Negative interest rates have arrived in the U.S. Stablecoin issuers say they'll maintain 1:1 parity with the dollar

Negative interest rates have arrived in the United States. Yields on short-term Treasurys, for both 1-month and 3-month bills, have fallen below zero as investors flock to the safety amid the coronavirus crisis.

In such a scenario, issuers of USD-pegged stablecoins could see some challenges to maintain the 1:1 parity to the dollar.

Why? This is because stablecoin issuers keep collateralized dollars in bank accounts and earn interest on them. In case of negative interest rates, they would instead be charged to keep funds, which could result in fewer dollars in those accounts than the number of stablecoins in circulation.

"Negative interest rates can potentially pose a challenge to the ability of USD-backed stablecoins to operate as-is," Garrick Hileman, head of research at Blockchain.com, told The Block. "Specifically, the types of backing assets held by a stablecoin operator may need to be adjusted in a negative rates environment, and such changes may introduce additional risk to maintaining the 1:1 redemption peg."

                                             Short-term Treasury yields below zero

Source: The Block Research, FactSet

Tether says it's not concerned about negative rates

Despite the negative interest rates scenario, major stablecoin issuers such as market share leader Tether remain confident that they will continue to maintain 1:1 parity to the U.S. dollar.

Tether (USDT), which boasts over 80% of the existing stablecoin market share, said its USDT will always be backed 1:1 against its reserves.

"Our reserves mean traditional currency and cash equivalents and, from time to time, may include other assets and receivables from loans made by Tether to third parties. If we head into negative interest rate territory, we still have the capacity to earn returns on the reserves. Tether will remain 100% backed by reserves," Stuart Hoegner, general counsel at Bitfinex, a sister firm of Tether, told The Block.

Hoegner declined to comment on specific strategies that would be adopted. 

Other major stablecoin issuers

The second-largest stablecoin issuer, CENTRE – founded by crypto startups Circle and Coinbase in 2018 – also said that its USD Coin (USDC) will remain redeemable for $1.

"USD Coin reserves are governed by the Centre Consortium network rules and reserve investment policy, where capital preservation and liquidity are the Consortium's primary mandates. These reserves are only held in highly liquid instruments, such as short-term U.S. government securities and cash deposits. We are closely monitoring the yield environment, the potential for negative yields, and will continue to provide solutions that ensure that $1 USD Coin will always be redeemable for $1 USD," Josh Hawkins, SVP of global corporate communications at Circle, told The Block. Coinbase declined to comment when reached.

Other top stablecoin issuers, including Paxos, TrustToken and Gemini, all said they will ensure to maintain a 1:1 ratio.

"We have a long-term view on this; we doubt that negative interest rates would last for a prohibitively long time in the U.S., so if it were to happen, we would cover the costs out of our corporate funds," Dorothy Chang, vice president of marketing and communications at Paxos, told The Block. "All the dollar-backed stablecoins we custody – Paxos Standard (PAX), Binance USD (BUSD) and Huobi USD (HUSD) - will remain 1:1 backed." 

A TrustToken official, on the other hand, acknowledged that negative interest rates are a "serious" economic risk factor, but said these "don’t pose a threat" to True USD (TUSD) parity with the dollar.

"TrustToken has been working with our banking and trust partners since long before the recent rate change to achieve above-market interest rates, and we're well placed to combat current interest reductions and maintain full dollar backing for the foreseeable future," the official said.

A Gemini spokesperson said the firm plans to "supplement the economics" to maintain the 1:1 parity for the Gemini dollar (GUSD) in the event of negative interest rates. They declined to comment on specific strategies to be adopted.

Binance, on their part, declined to comment on the matter for its BUSD stablecoin. But as it is managed by Paxos, it will remain 1:1 backed, as Chang noted.

Will negative yields last?

Blockchain.com's Hileman said the likelihood of widespread and persistent negative rates in the U.S. is a "heavily debated" topic, but the U.S. Federal Reserve has been “opposed to introducing negative rates based on the evidence to date."

"If negative rates expand and persist, one possible solution is for stablecoin issuers to move away from a hard 1:1 redemption peg towards a Libra-like net asset value (NAV) model, which allows for fluctuations in the value of the backing assets. If any stablecoin issuer did choose to change the composition of their backing assets (and thereby potentially take on more risk), the issuer should publicly disclose these changes to their users," Hileman told The Block.

Gina Pieters, assistant instructional professor at the University of Chicago's Kenneth C. Griffin Department of Economics, said negative interest should not matter for stablecoins that are "truly fully backed." Pieters has been researching cryptocurrencies and blockchain since 2014.

She also said that negative yields are unlikely to last longer, telling The Block:

"The Fed will not set the rates to be negative (the lowest would be zero) but the market may send it there anyway. The relevant questions are: (1) how long will the negative rates last (is it just a few blips in a day?) and (2) on which duration treasury yields? We've seen brief periods of negative yields for 30-day US treasuries before, but what about the 2-year treasuries, or if the negative yields persist for over a week? Both of those circumstances seem highly unlikely in my opinion."

Zac Prince, CEO of crypto lender BlockFi, which offers interest rates on stablecoins, said it's "a bit too early" to speculate on whether there will be negative carry cost on dollars held in a bank account.

"For now, it seems that the 1:1 backed stablecoins like USDC, GUSD and PAX are well-positioned to maintain parity," Prince said.

Meltem Demirors, chief strategy officer of crypto asset management firm CoinShares, told The Block that in a scenario where bank deposits carry a negative interest, "issuers of these stablecoins would have to pass that negative interest on to coin holders through periodic depreciation of the redemption value, or through a fractional reserve system where they take some portion of the collateral and invest it in yield-bearing assets."

Demirors went on to say:

"Moving away from a depository receipt construction could be very detrimental to the trust users have in stablecoins, but looking at what's happened to Tether over the last year is rather instructive. Despite the revelation that Tether is only about 70% backed by dollars, use of Tether has continued to grow, and Tether has maintained it's 80% market share of the stablecoin market. So arguably, so long as the market continues to believe there is sufficient use and future liquidity and market depth in stablecoins, a change in construction and a shift away from 1:1 collateralization to fractional backing may not have a material impact on the practical use of stablecoins."

George Samman, an independent blockchain and cryptocurrency advisor, shared a rather grim picture. He told The Block that most stablecoin issuers don't offer any other services as traditional banks do, "so it could be a death blow to their business models."

"It will also obviously hurt consumers as well. It could see a great many USD backed stablecoins dying and/or pivoting to different models, such as ones that hold baskets," he continued. "It may also cast a spotlight on some of the collateralized models and maybe just maybe we will see a glimmer of hope for algorithmic stablecoins."