DAR Crypto Weekly — 4/3/20

The Dash to Cash

Market Overview

Digital asset prices were up on the week with total industry market cap up 2.2% to $186.9B. Large-cap relative winners on the week were Ethereum (ETH +5.9%), Bitcoin Cash (BCH +5.4%) and Bitcoin SV (BSV +4.5%). Laggards in the large-cap category were EOS (EOS +1.3%), Tezos (XTZ +1.7%) and LEO (LEO +2.2%). Other noteworthy positive movers across the industry were Synthetix (SNX +19.8%), ICON (ICX +18.3%) and Cardano (ADA +6.9%). Other notable laggards on the week included KuCoin Shares (KCS -8.6%), Kyber Network (KNC -6.7%) and Maker (MKR -6.3%).

The Dash to Cash

In times of crisis and economic uncertainty, it’s common to see demand for haven investments increase. Those types of investments are typically US Treasuries (or similar obligations of other central banks around the world), gold, and fiat currencies (cash). Typically, these investments are inversely correlated to the price movements of risk assets, like stocks. However, there can exist a point in a crisis where long-established asset class correlations get warped and everything trades in unison, the so-called “correlations go to 1.0” effect. We saw this a couple of days over the past month where USTs were positively correlated with the US stocks. In times like this, usually the worst part of a crisis, no amount of diversification suffices. The only asset that investors seek during those times is cash, as all assets are sold seemingly without discrimination.

Over the past few weeks, the demand for the US Dollar, the most widely owned currency by central banks around the world, has been on the rise. Looking at the US Dollar Currency Index (DXY) as a proxy, the index is on an upswing (after much recent volatility), showing that the USD truly is the reserve currency of the world, even despite the weakening effects of all the monetary stimulus injected by the Fed.

Stablecoins Flex

As the dollar has long been considered as a haven currency, it should not come as a surprise that its digital counterpart, USD denominated stablecoins, have also an increase in market capitalization throughout the same risk-off period. Since bursting onto the scene in 2014, stablecoins have sprung up in all corners of the digital asset ecosystem. By linking legacy finance with blockchain-based assets, these coins aim to combine aspects of crypto and fiat, while offering an on-ramp for cash into the crypto ecosystem.

Though most don’t provide a yield, stablecoins offer price stability while Bitcoin has exhibited extreme volatility as of late. But the way that new stablecoin balances are created is by accepting fiat deposits in a bank and issuing tokens to purchasers. Stablecoins shouldn’t be created when Bitcoin is sold for Tether, for example, so this rising balance of stablecoins indicates cash coming into the ecosystem. We think this growing balance is an important statistic that investors should keep an eye on.

NIRP to ZIRP

For stablecoin operators that collect interest income on cash deposits at banks as a revenue source, the decline in nominal rates around the world should have their attention. While the Bank of Japan (BoJ) is the only major central bank currently with negative nominal rates, this practice could gain more widespread usage as central bankers continue to fight the economic impact of the spread of COVID-19 around the world. A continued decline in nominal rates could force stablecoin issuers with the prospect of accepting declining revenue or increasing the risks they take with their cash balances. These risks come in two forms: credit and duration.

Less creditworthy borrowers pay higher interest rates to lenders than high credit quality borrowers. We see this on the consumer level, with FICO scores, credit rating of corporate issuers (investment grade vs high yield), as well as credit ratings of municipalities and sovereign nations. To generate more revenue, stablecoin issuers could increase yields by accepting more credit risk, investing in loans to less reliable borrowers.

The other option is to lend out money for longer, extending the duration of their investments. All other things being equal, loans that take longer to pay back offer higher yields because of interest rate risk. This is the risk that interest rates will rise (or fall) during the life of the loan. This could be because of changing inflation expectations or other economic policies. When interest rates rise, fixed-income investments of the longest life (duration) are negatively affected the most.

A potential third option would be for stablecoin issuers to create new revenue sources entirely. These could be deposit or withdrawal fees or a pass-through of other fees directly to stablecoin purchasers. It could be with partnerships or revenue shares with financial institutions or merchants. Lending platforms like BlockFi offer rates of 8.6% on balances of USD Coin, Paxos Standard, and Gemini Dollar. But whatever stablecoin issuers decide, the path forward will be filled with tradeoffs. This could be exasperated by the explicit move to a negative interest policy (NIRP) by central banks. In this strange world, depositors pay banks for holding their cash. We’re not there just yet, but we’re not that far from it at this point.

What to Expect Going Forward

Where rates go from here will largely depend on how the COVID-19 crisis develops and what the Fed does moving forward. Though the current near-zero interest rate environment may be putting stablecoin issuers on the defensive terms of managing their cash reserves, we believe there will be a growing demand for stablecoins because of high yield lending options as well as an onramp to the crypto ecosystem. It’s clear to us that because of negative and declining real rates, fiat will continue to be devalued versus real assets. That should be incrementally beneficial to the crypto ecosystem at large. As can be seen in the following updated chart, the Fed’s intended action of pushing down real yields is starting to work, something we think crypto investors should view as the wind at their back.

That’s all the time we have this week. Please reach out with any questions, comments, or feedback on our work. Get our weekly wrap and daily news delivered directly into your inbox here.