Chris Doran

Stablecoins: What happens when the risk free rate is money

What the hell is going on with stables? #

A spectre is haunting DEFI -- the spectre of treasury bills.

Stablecoins are the talk of the town currently. Financial institutions are scrambling over each other to compete for their favourite thing: using other people's money to pocket the risk free rate. Or, in other words - using other people's money to buy US treasuries. Not a bad business model! But they're a decade late.

For those who don't know, Stablecoins like USDT and USDC (known as "Dollar backed" stablecoins) are dollar pegged tokens for deployment on a blockchain. For every dollar, an institution will normally buy a corresponding share of a US treasury bill which pays 2-7 percent anually - known as the risk free rate. In this way, these issuers have become massively profitable enterprises - and tradfin is noticing.

These enterprises have struck a simple bargain with crypto users and institutions for the past decade now: They will continue to redeem their tokens for US dollars indefinitely, virtually guaranteeing its peg. In exchange, they will pocket the sum total of the risk free rate. This business has been held up by 1. The highly profitable nature of cryptocurrency over the past decade - where users have previously had more and better opportunities for yield and 2. The absolute utility of a no questions asked, 0 KYC on chain USD alternative usable for whatever you see fit - a not inconsiderable risk for the issuer. Massive amounts of competition are about to enter the space - and here's what I think they haven't priced in:

1. Yield passed directly to the user #

USDC and USDT have been tolerated for so long due to their position as regulatory arbitrageurs. On chain users were willing to delegate their yield to these issuers in exchange for them taking the regulatory risk around a new and previously unknown technology. This isn't the case anymore.

If the utility of these issuers legal war chest is no longer in play, issuers will have to compete in the way that other financial instruments do: on yield. Some savvy issuers are already frontrunning this, although are backing their tokens with less conventional asset classes. Nonetheless, i expect there will be a race to the bottom in terms of "who can offer stablecoin holders closer to the risk free rate". Issuers, having no real platform on which users can buy and sell goods and services on, rely on their circulating supply being propped up by other vendor's acceptance of their coins. With institutional players stepping in, I expect this to change quickly. They will need to sweeten the deal. I predict there will be a race toward the risk free rate, with different vendors occupying different slots on the risk <> yield curve.

I don't know what the implications are for this on federal monetary policy - but i imagine they're not good. After all, when everyone gets yield, no-one gets yield, and so the risk free rate becomes zero, or more accurately, the spread between money and t-bills trends toward zero. High interest rate environments will make this GLARING. The difference between your lossy dollars and your yield bearing stablecoins (at 5.5%!) will be substantial. A new liquid asset class that directly disintermediates federal monetary policy? Satoshi blushes.

2. Tradfi competes at the speed of wire - DEFI simply vampires #

The race to give token holders the best yield could be vicious. Tradfin is accustomed to competing within walled gardens, but crypto is both open and even with tokenised RWAs, somewhat permissionless. This creates some wrinkles for issuers.

Say, hypothetically, i am an aggressive new stablecoin issuer. I create an aggressive yield low risk stablecoin with good distribution. Maybe i even have a network of users and use cases already - great! But circle has 50 billion tokens floating around. And what's worse, my users own a lot of them!

So, what if, as an issuer - i accept other stablecoins. I route them to arbitrageurs who burn them through their individual contracts with issuers. I use the new US dollar liquidity (at a small 15 bip impact to me!) to mint more of my own stablecoin, which i put back into circulation through pools, user withdrawals, or other methods. I'm directly draining the liquidity from their stablecoin and turning it into my own, thus pocketing any associated yield and better yet, diminishing their position. If they cease redeeming to the arbitrageurs, their coin will lose it's peg, or worse, they will breach contract. If they keep redeeming, they may have to keep selling bonds until there are none left, and are no longer profitable. This is one way to unwind an issuer.

Issuers can fight this in a few ways: by offering different backing assets (although, this is limited by regulation), risk profiles and yield amounts. I expect however, they will fight this with contracts - mint/burn agreements with enterprises and arbitrageurs that strictly limit the total possible outflows. This still doesn't solve the problem - but may stem the bleeding.

3. Order flow is king #

One key learning from DEFI in the 2023-2024 era is that value accrues to order flow. Order flow to ethereum and solana block builders means more MEV. Bananagun, pump.fun, Jito, all make substantial profits from order flow. Ultimately, platforms come and go, but value accrues to orderflow.

In this new stablecoin regime, issuers with organic orderflow have an opportunity to take advantage. In a world of hyper capital efficient stablecoin flows and vampire attacks, the game becomes: who can keep their coins circulating the longest. The most obvious way to do this: have a reason to use them. PYUSD - though not yet "crossed the chasm" at the time of writing, is a great example of this. Visa is also getting their foot in the door here. Stablecoins that have a reason to be, will be. Those that don't, may not survive.

So, what? #

In a world where money itself yields 5%+, the stablecoin game becomes one of distribution, risk management, and network effects. Survival means offering actual utility beyond mere existence. The winners will be those who build moats through real transaction volume rather than regulatory arbitrage or trying to nickel and dime yield from users. The cost will be 5%, but the prize could be the world's transaction volume.

Ultimately, this should evolve toward free-er, fairer money. After the dust has settled, capital efficient yield bearing collateralised debt protocols like MakerDao, Ethena, or LST backed stablecoins have an opportunity to shine here - but only after the institutions do battle over treasury bonds.