The Irony of Backing Stablecoins with US treasuries

Introduction

In the 15 years of cryptos exsistence, stablecoins have carved a unique niche for themselves. Designed to bridge the gap between the volatility of digital assets and the stability of traditional currencies, these digital tokens are often pegged to stable assets, such as the US dollar. But here's where it gets interesting: many of these stablecoins are now backed by US Treasuries, this move appears contrary to the fundamental principles of crypto.

While this backing offers a semblance of stability and trust, it also ties these digital assets to the very centralized systems they aimed to challenge. As interest rates soar and inflation trends downward, the crypto industry finds itself at a crossroads. On one hand, risk-on assets like Bitcoin become less appealing compared to conservative US government bonds.
On the other, the DeFi sector, particularly stablecoin providers, is innovating to capitalize on the current financial landscape. This intricate dance between decentralized crypto and centralized finance raises crucial questions about the future of digital assets. In this piece, we delve into the good, the pitfalls, and recent instances where US Government-backed stablecoins have fallen short of expectations.

The Good

Crypto, initially designed to challenge traditional finance, now finds itself intertwined with those very systems. This unexpected alliance might just be crypto's most significant advantage. With institutional backing, stablecoins emerge as a potential bridge, linking crypto innovations to the broader financial landscape. This fusion of old and new heralds a promising era. The benefits brought by stablecoins are manifold.

Stablecoins, merging the realms of traditional and digital finance, offer a compelling solution to the intrinsic challenges of crypto. Renowned globally for their stability, US Treasuries provide a sturdy foundation for these coins, fostering trust and dependability. As interest rates rise, the DeFi sector thrives. Coins such as sDAI and sFRAX capitalize on assets like T-Bills, attracting a broader range of investors while also delivering a real yield.

For traders, stablecoins act as a steadying presence in the face of market volatility. They also allow for financial inclusivity, allowing businesses without conventional banking to transact effortlessly. Designed for user-friendliness, stablecoins combine the security and speed of cryptocurrencies with the stable value of fiat currencies.

The Bad

Stablecoins, with all of their advantages, also come with their own set of challenges, especially when considering their underlying collateral, which often includes US government bonds.

For instance, US government backed stablecoins are heavily regulated and can be influenced by central banks or governments. Users of these coins must place their trust in both the custodian safeguarding the fiat and the auditors who verify these reserves. Furthermore, there's always the looming risk that issuers might not uphold the coin's value in the long run. Despite their promise, these stablecoins don't bring much innovation to the table, especially when compared to traditional banking systems.

One significant concern is their vulnerability to changes in the monetary regime. When issuers of stablecoins offer interest, they inherently tie themselves to the interest rate market of the pegged currency. This means that any shifts in the central bank's interest rates can have a profound impact on these digital assets. Additionally, there's a potential misalignment with the ethos of crypto. Relying on traditional financial systems seems to go against the core idea of decentralized crypto.

The Challenges of USDC and Tether in Crypto

Stablecoins like USDC (website) and Tether (website) have emerged as a bridge between traditional finance and the digital realm. However, recent events have cast a shadow on their promise of stability. In April 2023, USDC experienced a notable deviation from its $1 parity, a result of a series of bank failures that triggered a liquidity crunch in the commercial paper market. This incident not only exposed USDC's vulnerability but also highlighted the risks of intertwining crypto with conventional financial systems. Circle, the issuer of USDC, faced the brunt of this crisis due to its significant market exposure.

On the other hand, Tether has been a subject of debate for its opaque operations. Despite being one of the most widely used stablecoins, concerns about its full backing by US dollars or equivalent assets persist. Legal documents unveiled in June 2023 shed some light on Tether's banking associations and its commercial paper holdings. Yet, they also intensified the questions surrounding the quality and nature of USDT's backing assets.

Moreover, regulatory bodies worldwide have kept a watchful eye on both USDC and Tether. The intertwining of these stablecoins with traditional markets makes them susceptible to the latter's vulnerabilities. The US government, among other global regulators, is apprehensive about the systemic risks these coins might introduce, especially if their backing is questionable or tied to unstable markets.

Final Thoughts

The rise of stablecoins, particularly those backed by US government assets, has been both intriguing and paradoxical. While they promise stability and bridge the gap between the traditional and digital realms, they also bring to the fore the challenges and contradictions inherent in their design. As the crypto industry continues to evolve, it will be crucial to address these challenges head-on, ensuring that the promise of financial freedom and innovation is not compromised.