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Stablecoins are facing new challenges. With USD interest rates hitting 0% and US Treasury yields turning negative, it’s becoming increasingly hard to earn a profit simply by holding USD in reserve or by purchasing US Treasury bills.
While some stablecoins operate using alternative business models, those stablecoins which rely on such rates and yields for their revenues are now in a serious bind.
However, while analysts believe that relying on interest rates will no longer be possible in the current environment, they aren’t expecting any major stablecoin issuers to go bust. Most will either weather the storm by operating at a loss during the crisis (assuming the crisis isn’t that protracted), while others will diversify their sources of revenue in order to manage.
Stablecoins and negative interest rates
“Many stablecoins fund operational expenses through interest on funds held to back their issued coins, but a 0% or negative interest rate environment would definitely create problems for this model,” explains Brant Downes, a research analyst with Smith + Crown.
Here, Downes is referring to stablecoins such as Tether (USDT), USD Coin (USDC), TrueUSD (TUSD), and Paxos Standard Token (PAX). Normally, their reserves of USD would bring these stablecoin issuers a steady stream of income, but now, such income is likely to dry up.
“There are several factors that influence how this will unfold,” Downes adds. “One is the extent to which interest rates descend to 0%, or below, and the length of time at which they might remain there. Another is the range of revenue sources stablecoin issuers maintain. Those merely operating a fiat-backed stablecoin will be impacted earlier and more severely.”
Glen Goodman, a cryptoasset analyst and the author of The Crypto Trader, agrees that some fiat-backed stablecoins could have a “tough time surviving” under the current circumstances. “But there are other ways for stablecoin issuers to prosper,” he tells Cryptonews.com. “For example by carrying out market-making activities and charging fees for issuing and redeeming their coins.
USD-backed stablecoins will diversify
Other analysts agree that a climate of 0% or negative interest rates will prove very difficult for USD-backed stablecoins. However, most expect the issuers of such coins to diversify revenue streams.
“The models we might refer to as the ‘first generation’ of stablecoins have traditionally relied exclusively on seigniorage for revenues, which, needless to say, is a difficult situation in a prolonged negative interest rate environment,” says Dr Omri Ross, eToro‘s chief blockchain scientist. “We might see some stablecoin issuers introduce mechanisms where holders have to pay fees, resembling negative rates.”
Ross adds that stablecoins will prove more resilient to 0% interest rates if they operate as part of a wider ecosystem, such as a crypto-exchange or trading platform.
“Recent models such as eToro’s USDEX, the USDC model or the Dai credit system, yield more diversified revenue-streams by acting as necessary components in a larger financial context,” he tells Cryptonews.com. “This includes serving as a hedging tool, facilitating decentralized finance (DeFi) lending and acting as a credit system for collateral assets.”
Of course, some stablecoins and stablecoin issuers will be less concerned by 0% interest rates, given that they don’t rely on interest yields.
“For decentralized stablecoins like Dai, the impact is more complex,” explains Greg DiPrisco, head of business development for the Maker Foundation. “Because Dai is a digital dollar that’s created on the blockchain, its interest rates are determined by Maker Governance and not legacy banks.”
DiPrisco acknowledges that Dai isn’t impervious to the broader rate environment, since low rates in the legacy financial system should generally cause rates to trend lower across the spectrum. “Yet by being a step removed, good Maker Governance and intelligent collateral onboarding can help keep rates positive while the legacy system is at 0% or negative.”
As for other “centralized” issuers that rely on USD held in reserve, DiPrisco expects that they will operate at a small loss and continue to grow their market share.
That said, he still asserts that there are “new avenues of utility opening up for these issuers, such as USDC being included in the Dai collateral pool – highlighting new ways that centralized and decentralized stablecoins can overcome these difficult times together.”
Collapse is unlikely
Will any major stablecoin collapse during this period of 0% or negative rates?
“One would expect most issuers to be able to stomach shorter-term periods of 0% interest rates,” predicts Brant Downes. “Collapse of individual stablecoins is probably unlikely, although stablecoins moving away from their pegs for shorter periods could be imagined.”
That said, this prognosis could change if the economy enters a prolonged and deep recession.
“Extended periods of negative interest rates, which, frankly, we consider probably unlikely given the already announced and likely forthcoming government response to current events, might ultimately see some stablecoins simply closing and returning assets, but this is probably unlikely.”
The unstable world
Lastly, what does the current crisis say about the notion of ‘stability,’ especially given the likelihood of USD inflation and stablecoins potentially “moving away from their pegs for shorter periods”?
“In an absolute sense, no financial asset is ‘stable’, because it must always measure up against alternatives,” says Glen Goodman. “Even the almighty US dollar must be compared to the euro, the yen and sterling by investors.”
Yes, while numerous stablecoins might lose revenue and possibly their pegs, the US dollar will also likely experience inflation, as the Federal Reserve ramps up potentially “unlimited” quantitative easing. So even the world’s ‘reserve currency’ isn’t stable.
Learn more: Is Stablecoin Business Model Stable Or Is It Endangered?
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