The U.S. Department of the Treasury stated in a new report that the growth of digital assets is primarily driven by the use and popularity of stablecoins, creating a demand for short-term Treasury securities. Institutional adoption of “high beta” Bitcoin and cryptocurrencies may also lead to an increased demand for safe-haven assets in government debt in the future. However, the report also noted that stablecoins will need to be regulated similarly to narrow banks or money market funds.
Rapid Growth of Digital Assets, with Stablecoins Being Particularly Important
On Wednesday, the U.S. Treasury released a 132-page report prepared for the Treasury Borrowing Advisory Committee, with a subsection dedicated to the discussion of digital assets. The report indicated that despite having a smaller base, digital assets are growing rapidly, stemming from native cryptocurrencies such as Bitcoin and Ethereum, as well as stablecoins. The report specifically mentioned stablecoins, particularly the leading stablecoin, Tether. Currently, the most prevalent stablecoins in the market are fiat-backed stablecoins, most of which have their collateral in the form of U.S. Treasury securities and Treasury-backed repurchase agreements, with an estimated total of $120 billion in stablecoin collateral directly invested in U.S. Treasury securities.
Learning from History, Stablecoins Need Regulation
Although stablecoins typically hold a significant amount of U.S. short-term government debt as collateral, this is not a requirement. Nevertheless, the report still characterized stablecoins as a form of private on-chain currency, likening them to traditional financial money market funds. It cited two historical examples to emphasize that stablecoins need to be regulated similarly to narrow banks or money market funds.
The Era of Wildcat Banking
Before the establishment of a central currency authority, banks in the U.S. issued their own banknotes, which were inadequately backed and prone to bank runs, often trading at a discount in secondary markets. To address these issues, most state governments required that banknotes be backed one-to-one by government bonds, but the difficulties in exchanging various currencies prompted the passage of the National Bank Act in 1863, ultimately leading to the dollar becoming the only circulating national currency.
2008 Money Market Fund Runs
Major money market funds experienced significant runs during the 2008 financial crisis as prices of short-term commercial paper fell, undermining confidence in the repayment ability of these funds. A similar situation occurred again in 2020, as commercial paper prices plummeted once more. The report emphasized that so-called “risk-free” investment tools are only truly risk-free when backed by actual risk-free collateral (such as short-term U.S. government debt).
Regulation of Stablecoins
History has shown that stablecoins cannot effectively operate as private currencies and ultimately need to be strictly regulated like narrow banks or money market funds to ensure they possess risk-free collateral. Despite recent improvements in stablecoin collateral, significant risks remain. In recent years, stablecoins have frequently faced runs, leading to a loss of their peg to the U.S. dollar or a complete collapse. A collapse of major stablecoins like Tether could lead to a rapid sell-off of the U.S. government debt they hold, making regulation even more necessary to prevent stress in the stablecoin market from spilling over into broader financial markets and the government bond market.