The future of stablecoins: Guardians of the US dollar hegemony or martyrs of decentralization

Either die a hero, or live long enough to become a villain.

The Dark Knight

As the Fed implements tightening policies, market liquidity is drying up rapidly. As a result, the cryptocurrency market is also facing a cold winter. With the Terra-Luna crisis and Celsius bank run crisis, public distrust of cryptocurrencies is increasing. Bitcoin is now trading at 21k, about 70% lower than its high price.

Now more and more people are betting against the dollar. They believe that even if the Fed's tightening policy ends over time and the stock and real estate markets recover, the cryptocurrency market may not be able to recover. Is this true? In this article, I would like to analyze this question in the framework of "How will the United States try to maintain its dollar hegemony?"

Scenario 1: Stablecoins survive by “parasitizing” the US dollar.

The first scenario is to incorporate the stablecoin into the existing system. In other words, let it enter the traditional financial field and be treated like stocks and bonds. In this case, the original ideology and initiative - decentralization - is completely lost.

So why does the Federal Reserve want to embrace stablecoins? Because stablecoins have the characteristics that can bring practical benefits to the Federal Reserve: becoming a new buyer of U.S. bonds.

Treasury yields have fallen during every recession since the era of quantitative easing initiated by Ben Bernanke in 2008. This is because the Fed buys more Treasury bonds to lower interest rates, and investors prefer safe assets in difficult times. In addition, the United States keeps interest rates low by forcing trade surplus countries such as China and Japan to buy back U.S. Treasury bonds with the dollars they earn from trade.

However, the situation has changed, and the US national debt has soared from 23 trillion to 30 trillion due to the unprecedented quantitative easing policy after the epidemic. The Fed owns more than 6 trillion, which is about 20% of the entire US national debt. The Fed is now practicing quantitative tightening, which means selling their national debt (technically, they are not selling bonds, but they are not buying more, waiting for maturity to pass, or any other way). This means that the biggest buyer in the market has now become the biggest seller in the market. This will definitely put upward pressure on Treasury yields.

The question is who will buy their bonds. China has been steadily reducing their bond holdings since pre-2010, and Saudi Arabia doesn't seem to be buying more bonds now that there is a feud between Biden and MBS. Essentially, the commodity itself is losing its allure due to the Fed printing too much money. It seems that Japan is the only buyer, absorbing the huge selling volume in the market.

Therefore, the United States needs to find new buyers of bonds to keep yields low and maintain its dollar hegemony. I think stablecoins may be the next candidate.

With the exception of algorithmic stablecoins, such as Dai or Terra (which have recently collapsed), most stablecoins are collateralized by fiat currencies and real assets. However, the crypto market is a booming market, but lacks regulation and compliance. That is why private stablecoins are now able to manage customers' cash themselves in a form similar to mutual funds, such as buying bonds and stocks.

So what if the government intervenes? For example, what if the government legally mandates that all stablecoins hold, say, at least 70% of U.S. Treasuries? Then the system would proceed as follows:

• Private Stablecoin Companies Mint Tokens and Buy U.S. Treasuries

• They sell stablecoins to foreign investors.

• Stablecoin market size growth

• The more stablecoins are minted, the more US bonds they buy.

• …

Ultimately, a new channel for selling U.S. bonds to foreign investors will be formed. This will create a huge buying volume. The current total market capitalization of the crypto market is about $1 trillion, and the market capitalization of stablecoins is about 0.1 of that. Assuming the market grows in the long term, stablecoins may replace China's role as one of the largest buyers in the crypto market.

In this way, stablecoins can become new buyers of US Treasuries. In this case, stablecoins become the new guardians of US dollar hegemony. Ironically, this is completely contrary to their original "decentralized" and "anti-dollar" spirit. This is why I call it "live long enough to become a villain."

Scenario 2 : Stablecoins become martyrs of decentralization

The first scenario is not a fundamental solution to the US problem. Stablecoins may temporarily become new bond buyers, but one day the US will have to face its overwhelming debt and overflowing liquidity. Therefore, the second scenario is that the US immediately solves its liquidity problem - a catastrophic situation.

The global reserve currency is inevitably affected by the Triffin paradox. If the United States wants to maintain the dollar hegemony, it should bear the rising national debt, and the fundamental way is to destroy and solve the liquidity problem. In this case, stablecoins may be a good sacrifice.

As mentioned before, most fiat-backed stablecoins hold physical assets and collateral. However, due to the market conditions these days, the value of physical assets has dropped significantly. Distrust in stablecoins is an inevitable consequence. This could trigger a second Terra-Luna crash, which in the worst case scenario would flood the entire crypto market, destroying excess liquidity.

So why sacrifice stablecoins instead of stocks or real estate? The first reason is that it is obvious that in the long run, it has the potential to challenge the current dollar hegemony. The second reason is that many companies and pension funds are intertwined, and real estate is intertwined with the debts and mortgages of ordinary people, but the crypto market is just a pocket for speculators to store excess liquidity.

However, the problem is that the decline of the crypto market will also affect the traditional financial market. In the worst case, this will trigger an economic crisis. Then the story returns to the US-China trade war. The United States may launch a negative-sum "chicken fight" game, which will cause more serious impacts on the Chinese economy while also damaging themselves.

Regardless, in this scenario, the U.S. government could intentionally lead the economy into a recession and put all the blame on the speculative cryptocurrency market that seeks to challenge the government and the dollar system. This is the “die like a hero” scenario.

in conclusion:

In summary, there are two different scenarios for stablecoins and the crypto market

Scenario 1: Stablecoins become new buyers of U.S. Treasuries and the next guardians of the U.S. dollar system

Scenario 2: Stablecoins and the entire crypto market are punished and ravaged by the US government, dying as failed martyrs who tried to fight the US dollar system.

Original text: The Future of Stablecoins: Die A Hero or Live to Become the Villain