Crypto assets provide a leveraged exposure to “risk-on” or “risk-off” environments. At the moment it is definitely a risk-off environment.
That’s why the administration’s desire to make the US the centre of the crypto universe and bring it into the mainstream of US finance is open to debate. It has made the Trump family, and some of Trump’s cabinet members, far wealthier, but are there risks associated with their ambition?
Bank of Japan governor Kazuo Ueda’s comments sparked the latest crypto plunge.Credit: Bloomberg
The Genius Act provided a legislative framework for stablecoins – digital tokens, normally with a price fixed at $US1, that are backed with stable and liquid assets that enable them to maintain their value.
The Act requires stablecoin promoters issuing their tokens in the US to back them with reserves of cash, short-term Treasury securities or other safe assets. They will have to publish audited financial statements and will be regulated by the US, unless they are regulated by a country with similar rules.
Last week the group behind the biggest stablecoin, USDT, was downgraded by S&P Global Ratings, which assessed Tether’s assets as “constrained” and cited an increased in high-risk assets. Within the backing for USDT’s $US184.4 billion tokens in circulation are US Treasuries, gold and other commodities, Bitcoin, corporate loans and cash.
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S&P said Tether provided limited transparency on its reserves and its risk appetite. There was a lack of a robust regulatory framework and no asset segregation.
Tether pointed to its track record – apart from a moment in 2022 when USDT’s price sank as low as US95¢ during a panic within the crypto market it has generally maintained its peg with the US dollar – and said it led the industry in transparent reporting. It also said it had total assets of $US215 billion and liabilities of $US184 billion, leaving surplus reserves of about $US30 billion it could call on if necessary.
Tether doesn’t meet the criteria set by the Genius Act, so will probably need to establish a new US-compliant vehicle if it wants to continue issuing tokens to US investors. Originally headquartered in the British Virgin Islands, this year it moved to crypto-friendly El Salvador.
While it is conceivable that the Trump administration might declare that El Salvador’s regulations are sufficient – Trump has a good relationship with its president, Nayib Bukele, who has controversially accepted, and imprisoned, some of the administration’s deported immigrants – it wouldn’t be a good look, even for Trump, to allow an entity that the Biden administration accused of money-laundering, sanctions busting and assisting terrorist groups and arms dealers into the regulated centre of US finance.
Tether’s current asset base would also disqualify it from compliance with the Genius Act’s requirements.
The Genius Act is expected to dramatically increase the size of the stablecoin market, from several hundred billion dollars to several trillion dollars.
Because of the asset requirements – short-term Treasuries, cash and similar high-quality assets – stablecoins could end up being major investors in US government debt. A new, essentially forced, source of buying would help moderate US bond yields at the shorter end of the yield curve and help lower the cost of US government debt. US debt issuance has increasingly targeted short-dated (and lower interest cost) bonds in recent years.
As the second half of this year has shown, however, crypto markets are inherently volatile and, while they might be stable in most circumstances, as a crypto asset class, stablecoins aren’t entirely immune from contagion.
The steady flows of buying of Treasuries to match inflows of investors funds into their stablecoins could reverse and turn into torrents of forced selling in a general crypto panic.
The behaviour of the crypto market over the past couple of months underscores how, even with continuing infusion of institutional investors in response to the crypto-friendly (and crypto active) Trump administration, volatile it is.
There’s a more leveraged relationship with yields in forced sales than there is in normal buying – if Treasuries were being dumped, the yields would spike significantly. Whatever the benefits from a new sourced of buying, they would be dwarfed by the consequences of forced selling.
The administration might think they’ve found a clever way to help suppress US bond yields and reduce its interest costs, but a crisis in the crypto market could spill over into volatility and instability in the most important financial market in the US, indeed in the globe. If there were a more general financial crisis, turmoil in the crypto market would amplify its effects on the epicentre of the financial system.
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Acceptance of digital assets as a payment instrument (under the legislation stablecoin issuers can’t make loans) is likely to lead to a flood of new issuers, both from existing crypto players but, more significantly, from among the banks, retailers and big technology companies.
That will drive issuance and usage and, over time, link the stability of stablecoins to the stability of the US financial system.
If all it takes to cause the crypto market to wobble is a guarded comment from a central bank governor of what his bank might do, that could be a problem.
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