The Upside-Down Dilemma: Circle Deems U.S. Treasurys Too Risky For Stablecoin Reserves

EDITOR'S NOTE: In a jarring twist of irony, Circle, the issuer of the widely-used stablecoin USDC, has announced that it now considers U.S. Treasury assets too risky to hold as reserves. This startling revelation turns the conventional wisdom on its head, as Treasury assets are traditionally seen as one of the safest investments.

This paradoxical situation underscores the instability permeating the financial landscape, where a stablecoin—typically backed by the most secure assets—deems U.S. Treasurys, the bedrock of global finance, as too precarious. This inversion of financial norms signals not only the growing uncertainty in the U.S. economy, but also the potential for unprecedented upheaval in the cryptocurrency market. As Circle navigates this topsy-turvy scenario, the question remains: How deep does this financial rabbit hole go, and what further surprises might lurk in the shadows of the evolving economic landscape?

(Kitco News) - In an ironic twist that sounds like something a striking Hollywood screenwriter would pitch, crypto firms are now avoiding longer-dated U.S. Treasury notes as too risky.

Stablecoin company Circle, which issues USDC, the second-largest U.S. dollar stablecoin by market cap, wants no part of the United States’ dodgy debt instruments, according to Zachary Warmbrodt, author of Politico’s Morning Money newsletter.

“We don’t want to carry exposure through a potential breach of the ability of the U.S. government to pay its debts,” Circle CEO Jeremy Allaire told Warmbrodt. Allaire told him the company no longer holds any Treasurys that mature beyond early June.

Circle’s spurning of the longer end of short-term U.S. debt, while potentially inconvenient, must also have come with a measure of satisfaction given the unending barrage of criticisms from regulators and enforcement actions from the Securities and Exchange Commission (SEC) against crypto firms at home and abroad, including those focused on stablecoins.

Source: Kitco News

On Feb. 13, stablecoin issuer Paxos Trust announced it would stop issuing the Binance USD coin (BUSD), the third largest stablecoin by market cap, following an order from the New York Department of Financial Services (NYDFS). The action by the New York regulator came hours after Paxos received a Wells notice from the SEC, which is used to tell companies that they are the target of an enforcement action. The notice informed Paxos that the SEC considers BUSD to be an unregistered security.

Then, on Feb. 23, The Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency (OCC) issued a joint statement warning about the liquidity risks presented by certain sources of funding from crypto-related entities. According to the regulators, “stablecoin-related reserves” could pose heightened liquidity risks to banking organizations “due to the unpredictability of the scale and timing of deposit inflows and outflows.”

The following day, Allaire said he didn’t think the SEC was the right agency to regulate stablecoins. “I don’t think the SEC is the regulator for stablecoins,” Allaire said in an interview with Bloomberg. “There is a reason why everywhere in the world, including the US, the government is specifically saying payment stablecoins are a payment system and banking regulator activity.”

Circle wasn’t always skittish about U.S. debt. As recently as March 13, after U.S. regulators seized Silicon Valley Bank where some of their collateral was deposited, Circle provided details about the reserves backing USDC, indicating that 77% ($32.4B) of the stablecoin was collateralized with short-dated U.S. Treasury Bills, “the most liquid assets in the world and direct obligations of the U.S. government.” Those obligations looked pretty good at the time.

But the starkest example of what a difference a debt ceiling debacle can make is found in Congress’ recent draft bill outlining a regulatory framework for stablecoins published on April 15.

According to the bill, in order to be approved and to operate as a federally-regulated payment stablecoin issuer in the United States, a company would have to maintain reserves backing the stablecoins comprised of U.S. dollars or Federal Reserve notes, Treasury bills with a maturity of 90 days or less, repurchase agreements with a maturity of seven days or less backed by Treasury bills with a maturity of 90 days or less, and central bank reserve deposits, “on an at least one-to-one basis.”

Allaire took to Twitter soon afterward to share his reaction, which was largely positive. “It's an extraordinary moment for the future of the dollar in the world, and the future of currency on the internet,” he said. “While comprehensive, there are clearly open and challenging issues with the bill as proposed.”

Who could have imagined at the time that “Treasury bills with a maturity of 90 days” would be a nonstarter just three weeks later?

Vineeth Bhuvanagiri, Managing Director of EMURGO Fintech and previously at Paxos, told Kitco News that Circle’s move is perfectly reasonable under the circumstances. “This is risk management,” he said.

“The major stablecoin issuers, Circle and Tether, have made a tremendous amount of money in terms of yield buying and holding U.S. treasuries,” Bhuvanagiri said. “It’s been a huge boon to their business.”

Bhuvanagiri said that if Congress can’t come to an agreement on the debt ceiling and the U.S. experiences a technical default, “it could wreak havoc” on the markets.

“Circle is hedging its bets as a result of this possible outcome, thereby reducing exposure to treasuries, notably those that expire after the debt ceiling is due to kick in.”

“Any company would be doing what Circle is doing in this kind of scenario,” Bhuvanagiri said, “so they shouldn’t be faulted.”

Originally published by: Ernest Hoffman on Kitco News