Stable Coins – The New Risk-Free Blue Ocean?
With the GENIUS Act all the rage this week, we feel that we needed to address Stable Coins directly and tell our readers what we think wide scale adoption of stable coin usage will ultimately lead to.
In particular we want to ask an important question and that is,
what would stop Tether from entering into swap agreements with say Coinbase to take on BTC for USDT in a swap to then purchase US Treasuries and earn the risk free rate, simply by creating nothing?
If they are indeed able to create swap like agreements like this, then, the U.S. Treasury now has entities who could directly benefit by purchasing US T-Bills and other debt instruments and this demand should be able to scale as the years come. I have written a piece that I call, Stable Coins – The New Risk-Free Blue Ocean?
Here I discuss The Complete Risk-Neutral Yield Generation Strategy (with Hedging) Swap Agreement.
Please note and as a disclaimer: I am not implying at all that Tether, Circle or Coinbase employ any of these strategies, but what I outline seems like a plausible and relatively risk averse way that these entities could earn a true risk free rate, for virtually little or no embedded risk! This is a process in work to try to quantify both the utility and the potential of this growing stable coin industry.
Furthermore we arent the only ones concerned with the future in regards to this new industry, Peter Earle in the Daily Economy recently wrote that,
A further complication involves potential cross-border ramifications. If stablecoins issued by US banks under the GENIUS Act achieve global usage, they may functionally export dollar-based CBDCs abroad, amplifying dollarization in emerging markets without direct Federal Reserve oversight or policy coordination. Such outcomes could trigger complex geopolitical and regulatory responses, particularly in regions where dollar liabilities already pose risks to domestic financial stability.
OK without further adieu,
Stable Coins – The New Risk-Free Blue Ocean?
The Stable-Coin Issuer Complete Risk-Neutral Yield Generation Strategy Swap Agreement (with Hedging)
Tether and Coinbase enter a swap agreement for a 1-year term.
Today (Initial Exchange): Coinbase sends $500M worth of BTC to Tether.
In return, Tether sends $500M USDT to Coinbase. (This USDT is legitimately backed by Tether's reserves; its either newly minted against the incoming BTC, or its existing backed supply). *** The big question remains, who would stop Tether, Circle or any other stable coin issuer from over issuing at certain points in time?***
Tether's Immediate Actions (Conversion & Hedging): Tether now holds the $500M BTC.
Step 1: Sell BTC for USD: Tether immediately sells the entire $500M worth of BTC it received from Coinbase for $500M in actual USD.
Step 2: Invest in T-Bills: Tether uses this $500M USD to buy $500M in 1-year US Treasury Bills directly from the US Treasury. This is where the yield is generated.
Step 3: Hedge the Future BTC Obligation: To ensure it can return $500M worth of BTC to Coinbase in a year, regardless of Bitcoin's price fluctuations, Tether simultaneously buys Bitcoin futures contracts (or enters a long position in a perpetual swap or other derivative) equivalent to $500M worth of BTC, with an expiration date around 1 year from now. This locks in the future purchase price of BTC. During the Year: Tether holds the T-Bills, earning interest. Tether holds the long Bitcoin futures position, which will offset any increase (or decrease) in the spot price of BTC.
After 1 Year (Maturity & Fulfillment): The $500M T-Bills mature, paying out $500M in principle plus $21.25M in interest (at 4.25% APY). Tether settles its Bitcoin futures contract: If BTC's spot price has risen, Tether's futures position makes a profit, effectively providing the extra USD needed to buy the $500M worth of physical BTC on the spot market. (If BTC's spot price has fallen, Tether's futures position makes a loss, but the physical BTC is cheaper to buy on the spot market, netting out the cost.) Tether uses $500M USD (from the T-Bill principal and/or futures profit/loss) to buy $500M worth of physical BTC on the open market.
Swap Fulfillment (Tether's side): Tether returns this newly acquired $500M worth of BTC to Coinbase.
Swap Fulfillment (Coinbase's side): Coinbase returns the $500M USDT to Tether (which Tether can then burn, taking it out of circulation).
Net Outcome:
1. Tether has successfully returned the agreed-upon value of BTC to Coinbase.
2. Tether has earned a risk-neutral profit of $21.25M (the T-Bill interest), as the Bitcoin price fluctuations were hedged out.
3. The circulating supply of USDT was not artificially inflated. (most importantly)
4. The U.S. Treasury benefits from brand new demand simply created by a new swap product
5. Coinbase effectively removes the risk of holding $500m of BTC adds a layer of counterparty risk or could require access to the T-Bill to encumber themselves for added liquidity and or balance sheet capabilities.
What we have outlined is essentially a framework to bypass the traditional money center bank currency conduits. This is a shadow bank framework that will blossom into a highly somewhat esoteric quasi regulated system of, well who knows what proportions it will grow. Who knows at this point the systemic risks that this will create. We look at the stable coin industry and we see an industry that is creating digital dollars with very little oversite but having very real world effects. The ability to create something out of nothing, but then to encumber real assets, well that holds powers all unto itself.
We want our readers to understand that the shadow bank system is nothing new, think back to prior to the GFC and things like credit default swaps, credit default obligations (CDOs) and CDO squared, etc., the laundry list of swaps and deals unknown to the general public but sits right at the very heart of monetary system plumbing. These are the things we need to be aware of and as the law of large numbers eats into the U.S. debt pile and hinders U.S. hegemony, expect this shadow bank to grow a whole lot bigger just to feed the hungry debt appetite!
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