Shrinking Stablecoin Flows, De-inverting Yield Curve Pose Potential Risks to Crypto Market

De-facto retracements in stablecoins and the US Treasury's yield curve could instigate market volatility for Bitcoin. Historically, yield curve inversions signal economic downturn and risk aversion in equities, potentially spilling over into crypto markets. Stablecoins, a proxy for crypto market inflows, have been more influential than ETFs in sustaining high prices. However, any slowdown in stablecoin inflows could precipitate a correction. Additionally, fiscal deficit concerns and political pressures could lead to rate cuts, supporting risk assets and crypto in the lead-up to US elections.

Shrinking Stablecoin Flows and a De-inverting Yield Curve: Potential Headwinds for Crypto

As the crypto community remains captivated by the daily inflows into U.S.-listed bitcoin (BTC) exchange-traded funds (ETFs), astute market observers are casting their attention toward a more critical landscape: the realm of stablecoins and the intricate workings of the U.S. government bond market.

"Stablecoin inflows have been the backbone of strength for the crypto market," asserted Thomas Thielen, an analyst at crypto intelligence firm Messari. "While most have been fixated on the ETF inflows, stablecoin inflows have been a more substantial driver, underpinning the elevated crypto prices."

"A slowdown in stablecoin inflows could trigger a significant correction," Thielen cautioned.

Over the years, stablecoins, designed to maintain a stable value pegged to an external reference such as the U.S. dollar, have become indispensable in facilitating cryptocurrency purchases and fueling derivatives trading. Consequently, the supply of stablecoins is widely recognized as a reliable indicator of net capital inflows into the crypto market.

Notably, the flow of capital into the crypto market via stablecoins has outpaced that of spot ETFs. Since the inception of spot ETFs in the U.S. on January 11, the combined market capitalization of the two leading stablecoins, Tether (USDT) and USD Coin (USDC), has surged by a remarkable $25.6 billion, reaching a record $143.8 billion. In contrast, spot ETFs have amassed over $12 billion since their Nasdaq debut, according to data meticulously tracked by 10x Research.

A visual representation of the inflows into bitcoin ETFs and stablecoins since January 11 reveals that while ETF inflows have diminished in recent weeks, the supply of the top stablecoins has continued its upward trajectory, buoying prices within the $60,000 to $70,000 range.

Another potential source of volatility, according to Ilan Solot, co-head of digital assets at Marex Solutions, is the "de-inversion" of the U.S. Treasury yield curve.

The yield curve, an essential indicator of the structure of interest rates, depicts the yield on bonds with varying terms to maturity. Conventionally, the curve exhibits an upward slope, reflecting investors' demand for a higher return for investing or lending money to the government over extended periods.

Approximately two years ago, the curve inverted, an occurrence where the yield on the two-year note surpassed that of the 10-year note, as the Federal Reserve aggressively raised interest rates.

Historically, the yield curve tends to dis-invert at the onset of economic recessions. Now, the curve is reverting to its normal shape, driven by a faster rise in the 20-year yield, also known as "bear steepening." At the time of writing, the spread between the 10- and two-year yields stood at -0.28 basis points, a level not seen since January. In other words, the curve is merely 28 bps shy of normalization.

"Interpreting the curve is ever nuanced, but taking it at face value, this [bear steepening] could imply a waning confidence in either fiscal or monetary policy – or both. For instance, it could indicate that markets perceive an amplified risk of the Fed falling behind the curve or of borrowing becoming unhinged without a corresponding demand," Solot explained.

"That's not a favorable environment for risk in general and, initially at least, should have an impact on the crypto market as well," Solot added, highlighting that a dip would present an opportunity for bitcoin to demonstrate its potential as a hedge against fiscal and monetary instability.

Historically, de-inversions have coincided with the onset of economic recessions and a heightened aversion to risk in the stock market.

Phillip Gillespie, managing partner at U.K.-based hedge fund AWR Capital, believes that risk assets will ultimately find stability as long as the Federal Reserve continues to support the system through its overnight reverse repurchase (RRP) agreement facility.

The overnight RRP is a monetary tool employed by the Fed to drain excess cash from the money market. Since early last year, the RRP facility has been drained, signifying that the once dormant cash is being redeployed, invigorating risk-taking in financial markets.

"The Fed's ongoing support of the market via the overnight reverse repo facility, coupled with discussions of rate cuts in light of ballooning fiscal deficits and government pressure to curb its financing costs, suggest that risk assets will maintain their support in the run-up to the U.S. elections," Gillespie stated.

In conclusion, while the crypto community remains enthralled by the daily flow of funds into bitcoin ETFs, the potential slowdown of stablecoin inflows and the de-inversion of the U.S. Treasury yield curve have emerged as significant factors that could cast a pall over the crypto market. However, the Federal Reserve's continued support through the overnight RRP facility may provide a safety net until the crypto market can find its own footing amid these macroeconomic shifts.