eurodollars today, stablecoins tomorrow

2021.10.01 | stablecoins and the near future of crypto series

a more immediate vision

As is broadly known today, the original nirvana of crypto is a world free of fiat currencies. This vision is alive and well and inspires the work of a large swath of crypto builders and doers. In reality, the world really only runs on a single fiat currency - the dollar. So if you want to talk about a world free of fiat currencies, what you need to talk about is a world that is free of the dollar. This is a great vision. But in the near term, it’s unrealistic. So, what does a more realistic, if less idealisitic near-term future look like for crypto? A lot of smart people argue that it looks like a world that runs, largely, on the back of USD stablecoins.

offshore dollar demand remains strong

A few quick thoughts to illustrate that offshore demand for USD today is as strong as it’s ever been:

First, the US economy is still a behemoth. Even if it now has some company at the top, the world still very much wants into the US economy. I don’t think I need stats to convince you of this one.

Second, while US interest rates are incredibly low, rates in the EU and Japan are even worse ^{1 (stats)} . At the moment, rates for 1 yr ECB and BoJ bonds are negative. The world wants dollars so they can get higher yields:

Trade is still overwhelmingly done in dollars. ^{2 (stats)} You can see below that for data compiled through 2014, it is estimated that the dollar accounted for about 40% of all global trade invoicing. Interestingly, the EUR accounted for 46%. This is because the data includes “exports” between EU member countries which is a bit misleading. I consider intra-EU “trading” to be not much different than interstate commerce in the US. Also, note that embedded in this is oil. OPEC still prices its oil in USD and it’s hard to see that changing anytime soon. The petrodollar is alive and well.

Global Export Invoicing Currency Composition

Foreign holdings of dollar-denominated securities have gone up every year since 2009 ^{3 (stats)} . As of June 2020 - the most recent report available as of the date of publishing - the Fed estimates that there is $12T of foreign-held USD debt that needs to be serviced. That’s a lot of dollars. And keep in mind that much of this is long term debt - not the type to be easily or quickly extinguished.

Foreign Holdings of US Securites by type

parallels of stablecoins and eurodollars

Recall Milton Friedman’s definition of eurodollars from the previous post: dollar-denominated debt issued / held outside of the jurisdiction of the US. Let’s abstract that definition to something slightly more theoretical: eurodollars are basically synthetic dollars. They are “imaginary” dollars" created on top of “real” dollars; just like any other credit money. And for an even more theoretical definition: they are instruments which confer upon the owner access to m0 US dollars.

With this backdrop, let’s talk about stablecoins. Stablecoins are blockchain-based coins that are “backed” by some other asset at some (usually) predictable ratio. See sources for more on stablecoins themselves

Staking is at the heart of stablecoins. By way of example: users stake ETH, they are issued a coin - cETH - which they can trade in markets. The bearer of that coin can then redeem cETH for the underlying ETH that the original user has staked. That’s the basic concept of a stablecoin. USD-backed stablecoins work the same way - just with dollars.

As you can see, a USD-backed stablecoin also fits our description of eurodollars from above: an instrument that confers upon the owner access to m0 US dollars. Technical and implementation issues aside, it’s easy to see how USD-backed stablecoins could step in and become the crypto-version of eurodollars.

what does the opportunity for stablecoins look like?

In a word: enormous. Despite the apparently insane growth that USD-backed stablecoins have experienced, we’ve barely scratched the surface. Let’s compare some basic stats to see:

The marketcap of the top 5 USD-backed stablecoins is about $50B USD as of the date of this article ^{4 (stats)} . That’s about .4% worth of interest on the $12T of outstanding foreign-held USD debt.

To view that same from a slightly different angle: The peg for most of these stablecoins is about 1:1 (hopefully!). Therefore the market cap of these stablecoins, their circulating supply and the number of “real” dollars tied up in these stablecoins is all about the same: $50B USD.

Global trade in 2020 was about $17T USD (falling from $19T USD in pre-Covid 2019) ^{5 (stats)} . Based on the data above, roughly $6.8T of that trade was done in USD. Again, $50B USD is almost de minimus compared to this sort of volume.

You can slice these numbers all day long. The bottom line is, if stablecoins capture even a sliver of the eurodollars' use-cases - as they already are beginning to do - then it’s very early innings.

what crypto-dollar fusion might mean

While a dollar-backed “stablecoin world” might not sit well with crypto purists who want a complete separation from fiat, it may be the most likely scenario in the short term.

The use-case is overwhelmingly real and massive; the technology is in place and is proving its mettle; and because it ultimately serves to amplify the power of the dollar, it may thread the regulatory needle successfully. There are of course issues with stablecoins (read: Tether). Nevertheless, it’s clear they can get the job done, if imperfectly.

Bretton Woods declared that gold would be used to regulate international trade between major post-war powers. But it was inked under the looming shadow of the US dollar. In less than two decades, gold would be supplanted, if only unofficially, by the dollar. A few years later in 1971, the unofficial became the official and the world was off of gold.

It doesn’t take much of a stretch in imagination to see how a similar shift could happen with USD stablecoins and non-USD stablecoins. While the initial stablecoin system might be built on the Greenback, Bitcoin, Ethereum and other major cryptocurrencies loom. Once stablecoins are more established, crypto assets could slowly overtake the USD as the primary underlying stablecoin asset. Or they might not…

“Beware of stablecoins bearing dollars”?

“The dollar is dead. Long live the dollar”?

Both?

We’ll find out soon enough.