Bond Market Professionals Not Impressed by New Cryptocurrencies

Liz Capo McCormick, Emily Nicolle and Alexandra Harris
| Bloomberg

They are becoming the strangest bedfellows in the financial world: the famously safe securities issued by the U.S. Treasury and the infamously dangerous world of cryptocurrencies.

Issuers of stablecoins, which aim to track the dollar one-for-one, have become significant players in the Treasury market as they seek the safest and most liquid assets to back the value of their tokens.

For cryptocurrency promoters, it’s a newsworthy development as the industry seeks friendlier relations with the U.S. government. Tether Holdings Ltd., the issuer of the largest stablecoin, said it could “help support U.S. and global financial stability” as U.S. debt issuance increases and foreign purchases decline. The sector could even “prevent a U.S. debt crisis,” according to Paul Ryan, a Republican former House speaker who serves as an adviser to cryptocurrency firm Paradigm, in a June editorial in the Wall Street Journal.

But like many other crypto-related topics, there’s a grain of truth to it — and a lot of questionable hype. At least for now.

“Yes, of course it’s noise,” said Joseph Gagnon, a senior fellow at the Peterson Institute for International Economics who previously worked at the Federal Reserve. For example, the roughly $81 billion in Treasury bills held directly by Tether “is not a small amount,” he said. “But it’s just not a large amount by the standards of the trillions of dollars in the Treasury market. I don’t see it as a big deal.”

Right now, stablecoins are far from the main whales in U.S. debt markets, accounting for only about 1% of all Treasury purchases. The $6.19 trillion money-market mutual fund industry remains the largest buyer of the bills. At the end of June, these funds held about $2.4 trillion of government debt, according to Crane Data. And demand for them is likely to increase as new regulatory requirements that take effect in October impose mandatory liquidity fees on some funds in times of financial stress.

There are also corporate whales in traditional finance that dwarf the tether world: Warren Buffett’s Berkshire Hathaway Inc. increased its Treasury holdings to $234 billion in the second quarter, nearly triple Tether’s holdings and accounting for about 4% of its Treasury purchases. The total market capitalization of stablecoins now stands at about $167 billion, with Tether accounting for about $117 billion of that, according to data tracker CoinGecko.

Whether stablecoin issuers will become serious players capable of influencing the Treasury bill market depends largely on how quickly the cryptocurrency market itself grows and whether Congress ever passes legislation to that effect.

The most popular use of stablecoins is to replace the dollar in cryptocurrency markets. Traders invest in these tokens when they want to limit their exposure to volatile cryptocurrency markets or use them to invest in decentralized finance platforms that do not have entry and exit points for fiat currencies.

But remittances and protection against depreciating traditional currencies are also popular use cases — and a growing business. There’s already significant demand for stablecoins in emerging economies, according to an analysis by the Center for Economics and Business Research and BVNK from April to June this year. Businesses and consumers in 17 emerging markets were willing to pay an average premium of 4.7% over the standard dollar price to access stablecoins, the CEBR said, with that number rising to 30% in countries like Argentina. The researchers estimate that by 2027, those countries will pay a premium of $25.4 billion just for access to stablecoins.

According to JPMorgan Chase & Co. strategists led by Teresa Ho, demand for government bonds in the form of stablecoins could increase significantly if Congress passes legislation requiring the tokens to be backed at least one-for-one by high-quality liquid assets, or HQLA, a category that includes Treasury bills with maturities of 90 days or less.

Still, fixed-income veterans are skeptical about how much of a difference the purchases will make in the long run. Stablecoin issuers like Tether won’t stop yields from rising because of supply concerns and other market forces, according to Lawrence Gillum, chief fixed-income strategist at LPL Financial, who has worked in debt markets for two decades. Still, Treasury Secretary Janet Yellen should be grateful for any small increase in demand, he added.

“Any buyer you can find”

“Given that foreign investors have pulled out to fund deficits, the Treasury will have to find additional buyers,” he said. “And if it turns out that cryptocurrencies are a marginal buyer, that would be a good thing for Treasury issuance. If you’re Janet Yellen, you’ll take any buyer you can find at this point.”

Tether CEO Paolo Ardoino, for his part, is confident that his company will become an even more important player in the Treasury market. He believes that the growth of the stablecoin market will be strong enough for Tether, known as USDT, to become the largest holder of three-month Treasury bills in the next few years, and perhaps the largest holder of all Treasury bills within a decade. He expects Tether to eventually be 100% backed by U.S. Treasury bills, with only its excess reserves being invested in other asset classes.

The fact that Tether has become a player in the U.S. government debt market — and is being promoted as a force supporting the hegemony of the U.S. dollar — is a stark contrast to earlier years, when questions arose about the mysterious digital currency invented by the former child actor from The Mighty Ducks and how the company supported the stablecoin.

In 2021, Tether, a company registered in the British Virgin Islands, reached a settlement with the New York attorney general — without admitting any wrongdoing — over allegations that the company lied about its reserves and concealed losses. That same year, it reached a similar settlement with the Commodity Futures Trading Commission, without admitting or denying the allegations.

But the firm has since become a client of a Treasury mainstay: Cantor Fitzgerald LP. In 2020, Cantor Fitzgerald Chairman and CEO Howard Lutnick became interested in cryptocurrency companies, according to Ardoino. “We met up, he asked us, ‘Do you have money?’ We said yes. And he asked us, ‘Can I check every penny?’”

According to Ardoino, Cantor Fitzgerald spent about two years investigating Tether, which he described as “the deepest in-depth analysis imaginable.”

Not “Italian weirdos”

“And he finally thought, ‘Well, these guys that the media had been attacking for a long time, and people thought they had no money, were bad guys, etc., a couple of Italian weirdos. They happen to have money and they’re actually doing the right thing.’ That got him interested in us,” Ardoino recalls.

Lutnick himself has described the process similarly in public speaking this year, saying in a speech at the Bitcoin 2024 conference last month that Tether “had every penny, but it had it in places I would call pretty godforsaken,” including Chinese commercial paper. Cantor Fitzgerald agreed to take Tether, he added, on the condition that once that commercial paper and other investments matured, Tether would send the money to the company to buy Treasury bills.

“I’m interested in the 300 million wallets that hold Tether because those 300 million wallets are funding the U.S. Treasury debt,” Lutnick added. “The distribution of USDT to emerging markets is fundamental to securing our debt in our country, which helps us live in this beautiful way.”

Meanwhile, persistently high interest rates have made Tether’s pivot to T-bills a lucrative move, helping the company post a record $5.2 billion in net profit in the first half of this year, according to its latest assurance report. And a partnership with Cantor Fitzgerald, which also gives Tether access to liquidity through the overnight reverse repo market, has helped erase some of the skepticism about the stablecoin.

“This is one of our most impressive and long-standing Wall Street firms, with a great tradition of being a unique actor in the TradFi space,” said Matthew Graham, CEO of cryptocurrency-focused venture capital firm Ryze Labs. “That gives me a lot of confidence.”

Still, to get a true sense of Tether’s true significance in the Treasury market, looking at total debt outstanding provides perspective. When you include Treasury bills and bonds, which are securities with coupons and longer maturities than bills, the U.S. debt is $27 trillion. Bills only make up about a fifth of that total. The nonpartisan Congressional Budget Office projects that chronic deficits will increase the U.S. debt to about $48 trillion by the end of 2034.

That being said, Tether’s assets are “not nothing,” but they’re not game-changers in terms of funding deficits, says Mark Sobel, a former Treasury official who is now chairman of the Official Monetary and Financial Institutions Forum, a U.S. think tank.

“I’m sure the Treasury has much more important things on its mind,” Sobel said.