Stablecoins are being advertised as increasing the demand for high-quality assets. Some even suggest they may solve governments’ debt problems by producing an increased demand for Treasury securities. US Treasury Secretary Scott Bessent said: ‘A thriving stablecoin ecosystem will drive demand from the private sector for US Treasuries, which back stablecoins. This newfound demand could lower government borrowing costs and help rein in the national debt.’
This view rests on the strong assumption that stablecoins can increase the net demand for Treasury securities. While this is possible, it is not assured, and under some conditions net demand could be unchanged or even lower.
The stablecoin market is growing steadily
Stablecoins are non-interest-bearing payment instruments like electronic money issued on blockchain. They maintain a reserve to ensure that holders can convert them at par (1:1) on demand. The reserve should be constituted of high-quality assets that maintain a stable value. Short-dated Treasury securities are the preferred asset class.
The amount of stablecoins in circulation has increased steadily and now represents about $230bn. Stablecoin issuers are already listed among the largest holders of Treasury bills.
Speculation is widespread that stablecoins in circulation could exceed $2tn. There is some empirical evidence that stablecoins brought a reduction in the yield of Treasury bills suggestive of an increase in net demand, but such estimates should be viewed as partial only and not affirmation that stablecoins reduce aggregate borrowing costs.
The rise of money market funds during the 1970s and 1980s sparked a similar debate about market impact. MMFs started to offer shares to the public in the US in the early 1970s. Growth accelerated during the early 1980s as the interest rate differential between MMFs and bank deposits widened. The government came to rely increasingly on money markets for borrowing.
While MMFs became major holders of Treasury securities, there is little if any evidence that it caused an increase in the net demand for Treasury securities and decline in aggregate borrowing costs relative to a baseline scenario with no MMFs.
Multiple factors at play
Whether stablecoins increase the net demand of Treasury securities will depend largely on structural factors like the total amount of stablecoins in circulation relative to other Treasury securities-consuming financial transactions and instruments, on the total amount of transactions, liquidity preferences and money velocity. The net external demand for stablecoins may reinforce those factors.
Stablecoins may naturally increase the gross demand for Treasury securities. But the key aspect is whether additive or substitutive effects dominate. Most financial transactions consume or impact Treasury securities directly or indirectly. In a typical stablecoin transaction, a household sells its MMF, which then sells its Treasury securities holdings, and with the proceeds buys stablecoins with the stablecoin issuer buying Treasury securities as reserve, leaving the total amount of Treasury securities outstanding unchanged.
The stablecoin transaction volume has risen to about $950bn per month, according to Visa. It remains small compared with the volume of credit transfers that dominate money movements of about $100tn per month in the large value payment system of the US alone.
The transaction volume, however, only partially informs about the demand for stablecoins. The money velocity of stablecoins – the amount of stablecoins needed for a certain transaction volume – will critically determine stablecoin demand. Given that stablecoins transactions typically are instant and thereby can be immediately reused, a large transaction volume may actually be covered by a small amount of stablecoins.
Liquidity preferences may not change
The amount of stablecoins in circulation will also depend on the propensity to hold stablecoins that will rest on the liquidity preference of households and also on the opportunity cost of holding stablecoins. Households will attach a certain value to the ease of conducting transactions with stablecoins, which may compensate for the fact that they are non-interest bearing (for argument’s sake no return on staking is assumed here). This ‘liquidity service’ will have certain boundaries.
Unless liquidity preferences change, stablecoins are more likely to replace existing liquid balances than increase the overall value of liquid balances. The relative Treasury intensity of other liquid balances will determine the net demand for Treasury securities.
The interest rate level determines the opportunity costs of holding transaction balances. In a low-interest-rate environment, households may be more willing to hold non-interest-bearing instruments (but low interest rates also make issuing stablecoins less attractive). The demand for stablecoins will, similar to other instruments, be state-dependent.
The share of stablecoins in total financial transactions will also influence demand for Treasury securities. If stablecoins gain market share but exhibit higher velocity, net demand for Treasury securities may fall.
Determining demand is complex
The demand for Treasury securities is evidently complex. All else being equal, if stablecoins were to increase the net demand for Treasury securities, or at least for the shorter-dated ones, the yield on Treasury securities should be lower than in a baseline without stablecoins.
Equating an increase in gross demand with an increase in net demand is a well-known partial-equilibrium fallacy: it ignores general-equilibrium adjustments across balance sheets. It also rests on strong assumptions on liquidity preferences and/or the propensity to hold transaction balances. The net effect will reflect changes in velocity, the value of liquidity services and the degree of crowding out of other transaction instruments. Naturally, the increase in stablecoins would have to be substantial for those effects to be material.
It therefore seems imprudent to assume that stablecoins will produce a sustained increase in the net demand for Treasury securities. Governments should be wary of the claim that stablecoins can defy debt-induced gravity.
Ousmène Mandeng is Senior Adviser at Accenture and Visiting Fellow at the London School of Economics and Political Science.
Interested in this topic? Subscribe to OMFIF’s newsletter for more.