Dan- insightful application of the Treynor framework to Tether. It's interesting that you say the dealer's inventory is entirely dictated by their balance sheet, since in Tether's case they are a fully collateralized dollar bearer asset and cannot borrow (or so they've managed to convince the NY AG). The thing is that stablecoin issuers of fully collateralized tokens have to make good on their ability to redeem tokens for USD at any point in time.
I've found that dealers in the actual crypto markets here are institutions minting Tethers with their dollars to bring the price of the asset back to par (a dollar) and close the arbitrage available. Spreads are almost entirely deliniated in stablecoin markets by transaction costs to create/redeem the bearer asset, and in severe liquidity scenarios where dollars are so highly coveted they trade far above par.
Hi Cem! If I am understanding you correctly, then I think I don't disagree. Tether's full collateralization is the inventory that I am talking about. For a while they were not fully collateralized, and there will continue to be pressure on Tether because all of their assets are tied up. I think that speaks to the difficulty of what they are trying to do.
Those "severe liquidity scenarios" that you mention are the days that make this subject interesting. Thanks for reading!
Is the Outside Bid/Ask what I observe in my online broker's quotes for stocks or options? Is the inside spread what they see, i.e. unobservable unless you have privileged access?
Inside spread is the prices you get from the market-maker. Outside spread is the prices the market-maker gets from somewhere else. In some markets, outside might just be "the rest of the market." If the market-maker is not making prices inside the outside spread, then they can lose business to other market-makers. In a competitive market with tight spreads, it might be very hard to perceive the difference between inside and outside.
When you write: "Implementing a fixed price is about buying, selling and prices, and doesn't much depend on what is being bought or sold", you are telling a very different story than the mainstream narrative about supply and demand, correct? The supply and demand for paper contracts is more important than the supply and demand for whatever the underlying might be (oil, silver, mortgages ...)?
In other words, not only fixed but all prices are determined by financial markets and arbitrary whims of financiers, not physical supply and demand for a real good? Or do you not go that far?
I would say that prices are determined by the activities of market-makers, who create buying and selling opportunities for others by posting prices. There is a wedge between supply and demand, namely dealer inventories: market-maker balance sheets can expand and contract, reducing prevent price movements. The limit to that comes from dealers' ability to finance those inventories.
Stablecoins push this to one extreme - a market-maker like Tether has to be willing to absorb *all* fluctuations onto its own balance sheet rather than let them affect the price.
Hi Engin, thanks for reading! Tether's inventory is basically the size of their balance sheet. They can issue as many Tethers as they want, but there is some limit to the amount of USD or EUR that they can borrow. Increasing that limit is they key to allowing a bigger inventory.
There was a recent discussion on stablecoins on macromusings, and Beckworth made an interesting argument about stablecoins and global dollar hegemony: an increase in demand for stablecoins (tether) would mean greater demand for dollar denominated assets globally, which would put downward pressure on interest rates, which should make dollar borrowing cheaper (transcript here: https://www.mercatus.org/bridge/podcasts/08022021/larry-white-stablecoins-money-market-funds-and-history-free-banking).
So, an increase in demand for stablecoins should in theory create the conditions for tether to be able to increase its balance sheet (ie borrow dollars “cheaper”), no?
I think we are still a long way from stablecoins being able to swing interest rates one way or the other. There is something like $100 billion in stablecoins outstanding. The Fed rolls over more than $1,200 billion in overnight repo *every day*. We know that Tether has a lot of its funds in CP. Again, there is $100 billion in new CP issuance *every day*. Other stablecoins are just holding their funds in bank deposits. There are some $17,000 billion in deposits outstanding in the US. Stablecoins are a big deal relative to the blockchains they serve, but they are still small relative to dollar money markets.
Dan- insightful application of the Treynor framework to Tether. It's interesting that you say the dealer's inventory is entirely dictated by their balance sheet, since in Tether's case they are a fully collateralized dollar bearer asset and cannot borrow (or so they've managed to convince the NY AG). The thing is that stablecoin issuers of fully collateralized tokens have to make good on their ability to redeem tokens for USD at any point in time.
I've found that dealers in the actual crypto markets here are institutions minting Tethers with their dollars to bring the price of the asset back to par (a dollar) and close the arbitrage available. Spreads are almost entirely deliniated in stablecoin markets by transaction costs to create/redeem the bearer asset, and in severe liquidity scenarios where dollars are so highly coveted they trade far above par.
Cem
Hi Cem! If I am understanding you correctly, then I think I don't disagree. Tether's full collateralization is the inventory that I am talking about. For a while they were not fully collateralized, and there will continue to be pressure on Tether because all of their assets are tied up. I think that speaks to the difficulty of what they are trying to do.
Those "severe liquidity scenarios" that you mention are the days that make this subject interesting. Thanks for reading!
Is the Outside Bid/Ask what I observe in my online broker's quotes for stocks or options? Is the inside spread what they see, i.e. unobservable unless you have privileged access?
Inside spread is the prices you get from the market-maker. Outside spread is the prices the market-maker gets from somewhere else. In some markets, outside might just be "the rest of the market." If the market-maker is not making prices inside the outside spread, then they can lose business to other market-makers. In a competitive market with tight spreads, it might be very hard to perceive the difference between inside and outside.
Okay, thanks.
When you write: "Implementing a fixed price is about buying, selling and prices, and doesn't much depend on what is being bought or sold", you are telling a very different story than the mainstream narrative about supply and demand, correct? The supply and demand for paper contracts is more important than the supply and demand for whatever the underlying might be (oil, silver, mortgages ...)?
In other words, not only fixed but all prices are determined by financial markets and arbitrary whims of financiers, not physical supply and demand for a real good? Or do you not go that far?
I would say that prices are determined by the activities of market-makers, who create buying and selling opportunities for others by posting prices. There is a wedge between supply and demand, namely dealer inventories: market-maker balance sheets can expand and contract, reducing prevent price movements. The limit to that comes from dealers' ability to finance those inventories.
Stablecoins push this to one extreme - a market-maker like Tether has to be willing to absorb *all* fluctuations onto its own balance sheet rather than let them affect the price.
Neilson, firstly thank you for your article. It is interesting that I watched mehrling lessons on Treyor model on yesterday.
Questions:
1-How could Tether allow the bigger inventory? Company needs the demand for tether?
Hi Engin, thanks for reading! Tether's inventory is basically the size of their balance sheet. They can issue as many Tethers as they want, but there is some limit to the amount of USD or EUR that they can borrow. Increasing that limit is they key to allowing a bigger inventory.
Agree on EUR, but for dollars too?
There was a recent discussion on stablecoins on macromusings, and Beckworth made an interesting argument about stablecoins and global dollar hegemony: an increase in demand for stablecoins (tether) would mean greater demand for dollar denominated assets globally, which would put downward pressure on interest rates, which should make dollar borrowing cheaper (transcript here: https://www.mercatus.org/bridge/podcasts/08022021/larry-white-stablecoins-money-market-funds-and-history-free-banking).
So, an increase in demand for stablecoins should in theory create the conditions for tether to be able to increase its balance sheet (ie borrow dollars “cheaper”), no?
Btw: great newsletter through and through!
Hi Marat, and thanks for reading!
I think we are still a long way from stablecoins being able to swing interest rates one way or the other. There is something like $100 billion in stablecoins outstanding. The Fed rolls over more than $1,200 billion in overnight repo *every day*. We know that Tether has a lot of its funds in CP. Again, there is $100 billion in new CP issuance *every day*. Other stablecoins are just holding their funds in bank deposits. There are some $17,000 billion in deposits outstanding in the US. Stablecoins are a big deal relative to the blockchains they serve, but they are still small relative to dollar money markets.