a percentage point, within 10 days. A selloff of the same magnitude causes yields to rise by six to eight basis points.But those effects don't spill over into longer-term bonds, Ahmed and Aldasoro found, resulting in a steeper yield curve, or a bigger gap between yields on short- and longer-dated debt."The bottom line is that stablecoin demand for T-bills could grow into trillions," wrote Sløk, the Apollo economist. "The likely result is a steeper curve with significant new demand in the front end."Considering short-term bond demand hasn't been an issue in recent months — investors have appeared eager to snap up the relatively risk-free yields on offer — this dynamic has implications for the financial system. It could make policymakers and investors a bit queasy.First off, a growing stablecoin sector may weaken the Federal Reserve's ability to control short-term interest rates, Ahmed and Aldasoro argued. The duo compared the potential scenario to the so-called "Greenspan Conundrum" of 2005, when rate hikes by the Fed couldn't get longer-term bond yields to rise.The Federal Reserve and Treasury Department didn't respond to requests for comment.Growing investments in the short-term Treasury market could also affect financial stability, the researchers said. In particular, a fire sale of stablecoins could spark a sharp uptick in near-term yields that throws the Treasury market into disarray."Our results can be interpreted as evidence of stablecoins creating a bridge through which shocks to the cryptocurrency ecosystem transmit to traditional financial markets," Ahmed and Aldasoro wrote.The current concentration of the stablecoin market in two companies — Tether and Circle — is an added risk, analysts at Moody's Ratings said in a research note on Monday. Together, the pair have a market share of 90%, which "amplifies the potential implications of operational or liquidity disruptions at these firms," the Moody's team wrote.Tether pushed back on this assessment, pointing to the dispersion of USDT across 400 million users in various global markets."This widespread distribution effectively decentralizes exposure to U.S. debt across a vast and diverse user base, reducing concentration risk and contributing to greater resilience of the U.S debt," the company said in a statement.Circle declined to comment.Part of the motivation behind the Genius Act, it should be said, is to bring more stability and transparency to the stablecoin industry. Moody's expressed some optimism that the legislation will achieve this goal. Others, such as the consumer-advocacy organization Consumer Reports, argue the bill should be more stringent.All of these questions — how effective the Genius Act is, how big the stablecoin market will get, how heavily these digital tokens swing the bond market — likely will get answers years down the road.In the meantime, bond investors, the Fed, and the Treasury Department need to stay on alert.Write to Nate Wolf at [email protected] content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.