Metastablecoins Are Go!

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Terra (UST) was suppposed to be a "stablecoin", trading very close to $1. It rapidly became the third largest such coin. From April 11^th 2022 it started trading mainly around a 10% discount, and by May 11^th it was essentially worthless. The crash destroyed about $45B in notional value.

In Metastablecoins I pointed out that, absent the backing of a central bank, dollar "stablecoins" like UST were misnamed. They were, as UST had shown, in fact metastable so should be called metastablecoins. Wikipedia explains that:

By Georg Wiora

metastability denotes an intermediate energetic state within a dynamical system other than the system's state of least energy. A ball resting in a hollow on a slope is a simple example of metastability. If the ball is only slightly pushed, it will settle back into its hollow, but a stronger push may start the ball rolling down the slope.

Exactly what the "stronger push" that sent UST into its "state of least energy" was still isn't clear, but the coin's metastability is.

On July 18^th this year the GENIUS Act (Guiding and Establishing National Innovation for U.S. Stablecoins Act) was signed into law. It purports to regulate metastablecoins but, like most things about cryptocurrencies, it is largely gaslighting. Below the fold I explain why this is and discuss some recent publications about metastablecoins.

The GENIUS Act was the result of massive campaign spending and lobbying by the cryptocurrency industry, so one might reasonably doubt its effectiveness in regulating the industry. But that is only the first of many reasons for skepticism.

Metatsablecoins are a technology and thus as I point out ad nauseam the forces driving market concentration identified by Brian Arthur are very strong. This table uses data from coinmarketcap.com to show the top 10 among the many hundreds of metastablecoins:

Rank	Symbol	Market Cap ($)	24h Volume ($)	Cap %	Vol %
1	USDT	183448203111	138501540115	65.0	85.3
2	USDC	76173651225	18071460345	27.0	11.1
3	USDe	8434123250	179500156	3.0	0.1
4	DAI	5364792025	110692712	1.9	0.07
5	PYUSD	3125097912	107561114	1.1	0.07
6	USD1	2828795709	328700270	1.0	0.20
7	RUSD	1027661833	108029824	0.36	0.07
8	FDUSD	980602153	5000038217	0.35	3.1
9	TUSD	492822788	40305463	0.17	0.02
10	USDD	408966311	6898916	0.14	0.004

Of the top 10, the top 2 have 92.0% of the market cap and 96.4% of the daily volume. Of the top 10, the top 4 have 96.9% of the market cap and 96.6% of the volume. The alt-metastablecoins ranked 5 and lower are buried in the random noise.

So it is important to note that among the top 4 metastablecoins, the only one that the GENIUS Act regulates is USDC, with only 20% of the market cap and, more importantly, only 11% of the daily volume. The ones it does not regulate are:

1. Tether (USDT) is domiciled outside the US, allegedly mostly backed by high quality liquid dollar assets (and gold).
3. Ethena (USDe) is an algorithmic metastablecoin backed "by crypto-assets and delta-neutral hedging strategies in perpetual futures markets".
4. DAI is an algorithmic metastablecoin backed by cryptocurrencies.

Tether has long resisted meaningful regulation or even audit. Algorithmic metastablecoins, such as the late lamented Terra/Luna pair, do not conform to the GENIUS Act's idea of a "stablecoin" and, being implemented as "smart contracts" on blockchains such as Ethereum, cannot be regulated in the normal way. You can see that there are only two significant metastablecoins, one is vastly bigger than the other, and only the smaller is regulated (assuming the regulations are actually enforced).

Ethena's edge over the top 2 metastablecoins is that it generates yield:

In practice, each dollar of USDe is created with the protocol taking two opposing positions:

• A long position in spot crypto-assets as collateral (primarily BTC, ETH or staked ETH) held at off-exchange custody providers.
• An equal and opposite short position in perpetual futures markets on exchanges like Binance, Bybit and OKX.

This combination keeps Ethena’s exposure market-neutral, while generating yield from perpetual futures funding rates.

DAI also generates yield, through the DAI Savings Rate.

One might also be skeptical of how thoroughly the current administration would apply regulation to Paypal USD, linked to Peter Thiel and ranked #5, or to World Liberty Financial USD, the Trump family metastablecoin ranked #6. Thus the GENIUS Act appears to be Potempkin regulation at best.

Stephan Luck of the New York Fed's A Historical Perspective on Stablecoins starts with the GENIUS Act's definition of "stablecoin":

Stablecoins under the Act must be fully backed one-to-one by safe, liquid assets such as U.S. dollars, short-term Treasury securities, uninsured deposits at commercial banks, or cash equivalents. Issuers may not pay interest or yields on stablecoin balances, and holders enjoy priority claims in bankruptcy. To promote transparency, issuers must provide monthly public disclosures of their reserves.

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Luck goes on to draw the historical parallel with "national bank notes", which circulated in the US between 1863 and 1935, writing:

National bank notes were initially successful for two main reasons. First, given that they were traded at the same price as greenbacks and specie, they were a more useful form of money than other circulating notes. Second, bank notes faced little competition from other forms of money, such as bank deposits. Before the rise of deposit insurance, deposits were often risky investments and, historically, not a widely accepted form of payment.

However, as the interbank system in the U.S. developed, the use of deposits for payments became increasingly common. While national bank notes represented around 20 percent of total bank assets by the end of 1880, that share declined thereafter, as shown in the chart below. The decline in bank notes was mirrored by the increase in deposits. This pattern is in line with a decline in the demand for bank notes and the rise of bank deposits as an alternative source of money.

Bank of Scotland,
Zeete, CC BY-SA 4.0

Note the similarity with Scottish bank notes which still circulate in the UK, although treated with some suspicion in England and Wales:

Currently, three retail banks are allowed to print notes for circulation in Scotland: Bank of Scotland, Royal Bank of Scotland, and Clydesdale Bank.

Scottish banknotes are unusual, as they are issued by retail banks (not government central banks) and because they are not legal tender in the United Kingdom. They are also not legal tender in Scotland, where, in law, no banknotes (including those issued by the Bank of England) are defined as legal tender. Formally, they are classified as promissory notes, and the law requires that the issuing banks hold a sum of Bank of England banknotes or gold equivalent to the total value of notes issued.

Luck concludes:

This dynamic between national bank notes and bank deposits is a cautionary tale for the potential rise of stablecoins. Currently, most retail deposits pay little interest. Moreover, banks charge considerable fees for large instant payments such as wire fees. However, as stablecoins become more commonly used, the traditional centralized payment system may move to become more attractive in response. To avoid losing valuable deposits, banks may start to offer better terms on deposits or offer both higher interest and better payment services, just as they did during the National Banking Era. Alternatively, bank deposits may become “tokenized” themselves.

Thus, at least for domestic payments, the footprint of stablecoins may be limited given that many potential retail depositors may stick with bank deposits.

The market for regulated metastablecoins will also be limited because issuers "may not pay interest or yields on stablecoin balances", whereas the competing unregulated metastablecoins can provide "yield".

Luck notes that:

The historical experience of national bank notes illustrates that stablecoins may have a large potential to increase the demand for U.S. government debt.

In Stablecoins and safe asset prices Rashad Ahmed and Iñaki Aldasoro investigate this effect:

Inflows into stablecoins reduce three-month US Treasury yields by 2–2.5 basis points within 10 days, while outflows can have a larger impact, raising yields by 6–8 basis points. The effects are concentrated in short-term Treasury securities, with limited to no spillovers to longer-term maturities. Given its relative size, Tether (USDT) contributes the most to estimated effects, followed by Circle (USDC). These results suggest that stablecoins have already established themselves as significant players in Treasury markets. Their growth blurs the lines between cryptocurrency and traditional finance and carries implications for monetary policy, transparency of stablecoin reserves and financial stability – particularly during periods of market stress.

The alternative to commercial metastablecoins is a real stablecoin, a Central Bank Digital Currency (CBDC). Back in July Christopher Smart noted a provision of the GENIUS Act in CBDC for thee but not for me:

Amid the package of crypto bills that should head to the president’s desk in a few days lurks a ban on a digital dollar. With 72 other countries developing or launching a central bank digital currency and another 35 studying the proposition, what does America’s legislature understand that all these others do not?

The shame is that this prohibition on a central bank digital currency (CBDC) for the dollar comes as part of a mostly constructive framework for an industry that’s about to transform modern financial services. It’s as if Congress decided to hit the accelerator and the brake at the same time.

The brake comes from the right wing's fear of the Deep State:

They point to China’s pilot of the e-yuan as a future vision that includes the policing of Americans’ spending habits. What they neglect to say is that the government already tracks illicit spending now, within strict, court-supervised limits that would remain in place with any CBDC. They also fail to acknowledge the even more robust privacy mechanisms the European Central Bank is embedding in its CBDC design.

It is somewhat strange that the right thinks it is better to have companies monetizing your spending data than to have the government able to see it. There is obviously no possible way the government can buy or demand your spending data from the metastablecoin companies. But it is public on the relevant blockchain ...

Smart observes that:

There are perhaps more justifiable concerns about the financial stability risks that CBDCs might create. If there’s an easy way to convert bank deposits to cash, then CBDCs can facilitate a systemic bank run in a crisis without anyone lining up at a teller window. But online bank runs are already possible, as we learned from the collapse of Silicon Valley Bank in 2023. Moreover, the ECB’s plans to issue digital cash through banks and limit holdings in bank accounts will mitigate these risks.

In the wake of Circle's IPO, Bryce Elder asked Stablecoins might revolutionise payments, but what if they don’t?:

In practice, in the more than 10 years since their invention, stablecoins have carved out a few real-world niches but have not been widely adopted for anything other than crypto trading.

Elder was skeptical about the metastablecoin use cases:

Circle Payments Network, a real-time cross-border settlement system, pushed through its first transaction in May and still relies on traditional payment rails for FX translation and last-mile delivery. Crypto remittances need FX liquidity to be more efficient than the existing networks, and it’s not obvious right now where that liquidity comes from.

Circle also has a project with ICE to trial using stablecoins as trading collateral. The promise is for shorter settlement periods and lower margin requirements. But since the market cap of all stablecoins currently represents less than 0.5 per cent of quarterly US equity volumes, disruption is a very long-term prospect.

Finally, we can turn to Molly White for some recent reassurance that metastablecoin issuers know what they're doing:

• First, Paxos accidentally mints more than twice the global GDP in PayPal stablecoins:
  

  Paxos, the issuer of PayPal's PYUSD stablecoin, accidentally minted 300 trillion of the supposedly dollar-pegged token. For context, this is approximately 2.5x the global GDP, and around 125x the total number of US dollars actually in circulation. Paxos later announced that the mint was an "internal technical error", and that they had burned the excess tokens.
  
  While PayPal promises its customers that "Reserves are held 100% in US dollar deposits, US treasuries and cash equivalents – meaning that customer funds are available for 1:1 redemption with Paxos," there clearly isn't much in the way of safeguards to ensure that is always the case. As with most stablecoin issuers, Paxos merely issues self-reported and unreviewed portfolio reports, and monthly third-party attestations (not audits) of reserves.

• Second, Elixir shuts down deUSD after Stream Finance halt:
  

  After the defi yield platform Stream Finance announced a $93 million loss, Elixir announced it would be discontinuing its deUSD synthetic stablecoin. Stream Finance owes $68 million to Elixir, and holds around $75 million deUSD. Elixir has announced that they plan to allow deUSD holders to redeem their tokens for USDC through a process that will also eliminate the risk of Stream Finance cashing out their deUSD without repaying their loan. According to Elixir, "Stream comprised of 99%+ of the lending positions (and has decided to not repay or close positions)".

  deUSD was the 25^th largest metastablecoin with $88M market cap and volume of $64K.