How stablecoins are reshaping global finance

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Ken Worthington: Welcome to J.P. Morgan's Making Sense. My name is Ken Worthington. I'm a Brokers Asset Manager and Exchange Analyst for J.P. Morgan. Joining me today is Teresa Ho, head of U.S. Short Duration Strategy, and we're here to explore the fascinating world of stablecoins. What they are, what's driving their popularity, and how the market could evolve in the coming years. Teresa, thank you so much for joining me today.

Teresa Ho: Hi, Ken. Thanks for having me.

Ken Worthington: So Teresa, can you kick things off by giving us a brief overview of stablecoins, how exactly they work and why they're in the limelight right now?

Teresa Ho: I think the easiest way to think about stablecoins is that they are a form of cash in the digital world. So, it's digital cash where you can pay instantaneously at any hour of the day, at any day of the week. And they can do this because stablecoins make use of the blockchain technology to transfer those coins or tokens from point A to point B. Now, there are actually multiple types of stablecoins out there from algorithmic stablecoins, to commodity-backed stablecoins, to crypto-backed stablecoins. The version that we talk about is a fiat-backed stablecoin, which means that the coin is backed by the reserves of a fiat currency, say the U.S., dollar on a one-for-one basis. And this is so that they can maintain their stable value, hence stablecoin. So if there's $10-billion of stablecoins, the stablecoin issuer needs to have at least $10-billion of reserves in the fiat currency backing that coin. Now, some folks might be familiar with Tether and Circle. They are certainly two of the most popular fiat-backed stablecoins out there, or even just stablecoins in general. They currently make up about 90% of the entire stablecoin market. Now, why is this in the limelight right now? So the GENIUS Act was actually a very big deal. This is the stablecoin legislation that was passed in Congress in July and provides a framework in terms of how they're defined, who can be a stablecoin issuer, how they should be governed, et cetera. And that was the clarity that I think a lot of folks were looking for. It legitimizes stablecoins as an asset class at a time when the use cases for stablecoins are growing and evolving. And if you think back to the prior administration, any involvement with stablecoins or more broadly, crypto at that time was heavily scrutinized. So the GENIUS Act was really, I think a sea change for not only those that were involved in the crypto markets, but also everyone that wanted to be involved in the crypto markets. Beyond that, I would say, you know, another reason why this became a really hot topic of conversation for at least a lot of folks in the fixed income markets is we've had Treasury Secretary Besant repeatedly coming out to say that stablecoins could become a sizable buyer of Treasuries in the near term. So you know, you got a lot of folks thinking about how this could really reshape the financial system and the movement of deposits and the movement of cash. Is there going to be truly new treasury demand, new dollar funding, and so forth. So this kind of rippled across the markets through funding and policy discussions.

Ken Worthington: That's great. That was an amazing introduction here. So maybe taking this to the next step, how do stablecoins compare to deposits and money market funds? And to even take it a step further, how do stablecoins compare to tokenized deposits and tokenized money market funds? What are sort of the key differences that you see there?

Teresa Ho: Sure. For obvious reasons, people tend to compare stablecoins to deposits, which makes sense since they can be used as a form of payment. But when you think about it, it's actually not quite the same in that, you know, with stablecoins, you're not guaranteed that you can redeem your stablecoins at par. In fact, there have already been a few instances where stablecoins have de-pegged, which basically means they've deviated or fallen below the $1 NAV. So the dollar that you put in is not the dollar that you're going to take out. People have also compared stablecoins to money funds because they are backed by reserves or more specifically high-quality liquid assets or the very same assets that money funds invest in. But when you think more about that comparison, they're also not quite exactly like money market funds, because money funds are an interest-bearing product. Stablecoins at face value as written in the GENIUS Act, cannot pay out interest. So stablecoins are currently sitting in this very interesting intersection between deposits and money funds. And taking it one step further, how do stablecoins compare to tokenized deposits and tokenized money funds? I think that's an excellent question, and I think it brings up a related question in terms of can these things all coexist? Because, all three of these things are some form of digital cash in the digital ecosystem. So stablecoins, as I said, are digital coins that are backed by reserve assets. Tokenized deposits are exactly what they sound, it's deposits that are on chain. And tokenized money funds are the same thing, money funds that are on chain. And because they are all on chain, they all have the benefit of the speed and cost efficiency that you will get with something being on blockchain. But across the three types of products, there are some key differences. And I will say one of the biggest differences between these products is that stablecoins are still a fairly new product, and with it there are some unknowns in terms of how will they be treated on bank balance sheets, what are the KYC and AML requirements, what does liquidity look like, how does redemption look like, et cetera. Comparatively, we know how deposits work, just bringing it on chain doesn't change any of that. Banks still treat tokenized deposits as a liability, it's subject to the same capital and liquidity requirements and leverage requirements. So in that sense, with tokenized deposits, you're moving into a product that you mostly know and understand and trust. The same cannot be said for stablecoins right now just because it's so new, but that clearly could change down the road.

Ken Worthington: Let's try to put some numbers around this. What is the current size of the stablecoin market and how do you see that growing in the future? And then I think the more interesting question is, how does this relate to treasury demand? As a stable market grows, what does this mean for the treasury market?

Teresa Ho: So the stablecoin market right now, and I'm specifically referring to the fiat backed dollar stablecoin market, that market right now is about $300 billion. And as I said earlier, Tether and Circle makes up about 90% of the market. In the next few years, I believe that we could see it grow to about 500 to $750 billion, maybe a trillion dollars if everything lines up. And that growth will be predominantly driven by the crypto market as that continues to grow. And so what we have found is that there's a pretty strong correlation between the size of the crypto market and the size of the stablecoin market, which makes sense as stablecoins are predominantly used to trade in and of native cryptocurrencies and facilitate those transactions. So you know, we continue to think that's going to be the biggest use case in driving the growth of the stablecoin market. The other growth factor I think comes from non-US persons, particularly those in EM countries, they see dollar stablecoins as a better store of value than their local currency because that local currency is subject to hyperinflation or unstable government regimes. So they just find the dollar, more specifically the dollar stablecoin, to be just a much better store of value for, for their cash. And so we think that's going to be another contributing factor to the growth of the stablecoin market. Now, there's a lot of talk about stablecoins becoming a form of payment. And kind of in that use case and in that version of things, we're a little skeptical on that in that it could completely replace the payment rails, because at the moment we just don't see a really compelling need for consumers to move to stablecoins as a form of payment. I mean, I would venture to say that most folks are pretty happy exchanging money on Venmo, PayPal, Zelle, what have you. I just really don't see folks going to Starbucks and say, "I want to pay their coffees with stablecoins." Right. And so on the institutional side, I think there's a more compelling case for the use of payments, for the use of digital cash as a form of payment. But thinking that through, it's also unclear to me whether digital cash necessarily needs to be in a form of stablecoins once you factor in KYC, AML governance, risk management, compliance, fraud, and all those things that are very important at the institutional level. So I think as a form of payment, it's a little bit hard to kind of scale that really high. But where I see it could provide some value is you have transactions that are going from the U.S. to the emerging markets. So cross-border payments specifically to EM, because I do think the corresponding banking network and the current payment rails right now is very costly and time consuming. So I think there is a opportunity for stablecoins there. And then on the question on treasury demand, just very quickly, you know, the GENIUS Act sets out requirements in terms of what kind of assets they can invest in, one of which is treasuries and more specifically T-bills. So as this market continues to grow, it will certainly contribute and add to the demand for T-bills. But the only thing I would say to that is that it's important to consider, you know, just where the money is coming from that's moving into stablecoins. If it's moving from money funds to stablecoins, when you think about it, money funds are already buying those T-bills. And so when you move that cash to stablecoins, that are also going to buy those T-bills. You are just really changing the ownership of those T-bills. You're not necessarily adding to net treasury demand. If it's coming from bank deposits, then I think there's a case where you can have more incremental treasury demand. So it kind of depends on where the cash is coming from. So I've said a lot, Ken, let me turn it over to you because you cover stablecoin issuers and crypto exchanges as part of your research. What trends and movements are you seeing in the stablecoin space?

Ken Worthington: So I guess maybe first and most importantly is we're seeing interest, right? Since GENIUS, we're seeing more corporate dialogue both inside and outside of financial services, and we're seeing more brainstorming on how stablecoins can make life easier. The next thing is we're seeing growth. We're seeing money go into the leading stablecoins, which are really Tether and USDC, and the stablecoin balances are growing, but the pace of growth has also been increasing. GENIUS has really been a factor in unlocking the pace of growth. I would say third, that we're seeing not just stablecoins grow, but interest in these digital dollar equivalents also growing as well. So you talked about tokenized money market funds, we're seeing those adding assets. So BlackRock's Biddle, Franklin's Benji, they're both taking in more and more dollars as time goes on. And then what sort of hits our world is we're seeing companies going public that are attached somehow to the stablecoin market. So Circle, which manages USDC, went public in June. Bullish, which has a big business promoting new stablecoins went public in August. So we're seeing the business of stablecoins starting to go mainstream as well.

Teresa Ho: Thanks, that was really insightful. And finally, what do you think are the key growth opportunities and challenges for major stablecoin players in the coming months and years?

Ken Worthington: So in terms of opportunities, we see a handful, but the handful are really big. So one is cross-border payments. So this is either retail remittances, or I call it like corporate value transfers seem to be better when done with stablecoins. So we're seeing more activity there. We're seeing experimentation. But it's a big market and it seems like the technology is better. Second is dollarization. So instead of holding dollars in mattresses, we're seeing stablecoins increasingly used as a store of value in parts of the world where access to the banking system is limited or local currencies are depreciating. And then you talked about payments, we see traditional consumer payments as possibly being better using stablecoins than what exists in sort of consumer payments today. And I would say what could make stablecoins better is maybe the unbundling of the various services that are incorporated into payments today, but may or may not be valued highly by consumers. So just like, five years ago, 10 years ago, we had cable, we had all the channels, and we've seen an unbundling of cable because you didn't want to pay for the stuff you didn't need. Maybe stablecoins offers that same opportunity to unbundle on the payment side. So who knows, it's early days, but we see potential. Now, there are issues that have to be worked out. So it's opportunity, but opportunity does have a cost. So you mentioned KYC, AML, so this is know your customer, anti-money laundering. Stablecoins make it easier for the legitimate side of the world, but they could also make it easier for bad actors to pursue illegal and unethical activity. So that's something that needs to be brought into check. And then the proliferation of stablecoins. We don't want this done in a way that threatens our banks and our economy by changing the rules of the road so quickly that the market doesn't have time to properly adjust. So there are opportunities, but there are things that we need to make sure remain in check as well, so things don't get worse before they get better.

Teresa Ho: Got it. So the takeaway I think, is that there's still a lot of unknowns, and there's still a lot of issues to work out in this space. And so, you know, there will be more to come. It's a fast moving market. And so the takeaway is that there are still all these issues, but stay tuned because things are unfolding.

Ken Worthington: Well, thank you, Teresa. I think that's a great place to wrap up. Thank you all for your interest in stablecoins.

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