SKEPTIC’S GUIDE TO INVESTING

Stable Coin GENIUS Act: Greater Crypto Investibility?

• Steve Davenport, Clement Miller

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Stablecoins represent a fascinating middle ground in the crypto universe - digital tokens backed by real dollars, designed to provide stability in the notoriously volatile cryptocurrency landscape. Steve Davenport and Clem Miller take you on a deep dive into this evolving ecosystem, examining the regulatory framework established by the recently passed Genius Act and what it means for companies like Circle that have gone public.

The conversation reveals the surprising vulnerabilities of stablecoin issuers, particularly their exposure to interest rate fluctuations. When Circle's stock soared from $45 to nearly $200 before retreating, investors weren't buying more backing assets - they were speculating on future revenue streams at multiples far exceeding traditional financial institutions. This creates a precarious situation where shareholder value could evaporate if interest rates decline, as regulations prevent these companies from hedging against such risks.

We explore the crucial distinction between investing in stablecoin companies versus holding the coins themselves, unpacking why shareholders have no claim to the underlying reserves that back the coins. The discussion extends to government involvement in cryptocurrency, raising important questions about the wisdom of establishing crypto reserves with taxpayer dollars. Are we legitimizing activities without fully understanding their implications? Should governments be speculating in digital assets? The answers aren't simple, but they're essential for anyone navigating this rapidly evolving financial landscape. Whether you're curious about crypto or actively investing, this episode provides clarity amidst the intentionally complex terminology that often surrounds digital currencies.

Straight Talk for All - Nonsense for None

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Disclaimer - These podcasts are not intended as investment advice. Individuals please consult your own investment, tax and legal advisors. They provide these insights for educational purposes only.

Steve Davenport:

Welcome everyone. This is Steve Davenport and Clem Miller here today to talk about the ever-evolving week of the Genius Act and the Trump administration's efforts to make crypto mainstream. The Trump administration's efforts to make crypto mainstream. This week, we focused a lot on stablecoin and different ways to allow stablecoin to be an asset that could be used in many transactions, particularly dollar denominated, and I think it's an interesting step forward to start with stable coin versus Bitcoin, and there's a lot going on in this space. What do you think, clem, about what's happened this week and what might be happening in the legitimization of crypto?

Clem Miller:

So, first of all, there's basically three acts of Congress that are in play right now. Act one one is the genius act , which has already been passed by both houses . Then you've got the so-called Clarity Act and then, third, you have the Central Bank Digital Currency Anti-Surveillance Act, which is still kind of struggling up there. So let's focus first on the Genius Act. So what the Genius Act does is it creates some rules around how various companies can issue so-called stable coins. So let's talk about what a stable coin is.

Clem Miller:

I mean, essentially, a stable coin is a crypto token whose value is equal to that of the US dollar. So, basically, it's a dollar, it's linked to the dollar. It's like another currency, but it's linked to the dollar. It's actually dollar for dollar. And you might wonder well, why wouldn't you just want a dollar rather than something that is a representation of a dollar? And the answer to that is that there are lots of so-called decentralized finance applications that operate solely within a token framework, and so they don't really use real dollars. They just use these tokens that represent dollars. So that's how that's used. So that's that those are stable coins and there were no rules. I mean, there are no rules around crypto in general, but in particular, there were no rules around stable coins, and there is this perception out there.

Steve Davenport:

Clem who keeps track of whether it is actually backed by the dollars, like when someone says this stable coin has $60 billion in treasuries backing it up. Is there some custodian who will say, yes, that's the value, or will report that to the news media so that you can get your? Or is it live in terms of its valuation, because it would seem like people are adding and taking out all the time?

Clem Miller:

Yes, well, that's that's true. And there are auditors that are hired to to manage that by the, by the stable coin companies, that by the stablecoin companies, basically the second biggest stablecoin company just listed on the market. Its company is called Circle and it manages the so-called US digital coin, or USDC, and Circle does have an auditor who makes sure that there's enough in cash and in short-term treasuries to back that currency one for one. Now, that's a good thing, but it's also a bad thing. And it's a bad thing because one of the limitations on Circle's profitability is the fact that they do have to have all of this short-term backing and they really can't do interest rate hedging so that you know if you've got changes in interest rates. Those could work against Circle as a company, and so that's one reason really not to, you know, not to hold Circle as an investment.

Clem Miller:

If that's what you know you're thinking about, which is, you know, maybe you know what are the investment opportunities here. There's a real risk of interest rates working against, working against circle. Uh, there's another problem too, steve, with circle, and that is, um, that, uh, you know, circle, uh, you know, is the technology that, that and the platform that backs up the USDC. But really the people who trade USDC trade it on Coinbase and Robinhood and other kinds of exchanges and other kinds of exchanges and what happens is that a good chunk, in fact the majority of the revenues that come in from the trading of USDC actually go to Coinbase and Robinhood and don't go on to Circle. So that's another limitation on Circle's profitability and ability to grow going forward and those things were One thing, clem, if we could just stop for that example of Circle.

Steve Davenport:

So I understand the idea that it's backed by $60 billion and I understand it went public, and it went public at 45, 50, and then it raced up to almost 200. And now it's pulled back from that. So that would tell me if it's gone from 45 to 200 and originally it was 60 billion. If there's no more than the $60 billion, what are we really getting for $200? We're not getting four times as much crypto right or four times as much stablecoin, because it still has the $60 billion original. So what we're paying for is the interest amount, is what you own the stream of income coming from that $60 billion. With Circle, you don't actually own something that's backed by $240 billion or $300 billion. They haven't gotten more stable coin, they just have gotten a higher multiple on the interest earned of the treasuries they owned.

Clem Miller:

Is that how it works? So let me just make sure we understand what happens. You're not actually backed by either USDC or by dollars themselves. I mean, this is not a collateralized stock. The stock is just the flow. What you're backed by is only the flow of potential profitability going forward, just like with any other stock. So there's no collateralization of the shares that you're buying. There's only collateralization of the token itself, and so those who buy and sell the token itself USDC are, at least conceptually, collateralized by the reserves that are there. But if you invest in Circle, you're just taking a chance on whether that company is going to be profitable in the future and what the earnings stream is. So two different things.

Steve Davenport:

So when I think about what I'm buying, if, worst case scenario, circle were to have some financial liability come because of a lawsuit or something, and it would be put into bankruptcy, let's just say because interest rates go back to zero and it doesn't have much of a stream of income and therefore we find some reason that the corporation will have to reorganize you as a shareholder would not be allowed or contracted to receive any of the underlying $60 billion of assets. You are only really invested in how the company manages the income it receives from those treasuries. And so if that income goes down because we have low, low interest rates which I know we would never do here in an inflationary environment, but let's just say that happened we went back to zero. If we went back to zero, the value of circle, which is distributing that income, should also start to approach zero. Is that true?

Clem Miller:

That's exactly what would happen. Is that true? That would. That's exactly what would happen, and you know to the point about where the collateral would go. The collateral would go to the holders of USDC, theoretically at least, they would be the. They would be the debt holders, in effect, right of of. You know of Circle, in effect, right of Circle. And so, in any bankruptcy circumstance, the debt holders get paid out first and the shareholders can be left holding the bag which, essentially, might have zero in it.

Steve Davenport:

So am I right to assume that there's quite a bit of interest rate risk in the Circle company?

Clem Miller:

rate risk in the Circle Company? Absolutely. As I mentioned earlier, the Genius Act. The so-called Genius Act actually says that they have to hold short-term instruments or cash. They can't hold long-term instruments. There's no ability here to hedge interest rate risk.

Steve Davenport:

It feels like if we know rates are going up, they're going to be leveraged to more right.

Clem Miller:

Sorry, what did you say?

Steve Davenport:

If we are going to have rates go higher and they go from 4% to 6%, that's 50% more income. The only thing that happens is your multiple as a circle shareholder goes down because you now have more income. But the ratios that we're looking at are 300 to 400 times the income level for this share of stock. So if we were looking at it as compared to a JP Morgan or a Bank of America and other holders of complex instruments, they're trading at 15 to 16 times their earnings. So what's the advantage of getting a 300 times? Because if more and more people keep buying it, isn't it going to be harder and harder for it to survive, especially if rates stay the same or go down?

Clem Miller:

Absolutely. I mean, it's much better to buy a more established financial institution and, on top of that, the established financial institutions are looking at doing their own in-house currencies or crypto tokens in-house currencies or crypto tokens to use with their clients. So MasterCard is looking at it, paypal is looking at it. Actually, paypal already has one. Mastercard is looking at it, visa is looking at it and some of the banks I believe JP Morgan itself is looking at some kind of crypto token.

Steve Davenport:

So the reason we call it a crypto token versus just any other kind of token is that because it's set up with being able to transfer and compensate people on that crypto platforms. That's why it's being viewed. It's a treasury-based, US dollar-based item that is able to be used on the different crypto platforms, but it isn't really a crypto in the sense that its value is determined by a formula or by some way of securing the information regarding the internal coin. The value of the coin comes from something to do with the interest on the dollars, so it's not based on some formula and similar to a Bitcoin.

Clem Miller:

Correct. Bitcoin is based on an algorithm and these stable coins are based on having reserves to back them, so, in a conceptual sense, the stable coins are actually, in a sense, more real than Bitcoin. Is because of Bitcoin being supported only by an algorithm, using stable coins as a means of exchange and investing in the companies that issue them, given the interest rate risks that we were just discussing. Steve.

Steve Davenport:

So, when I look at this, I do like stable coins better than Bitcoins, based on the being backed by treasuries and dollar denominated assets being backed by treasuries and dollar-denominated assets, but it feels to me that we should be buying the coins. If we want to have a medium to transport, then we should be buying the stock of the coin producer. Is that a fair statement?

Clem Miller:

Well, yeah, fair statement. Well, I yeah. If, uh, if indeed there was an ability, uh, you know, a sustained ability to make profits, uh, I would say, yeah, maybe uh circle and and those other and you know tether, if it becomes uh, if its company becomes uh public, you know, might be good opportunities, but right now this Genius Act constrains them. The Genius Act actually helps to protect the banks. It doesn't help to protect the stable coins.

Steve Davenport:

Now, when we talk about the future in this space, is the government going to? I know they own some of these coins because of criminal activity, where they've been seized, and the government has them in seized assets and they might be distributed, but as for now, they sit at the US Treasury. Do you see us using or buying more stable coins versus dollars in the US government, the Treasury, or how do you see governments being able to use this as, instead of buying gold, they're buying stable coins? Is that the way we should think about it?

Clem Miller:

Well, now we're sort of on a slightly different topic which there's been discussion, and in fact, there have been some laws passed about whether there should be a crypto reserve or not, and my understanding of these laws is that there's essentially two reserves that have already been created in the US. One reserve is to basically formalize the holdings that have been seized as a result of criminal activity, and the other one is one that could conceivably buy cryptocurrency as being just a way of transferring taxpayer money to those who create these tokens. So, in other words, it's almost like a criminal venture, I think, for the government to actually just sort of subsidize and buy these assets.

Steve Davenport:

That may not have any. It's legitimizing what is an activity that we don't really have a reason to understand the legitimacy of. Is that?

Clem Miller:

fair. That is absolutely fair, and so I think it's. You know, from a public policy standpoint. Yeah, you got to do something about crypto that has been seized through criminal activity, but to actually buy crypto from those who issue it and send real dollars to those people who are issuing it, some of whom themselves may be criminals or quasi criminal, I think that's a public policy mistake or quasi-criminal.

Steve Davenport:

I think that's a public policy mistake. But if the US government gets a good price I mean, if we entered Bitcoin at 20,000 and now we're at 120, then the treasury made a good trade right, and so shouldn't we give them the benefit of the doubt and hope they'll do another good trade on the next few buys? Or how do we determine that Treasury is doing a really good job of when to enter and when to exit some of these? Do they have a model, you think at the Treasury, of how they put the valuation on crypto and that helps drive their decisions about when to buy and when to sell?

Clem Miller:

that helps drive their decisions about when to buy and when to sell.

Clem Miller:

Well, you know.

Clem Miller:

So, even though this capability exists, you know, as far as I know, they haven't done anything yet with this capability, and so I'm not sure what kind of methodology they're using in order to decide when to buy or when not to buy.

Clem Miller:

I do know that, with regard to the holdings that have come about through, you know, through seizures, to buy, uh, I do know that, with regard to the holdings that have come about through uh, you know, through seizures, through criminal seizures uh, you know they get, they get the coins whenever they see they get the price uh, that exists whenever they seize them, right, so they're not making a. They're not making a decision based on price, they're making a decision based on uh, right, on fighting crime, and so they're not presumably they're going to sell them when the value rises to a certain level. So there's some decision that's to be made about whether, if they think a profit can be made in the future, they may sell it. So there might be some methodology with regard to deciding when to sell the seized crypto, but in reality, the idea is to try to sell seized assets as quickly as possible, and that's true whether it's a Bitcoin or any other kind of seized asset.

Steve Davenport:

So when they get cars, do they renovate them and paint them before they sell them, or do they sell them as is? It would seem like they would just sell every asset as is.

Clem Miller:

I am pretty sure they sell them, as is all right. I think they're not the government. The government doesn't flip assets. The government, you know. They seize them and then they sell them, as is when you, when you uh encounter auctions of government seized property, uh, it's always I. I don't want to use the word always, because always is a strong word, but I've only seen them advertised as is.

Steve Davenport:

All right, I think we're going to ask for any final comments and wrap up. It feels to me like this is a path that we're going down, that we don't fully understand all the benefits and liabilities of how we're going to do this. So I thought the government was struggling to pay debt and struggling to keep a balanced budget and trying to keep the debt levels down so that they would be within the government's debt ceiling. But if we're buying assets that we don't have a real methodology or valuation for, it feels like we might be opening up the proverbial can of worms. How would you wrap up this topic, clem?

Clem Miller:

of worms. How would you wrap up this topic, clem? I would say that, regardless of whether you want to experiment or not in using these crypto tokens, I would stay away from this area in terms of stock investing, because right now, I don't think it's uh, you know it's an investable area for stock, uh, stock investors. So that would be my, that would be my warning, that's always been my, uh, my warning about this. You know people who, you know people who put aside their own money, uh into, uh, these companies, uh, whether it be through deposits, you know, like the FTX circumstance or whatnot are subjecting themselves to potential, uh, you know, um, you know, fraud, uh, potential theft.

Clem Miller:

Uh, it's a, uh, it's a fairly dangerous area, and I would say don't be, don't be, confused by all the terminology that's out there. There's a lot of terminology being thrown around. Just realize that this is not, you know, this is not rocket science, right? This is not. You know, nvidia, ok, this is. This is stuff that's complicated and I think, to a certain degree, the terminology is meant to be confusing, and that's exactly the kind of area where a reasoned investor should be very skeptical and, if you're me, uh, avoid altogether I mean, it feels like it's um, you're, you're doing something that's basically speculation versus investing, if you don't have a real system for this.

Steve Davenport:

so, thank you, listeners, we appreciate you and and please share with others and let us know if you have any comments. Again, we're going to have guests coming up over the next few weeks and we would love to continue the discussion. Thanks, have a good day.

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Clem Miller, CFA

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Steve Davenport, CFA

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