The U.S. Treasury stated in a new report that the growth of digital assets primarily stems from the use and popularity of stablecoins, creating a demand for short-term Treasury bills. Institutional adoption of 'high beta' Bitcoin and cryptocurrencies may also lead to an increase in future demand for Treasury bonds as a hedge. However, the report also points out that stablecoins will need to be regulated like narrow banks or money market funds.

Digital assets are growing rapidly, and stablecoins are particularly important.

The U.S. Treasury released a 132-page report on Wednesday, written for the Treasury Borrowing Advisory Committee, with a section dedicated to discussing digital assets.

The report states that although the base of digital assets is small, it is growing rapidly, stemming from native cryptocurrencies like Bitcoin and Ethereum, as well as stablecoins. The report specifically mentions stablecoins and the leading stablecoin Tether.

The most common stablecoins in the market today are fiat-backed stablecoins, with most of their collateral existing in the form of U.S. Treasury bills and Treasury-supported repurchase agreements, estimated at a total of $120 billion directly invested in U.S. Treasury bills.

Lessons from history show that stablecoins need to be regulated.

Although stablecoins usually hold a large amount of U.S. short-term Treasury bonds as collateral, this is not a requirement. Nevertheless, the report still describes stablecoins as a form of private on-chain currency, likening them to traditional financial money market funds. It references two historical instances, emphasizing that stablecoins need to be regulated like narrow banks or money market funds.

Era of Wildcat Banking

Before the establishment of a central currency authority, banks in the United States issued their own banknotes, which were under-collateralized and prone to runs, often trading at discounts in the secondary market. To address these issues, most state governments required banknotes to be backed one-to-one by government bonds as collateral, but the difficulty of exchanging various notes led to the passage of the National Bank Act in 1863, ultimately resulting in the dollar becoming the only circulating national currency.

2008 Money Market Fund Run

Major money market funds experienced significant runs during the 2008 financial crisis as the prices of short-term commercial paper fell, undermining confidence in the funds' ability to meet redemptions. A similar situation occurred again in 2020 when commercial paper prices fell sharply once more.

The report emphasizes that so-called 'risk-free' investment instruments are truly risk-free only when backed by actual risk-free collateral (such as short-term U.S. Treasury bonds).

Regulation of Stablecoins

History has shown that stablecoins cannot effectively operate as private currencies and ultimately require strict regulation like narrow banks or money market funds to ensure they possess risk-free collateral.

Despite recent improvements in the collateral of stablecoins, significant risks remain. In recent years, stablecoins have frequently experienced bank runs, leading to a loss of their peg to the dollar or complete collapse. A collapse of major stablecoins like Tether could lead to a rapid sale of the U.S. Treasury bonds they hold, hence the need for regulation to prevent the pressure in the stablecoin market from spreading to the broader financial markets and the Treasury bond market.

This article U.S. Treasury Report: Stablecoins Increase Demand for Treasury Bills, Need Strict Regulation first appeared in Chain News ABMedia.