The four prices of money and why it matters for Stablecoins
Aka why Frax must acquire a Fed Master Account if it wants to reach mass adoption
What’s the price of money?
Well $1 equals $1
A pound equals a pound
A euro is a euro.
Ok, so what about dollars in pounds? Or Euros in dollars?
What about dollars in oil or gold?
What about a dollar in 1 year, or 30?
Different monies can have different prices. These four prices are crucial to understanding the financial markets and how money works in modern finance.
The four prices of money are:
Par refers to the price of one money in terms of another similar money. In 2022 we don’t really have issues with par. When you pay with dollars in NYC that you got in LA, there’s no tax on your payment. Businesses all across the United States are required by federal law to take dollar payments at par.
But a few hundred years ago, when there were multiple state and private monies issued, questions around par were very present. If you brought money from another state or bank that was far away, it might not have been accepted at face value. You might have been charged a few percent discount on your money to transact with it. The money’s value could only be redeemed by returning to the state or bank operating area, thus the extra premium. In 2023, everything is digital and the United States has gone through a long process of fortifying, centralizing, and homogenizing the dollar so that it’s accepted everywhere at face value. For example, bank deposits are convertible into physical cash, and you would expect to get one dollar of cash for every dollar of deposits. This is what is known as par. Now, when you swap money between your bank, Cashapp, Coinbase, or any other third party application, you rarely have to pay fees to do so. Same dollar amounts magically appear in different accounts… its the wonder of technology and strong consumer protections enacted at the federal and state levels.
Anywhere there is debt, questions of par arise, as most all modern money is debt issued. In cases where repayment of debt is questionable, say when your multi-billion dollar exchange is burning to the ground.
Interest rate refers to the price of money today in terms of money tomorrow. It is the cost of borrowing money, and it is determined by the lender's assessment of risk. When you take out a loan, you are paying interest to the bank for the service of lending you money. The bank's IOU (deposits) is worth more than your IOU (loan), and the interest is what you pay to the bank to get them to do the swap.
Exchange rate refers to the price of domestic money in terms of foreign money, such as gold. In a gold-standard world, foreign money is the same thing as gold, and the important feature is the "international standard" part. However, exchange rates become more complicated when we move onto floating exchange-rate currencies. A floating exchange rate is a system in which the value of a currency is determined by the market forces of supply and demand. This means that the exchange rate can fluctuate based on a variety of factors, such as economic conditions and political events.
Finally, the price level refers to the price of money in terms of commodities and goods. We can talk about a dollars worth of gold or oil or the reverse about how much a barrel of oil or oz of gold buys. Prices of commodities and goods are an important factor, because you might find yourself in a global easing and inflation period where every central bank is pumping loads of new money into the system, so while the relative value of your money might stay similar to pounds or euros, in terms of oil, you might lose a ton.
Lets review the 4 price of money again
Par (Today’s value)
Interest (Future value)
Foreign Exchange (Relative value)
Price Level (Absolute value, value in commodities and goods)
Stablecoins and the price of money
Ok so where do stablecoins fit in all of this? The last two points on the price of money we can leave aside for this discussion. 90+% of all stables are dollars. Crypto traders don’t think of Bitcoin or ETH in domestic currency terms. Additionally, the stablecoin market is less than $100bn and the quantity of stables only affects crypto prices.
With stablecoin prices, the important parts have to do with interest rates and the peg.
Stablecoin Peg Problems
Stablecoin are backed with assets that should provide 100% backing. What exactly those assets are and how liquid they end up being is a more opaque difficult question. We can say for certain what backs USDC. They release monthly attestation reports that show the exact securities and cash that makes up the value of their onchain dollar. Tether is also releasing reports, but only after a nice request from the New York AG’s office.
In their first reserve report Tether said they had 15bn in treasuries, 1bn in reverse repo notes, 6.2 bn in cash and bank deposits and….. Drumroll 30bn in commercial paper.
Commercial paper is short term unsecured debt issued by corporations. It’s not government issued, which means the default risk can be much, much higher. Tether further stated that its commercial paper had a variety of A ratings, with no further detail. Much fanfare was given to Tether’s announcement at the time, every big new agency picked up the story and a lot of handwringing was made on CT about the solvency of Tether. Just a year later similar questions about FTX’s solvency led to its collapse within 2 weeks. But here we are nearly 2 years after the report came out and Tether is chugging along better than a cockroach in the nuclear apocalypse.
The only times Tether’s peg has deviated was when the entire markets were burning down and investors were running for the exit.
Remember how all stablecoin issuers invest their cash into yield? Well it becomes locked in the notes and other debt securities they buy. When the shit hits the fan due to “effective altruism,” investors rush to redeem to move to cash. Fiat in the bank is far more safe than dollars on-chain. So the stable issuer has to pony up what can be an insane amount of cash in a short amount of time.
Here’s the problem.. If Tether dishes out all of the 6bn they have in cash, they have to move onto more illiquid assets. Looking at their balance sheet, once the cash is gone Tether moves onto treasuries and then… the commercial paper. Its a chain of illiquidity. Treasuries are liquid, but commercial paper… hmm no.
So when you go to sell your commercial paper, especially when the shit is hitting the fan, you might have to sell it for 95 cents on the dollar. Fine for a few million… but billions? Houston we got a problem.
Stablecoins and Interest Rates
Interest rates are an interesting bit. Ask yourself a question. Why do stablecoin issuers pay no interest? The dollar is constantly being devalued and loses 2% to inflation on average every year. Furthermore, every stablecoin in existence has to be held by someone until it’s unminted or burned. So someone, somewhere has to be willing to hold stables with no possibility of receiving any of the profit Circle or Tether makes from its businesses. Circle is on track to make hundreds of millions of dollars this year and USDC holders will see none of it. It’s weird isn’t it?
When you put money into a bank account, either checking or savings, you always get interest, even if it's like less than half of a percent a year. The bank compensates its depositors for letting them use their funds in loans and other profit making operations.
Circle and Tether do the same thing with their collateral deposits. They invest a good portion into a variety of short term treasuries and other highly liquid assets to earn a yield. Right now short term treasuries are earning around 4% a year. After operating costs and fees, the actual yield is probably around 2%, which goes straight to Tether and Circle shareholders pockets.
The problem (or lack thereof) is that crypto people don’t care enough to demand those profits. Since DeFi summer kicked off in 2020, the yields have been stupid, prices have pumped and the demand for leverage was insatiable. Even now in the depths of the bear market close to a billion dollars of USDC is in the lending market Aave earning just 1.49%. Purely rational investors should look at the yield and pull their liquidity to go invest into treasuries to earn the extra 2.5%.
So what gives? It means crypto doesn’t care about the future value of USDC and USDT. In his latest paper, Yale professor Gary Gorton argues that leverage, escaping inflation in non-US fiat currencies, and illicit activities negate any demand for interest generated by Circle and Tether.
One option that could work given that crypto monies are “tokens” is by offering on-chain treasuries. Treasuries pay an interest rate, even with short term durations. We don’t use treasuries as cash in the wider market because securities in their current form are cumbersome, require intermediaries and fluctuate in price. But in token form treasuries get super powers, as they can be traded and used in AMMs like Uniswap and Curve. In everyday real life, we humans think about numbers and money in whole amounts. But with an AMM, you can have trillions of tokens of Shigecoin and swap them with one click to billions of Arrr-thereum (pirate themed memecoin). By hiding all the math, AMMs make transacting asset independent; it doesn’t matter if you are trading oil, crypto, gold, or any other asset so long as it's tokenized.
Ondo Finance is one of the first major institutions to offer tokenized treasuries. The Ondo Funds require KYC/AML checks and qualified purchaser status and are held in a bankruptcy-remote entity with independent fund administrators and auditors. A “qualified purchaser” is someone with more than $5 million in assets, which means that basic plebs can’t buy them, not to mention the $100k minimum investment required. Because of KYC/AML, the tokens can only be transferred between whitelisted addresses.
Ondo funds exist not to be money, but to serve as collateral and access crypto credit markets. Ondo DAO also governs Flux Finance, a decentralized lending protocol with OUSG, DAI, and USDC markets. The fOUSG market will respect the KYC/AML restrictions of OUSG, while there are no such restrictions for fUSDC and fDAI.
These onerous restrictions on treasuries make them poor substitutes for money. Another option that could work as money is y, a, or c-tokens from Yearn, Aave, or Compound respectively. These wrapped interest bearing tokens have no transfer restrictions and can be traded on AMMs without KYC. They also are instantly unwrappable into their underlying assets. However, each comes with additional protocol risk which the base collateral doesn’t have.
So while there are money-like substitutes in crypto that pay an interest rate, their demand is fractured and weakened by protocol risk. Boring, run-of-the-mill stable dollars are preferred over other options even though their value is constantly declining. Is there a better option? Not at the moment. Until there are stronger regulations for banking on crypto networks, stablecoins will be lacking. This is the core reason why Frax needs a FMA account. The billions and soon to be trillions of dollars in collateral Frax controls must constantly be used to find yield in DeFi, while Circle keeps all the profits made from investing off-chain for themselves. With an FMA, Frax can issue its own stablecoin for on-chain collateral and swap all of the USDC into their own branded and controlled collateral asset. FMA access will help improve the price of Frax and its stability and will continue to be a core roadmap goal into the future.