What near-zero interest rates mean for stablecoin and why it won’t hamper its growth

Overview Extraordinary measures for extraordinary times, and it could also mean leading to extraordinary aftermath. Although we've seen the asset markets initially recovered from the coronavirus selloff, yet, the pandemic is far from over, and the fear of having a global recession has been growing.

The water that bears the boat is the same that swallows it. The ultra-easing measures adopted by global central banks and policymakers may somehow contain the economic damage, but it could also create other challenges.

Both the traditional and crypto markets are apparently increasing concern about having negative rates in the US, and recently, there were a lot more conversations about this topic among policymakers. If we see negative interest rates in the US, how will this extreme measure affect the stablecoin market and its business model and the cryptocurrency market in general?

 

Pandemic sends rate to near-zero

The US Federal Reserve and other central banks have taken bold measures to cushion the impact of the coronavirus on the global economy and financial markets. After the two surprise rate cuts on March 3 and March 15, the fed funds rate is now reduced to 0-0.25%, levels that markets haven't seen since the global financial crisis. Moreover, on March 23, the Fed announced the resume of quantitative easing without limit, opening the door for purchase assets that "needed to support smooth market functioning." 

Figure 1: US Federal Funds Target Upper and Lower Ranges (Source: Broad of Governors of Federal Reserve System; St Louis Fed.)

Reactions from the treasury markets have caught analysts' attention. The yields of the US 1-month and 3- month have dipped in the negative area. The drop came not too long after the Fed made its "QE infinity" announcement. Even though they both have slightly rebounded from the lows, still, markets have not entirely ruled out the yields could back into negative.

Figure 2: US 1M and 3M Yields went into negative (Source: Tradingview)

 

Negative interest rates in the US, for real?

In the wake of that, discussions around having the fed funds rate go negative have been increasing, markets and policymakers have been holding some very different views.

In a press conference on March 15, Fed Chair Jerome Powell warned that US economic growth would likely be "weak" in the 2Q. Still, the central bank "will not use negative interest rates to combat the coronavirus pandemic." Powell added that "We do not see negative policy rates as likely to be an appropriate policy response here in the United States,"

Some other Fed officials seem to have shown a softer stance on this issue. Neel Kashkari, President of the Minneapolis Federal Reserve, said negative interest rates are unlikely though not impossible.

Meanwhile, President Donald Trump seems more like a supporter of the negative rates policy. Back in the World Economic Forum, Trump said, "We're forced to compete with nations that are getting negative rates, something very new, meaning they get paid to borrow money, something I could get used to very quickly. Love that."

Just recently, the Federal Reserve Bank of St. Louis Economic Research released a study about central banks that have negative rates, and the possibility of the US Fed goes negative. So, will the US go negative? It seems that there's no short answer for that, at least for the short term, but nothing is really off the table in the current situation. Though, how will the USD-centric stablecoin market react when a negative rate environment in the US materialized?

 

Interest rates, dollar, and stablecoin

The dollar has long been considered as a safe haven currency during stressful times, and the recent COVID-led market turmoil is a classic example. On the back of the virus concern, the Dollar Index surged from the upper 94 handles to the 102 area during the peak of the selloff.

Stablecoin carries a similar concept, USD-pegged stablecoins like USDT and USDC were considered a safer crypto asset relative to other cryptocurrencies when market tumble.

The market capitalization of major stablecoins has surged significantly in March. The appreciations highlighted the risk-off sentiment at the time that BTC prices dropped from USD9200 to as low as USD3850 in a matter of a week. Other indicators, such as on-chain transaction volume and count, also painted that haven-demand picture.

Figure 3: Market cap of major stablecoins until March 31 (Source: DeFiPrime; Messari)

USD-pegged stablecoins are sensitive to the demand of dollars due to its nature, and it's impossible to ignore the general market's view on the greenback, the interest rate stance of the Fed, and other related factors when discussing USD-pegged stablecoins.

Since USD and dollar stablecoin is 1:1 in value, stablecoin issuers deposit their clients' money into traditional bank accounts when issuing the equivalent amount of USD stablecoin. Issuers profit from collecting interest generated by this money, and this has been the major source of revenue for stablecoin issuers.

Now, we have the Fed cut its benchmark rates to near zero, meaning banks will also lower the annual percentage yield on savings accounts matching the Fed's move. Stablecoin issuers are now probably getting less income from interest payments. Imagine if the fed funds rate went into negative, savers could even need to pay the banks for keeping their money, like Europe and Japan, and stablecoin issuers won't immune from that.

 

Stablecoins are here to stay, and getting bigger

The current low-interest rates environment may push stablecoin issuers to pursuit other revenue sources, like putting clients' money into non-zero risk investment vehicles, while some other issuers may start to collecting fees from users, but that doesn't mean stablecoin issuers are going out of business anytime soon. It may be the other way.

Institutional interest in stablecoin has been booming, especially in the money movement, payments in securities transaction areas. JP Morgan's JPM Coin is an excellent example of a major investment bank that wanted to leverage on blockchain technology to enable the instantaneous transfer of payments. However, it's just between their institutional clients.

The fact that not just banking giants want to take advantage of blockchain technology, central banks have shown growing interest as well. The PBOC has been working on a digital form of the yuan, and it's reportedly getting closer to launch. Reports also indicate that the central bank sees digital currency as a "convenient tool for its zero and negative interest rate." Meanwhile, the Fed, ECB, BOE, and BOJ have also stepped up their efforts in this area.

Although CBDC and stablecoins may not work the same way, central banks' awareness of blockchain signifies how this disrupting technology could change the way to do settlement in a more practical approach, and that's where stablecoin comes in.

DeFi could be another bright spot for stablecoin. In light of the recent USD 4mln debt bubble due to the price drop on ETH, which almost made MakerDAO an emergency shutdown, the voice of having a USD centralized collateral in the DeFi system has been growing.

Paolo Ardoino, CTO at Tether, told Coindesk that, "You cannot have algorithmic stablecoins relying only on the crypto-assets themselves," Ardoino added that centralized collateral of USD could provide a "safe set of shoulders" to the DeFi ecosystem.

As DeFi is expected to continue its growth, we believe there will be increasing conversations around this soon, and that's something that stablecoin watchers won't want to miss.

 

Conclusion

The current near-zero interest rate environment may be putting stablecoin issuers in a slightly proactive position in terms of managing their reserves. However, this is not necessarily a bad thing. In a bigger picture, stablecoin has been an essential part of the broader crypto space; its importance has been expanding and will continue that way. As an individual investor, stablecoin could provide shelter in rough market conditions. At the time that the stablecoin market is getting more competitive, traders and investors can explore the options they have within the stablecoin space. OKEx recently introduced the top 10 cryptos to USDC pairs, including BTC, LTC, ETH and XRP, the launch came after USDC market cap surpassed USD680 mln in late March, compared to just USD439 mln in February.