The Rise of Stablecoins: A New Force in the US Financial Market

The US financial market has long been the backbone of the global financial system, with its ebbs and flows dictated by central banks, sovereign assets, and traditional money market giants. However, a recent report by the Bank for International Settlements reveals a new player on the scene: stablecoins. These digital assets have quietly become a significant force in shaping the price of vital secure assets, and their influence is only growing.

A New Generation of Money Market Funds

Large stablecoin emitters, such as Tether and Circle, are essentially acting as a new generation of money market funds. They collect massive pools of assets in dollars and invest them in the short-term repo market, similar to their traditional counterparts. However, there’s a significant difference in regulatory oversight, which is currently lacking. This raises important questions about the potential risks and consequences of stablecoin growth and investment practices.

How and Why Stablecoins are Impacting the Repo Market

Stablecoin issuers, like Tether, often keep vast reserves in dollar-denominated assets, such as short-term T-bills and financial instruments. As part of their investment strategy, they may participate in the US repo market, which is a crucial market for short-term loans. By doing so, they can become a source of financing for companies engaged in basic trading, an arbitrage strategy used by many traditional financial players, including hedge funds. This strategy involves borrowing money through the repo market to buy Treasury bonds while simultaneously shorting Treasury futures on the CME.

While some market commentators may view this basic trade as a potential threat to the wider financial market, it’s essential to understand the benefits that digital assets can bring to the traditional financial system. The report highlights how stablecoin emitters can indirectly help finance the activities of hedge funds engaged in basic trading by providing liquidity to the repo market.

The Risks and Consequences of Stablecoin Growth

The growing footprint of stablecoins has significant implications for the US financial market, monetary policy transmission, financial stability, and the future of global payments. With stablecoin Treasury holdings exceeding $200 billion by March 2025, emitters like Tether and Circle are becoming increasingly comparable to traditional financial market players, such as large foreign investors and money market funds. However, this growth also increases the risk of market disorders, particularly if stablecoin issuers contribute to the financing of basic trading.

The report warns that a potential fire sale during a redeem run could cause significant disruptions to the market, with stablecoin outflows having a disproportionate impact on Treasury markets. If the stablecoin sector grows to $2 trillion by 2028, a proportional increase in 5-day flow variance could lead to a 2-standard deviation flow of approximately $11 billion, with an estimated impact of -6.28 to -7.85 basis points on T-bill yields.

The Need for Greater Transparency and Regulatory Attention

The growing influence of stablecoins on the US financial market demands greater transparency and regulatory attention. Stablecoin emitters must welcome increased scrutiny to build trust in their business operations, which are no longer limited to the crypto sphere but have concrete connections and potential effects on core markets, such as the finance and repo markets. Pending laws, such as the Genius Act, may help lay the foundation for the proper integration of this new class of buyers on a large scale, ultimately improving the financial markets rather than sabotaging them.