An obvious improvement over USDC

Under-appreciated: The effect of rising interest rates on stablecoin markets

Circle, the issuer of USDC, stands to gain from a rise in interest rates. They back each USDC with one dollar of fiat — in the form of cash or short-dated US treasuries.

As US interest rates rise, Circle pockets the interest on each dollar of collateral they hold. (This is an analogous model to having an insurance float and pocketing the interest earned by that float).

As interest rates rise globally, an opportunity will emerge for competitors to Circle (because Circle will start making a lot of money from interest).

USTC: The obvious improvement to USDC

Instead of having a token that tracks the USD as USDC does, one could define a token (perhaps USTC, short for United States Treasuries Coin) that is backed with short-dated US treasuries. With interest rates greater than zero, the price of USTC would rise over time versus USDC — because holding treasury results in the instrument rising in value over time if interest rates are positive.

It would be strictly better to hold USTC in your wallet than USDC because USTC would appreciate versus USDC.

[Side-note: Circle could start paying interest on USDC to compete with this, and I wouldn’t rule that out.]

The analogy between RAI and USTC

There’s a pretty interesting analogy here between RAI (see my latest article here) and USTC:

Consider the US economy:

• Economic activity is represented by GDP.
• Government revenue comes from tax collected on economic activity.
• US debt and US dollars are “backed/collateralised” by US tax revenue — which is a percentage of US GDP.
• The supply of US dollars is affected, amongst other factors, by federal reserve interest rates.
• Interest rates affect the price of leverage — notably mortgages on real estate and corporate bonds on corporate equity prices. [One can also look at this the other way around and say that demand/supply of leverage influences interest rates.]

Consider RAI and the Ethereum economy:

• Ethereum can be viewed as an economy with its own GDP.
• Protocol revenue comes from gas fees (a fee on economic activity) and accrues to Eth tokens.
• Reflexer (DAI) allows debt to be issued backed by Eth (which is effectively debt that is backed by the economic activity on Ethereum). USD is leverage on the US economy. RAI is leverage on the Ethereum economy (and so is LUSD and single-collateral DAI — but they are more like currencies while RAI is more like a short-dated treasury imo).
• Owing to the design of RAI’s controller, and that RAI’s price floats, I view RAI as a form of short-dated treasury on the Ethereum economy.

USTC would be a source of leverage derived from the US economy. RAI is a source of leverage derived from the Ethereum economy.

Cross economy arbitrage and equilibrium

The US and Ethereum and indeed world economy are all linked. Owing to foreign exchanges, fiat-crypto bridges, and synthetic assets (e.g. stocks on Synthetix), a source of leverage in one economy can be used in another economy.

There should be an equilibrium in the price of leverage derived from each economy.

While many factors affect that equilibrium, my guess is — directionally — that:

• As US interest rates rise, Circle will start to pay interest OR something like USTC will emerge.
• RAI will start to appreciate in value (note that RAI has a 2% borrow fee that will cause some lag versus something like USTC).
• If another fiat currency overtook the US dollar, RAI may start to track treasuries of that country instead.
• My sense is that LUSD will move up in price above it’s peg — towards $1.1 (where there is a hard peg limit) — because the protocol does not have an interest rate to adapt.

All in all — setting aside questions around controller performance and collateralisation risks during flash crashes — RAI (or something like RAI) may end up tracking the price of the strongest “risk free” fixed income instrument.

Achieving something like this could be significant (whether it’s RAI or something better), because it may mean that it becomes strictly superior to hold RAI over any fiat currency (in a positive rate environment, assuming RAI can get the borrow fee down and still cover costs) and (assuming zero RAI protocol fees) strictly equivalent to hold RAI as compared to any fixed-income short-dated government security.

[Side note — I had a question of why RAI trades now below it’s starting value of 3.14 . One answer is that only the P part of the PID controller was turned on at the start, and controller inaccuracies can lead to error. Note also that the 2% annual borrow rate causes a drag. All in all, RAI is about 3% below it’s starting price, which is in the ballpark of interest rates (minus the borrow rate) over the last two years.]