So far, dollar backed stablecoins like Tether’s USDT or Circle’s USDC don’t pay any interest to holders of their coin. We think that is about to change in 2019. As of today, the users of stablecoins are effectively giving their providers free loans in return for a service (digitally transferring bank dollar certificates) that is not very distinguished from one provider to the next.
Stablecoin providers make money by putting their customers’ money in the bank and collecting interest from these deposits. At the time of writing, the five largest stablecoins collectively hold $2.67B of customer deposits. At a rate of 2.5% per year, these deposits generate an annual $67.5M in revenue for them. In addition, Circle, already announced that “in the future, [they] may also invest these fiat funds in highly-liquid, AAA-rated fixed income securities.”
When there’s no interest, on the other hand, there’s no business model. So as a result of the zero interest rate policy of the BoJ and ECB, there is no competition for a EUR or JPY stablecoin.
To evaluate the stablecoin market of tomorrow, let us look at the US banking market of today. While the national average interest rate for many brick and mortar banks is still 0.1% or less, online banks are starting to undercut them heavily on prices. They can do that by giving much of the interest they receive from lending the funds in the interbank market (currently ~2.7%) straight to their customers.
The result is a price war where major banks like Goldman Sachs, HSBC, and Barclays as well as fin-tech companies like American Express or Wealth Front have all started to offer online savings accounts that pay over 2.1% p.a.
The brick and mortar banks can survive at much lower rates because they offer ancillary services in the form of branch banking, ATM networks and personal support that are also valued by their customers. Their customers tend to value the personal connection and comfort that these local banks have to offer, while customers of online banks are on average more price-sensitive.
Stablecoin providers are definitely closer to online banks in comparison. They all offer roughly the same service and level of security, and the exit cost is tiny — stablecoin users are not locked into any mortgage or insurance contracts, and changing their provider is a matter of minutes.
In 2017, it seemed like Tether had left their rear open to a new, entirely regulated stablecoin. But then 2018 showed that Tether didn’t have to do all that much to clean up their image and become more transparent, and the new competitors soon lost their moats again.
Because it is so hard to offer any meaningful distinction from your competitors, it’s likely that the next push after the FUD war and ensuring transparency war will be a price war. Stablecoin providers will have to start paying interest to their holders or be outcompeted. We saw a glimpse of that when Gemini briefly allowed customers to buy their $1 token for only $0.99 — a full 1% discount.
The easiest way to implement interest payment is to send it once every one or two months to all addresses. The interest payments will start to get priced in by the market the same way it does for a bond ETF pre- and post-dividend, so holders don’t have to worry about anything.
As a result, the market for stablecoins is about to get much better for consumers and much worse for stablecoin providers, who will see their margins shrink away. We have long speculated that there was overinvestment in the dollar backed stablecoin space, given how hard it is to have any moats there.
Running a stablecoin based on net interest margins is a fragile business model. Providers are not just vulnerable to fierce competition, but also to lower rates that can sweep the rug from under them. Still, the current “gentlemen’s agreement” can’t last forever. Which stablecoin will step out of line first and start the price war?
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