Stablecoins as Key U.S. Treasury Market Players: A Look at Shifting Dynamics

Stablecoins: A New Driving Force in the U.S. Treasury Market

Amidst a U.S. national debt surpassing $37 trillion and continuing to climb, the U.S. Treasury market is witnessing a new dynamic driven by the increasing demand from stablecoin issuers like Tether and Circle.

The GENIUS Act: A Regulatory Framework Fostering Growth

The recently signed "GENIUS" Act plays a crucial role in this shift, providing a clear regulatory framework for stablecoins in the United States. This framework boosts investor confidence and encourages the adoption of these dollar-pegged digital currencies.

The US Dollar in the Digital Age

Analysts at HSBC have suggested that a well-regulated stablecoin market could solidify the U.S. dollar's dominance in the digital finance world, aligning with former President Donald Trump's goal of making the U.S. a global crypto hub.

Treasury Bills as Preferred Collateral

Under the new law, stablecoin issuers are required to hold reserves backed 1:1 by U.S. dollars or high-quality liquid assets. This makes short-term Treasury bills an attractive option as preferred collateral.

The GENIUS Act's Impact on the Bond Market

Bensent highlighted the potential benefits of the "GENIUS" Act, noting that it could underpin the U.S. dollar's status as the global reserve currency, expand access to the dollar economy for billions worldwide, and lead to a surge in demand for U.S. Treasuries as backing for stablecoins. This creates a win-win situation for everyone: stablecoin users, issuers, and the U.S. Treasury.

Tether and Circle's Market Dominance

Tether and Circle dominate the $250 billion stablecoin market. According to Morgan Stanley analysis, Tether accounts for roughly 65% of the total stablecoin market capitalization with its USDT coin, while Circle's USDC represents another 25%. Together, these two companies dominate 90% of the market.

Tether's Strategic Expansion

Tether recently announced the appointment of Bo Hines, a former White House crypto policy executive, as a strategic advisor to help guide its expansion in the United States.

Limited Impact Currently, Immense Growth Potential

Although the majority of issuers' reserves are in the form of short-term U.S. Treasury bills, the industry has not yet been considered a major component of the Treasury market. The Federal Reserve Bank of Kansas City estimates that issuers hold approximately $125 billion in Treasury bills, less than 2% of the total $6 trillion in outstanding Treasury bills. However, economists anticipate significant market growth in the coming years.

Ambitious Growth Projections

JP Morgan forecasts that the market will double in size by 2028 to $500 billion, while Standard Chartered expects it to reach $2 trillion over the same period. Bernstein anticipates it could reach $4 trillion by 2035. These projections reflect the growing interest in the potential of stablecoins and their impact on the financial system.

Changing Bond Market Dynamics

As demand for stablecoins rises, the U.S. Treasury is increasingly relying on issuing short-term Treasury bills. At the same time, traditional actors like China, Japan, and Canada are reducing their purchases.

Decreasing Share of Foreign Bond Holders

Analysis from Ark Invest shows that the share of U.S. Treasury bonds held by the largest foreign creditors has declined from 23% to just over 6% in the last 13 years. This trend is expected to continue under former President Trump's tariff policies and a broader shift in foreign central banks to reduce bond holdings.

Impact of Quantitative Tightening

Additionally, the Federal Reserve is gradually reducing its bond purchases in a process known as quantitative tightening.

Stablecoins as a Potential Demand Driver

In 2024, Tether was the seventh-largest purchaser of U.S. Treasury bonds, trailing only the United Kingdom and Singapore. Lorenzo Valente of Ark Invest wrote in June, "Clearly, Tether, Circle, and the broader stablecoin industry could create the largest source of demand for U.S. Treasury bonds in the coming years and potentially replace Japan as the largest holder by 2030. If so, the stablecoin industry could contribute significantly to the goal of lowering long-term U.S. interest rates."

Impact on Short-Term Bond Yields

According to the Bank for International Settlements (BIS), stablecoins pegged 1:1 to the U.S. dollar may be having an impact on short-term yields. Their data indicates that five-day, $3.5 billion stablecoin inflows lower three-month Treasury bill yields by approximately 2-2.5 basis points within 10 days.

Potential Implications for Debt Issuance

Christopher Vecchio, co-head of global macro at futures and options trading network tastylive, notes, "If industry forecasts are even modestly accurate and stablecoin demand surges to over $1 trillion in the coming years, stablecoins will not only continue to influence short-term yields, they will inevitably become an important factor the Treasury must consider when determining its debt issuance schedule."

Warnings About Outflows from Banks

Industry observers warn that as money shifts into stablecoins, it's likely flowing out of bank deposits, reducing bank balances and lowering their reserve requirements. Jacewitz of the Federal Reserve Bank of Kansas City wrote, "This potential outflow of funds from bank deposits into stablecoins could increase demand for Treasuries, but it could also reduce the supply of loans in the economy."

Overall Positive Outlook

Nevertheless, industry participants believe the net effect is positive. Will Beeson, founder of fintech infrastructure company Uniform Labs, notes, "Stablecoins will be a meaningful accelerator of economic growth in the U.S. and abroad."