Stablecoins, U.S. Government Debt More Important Than Bitcoin ETF Inflows, Crypto Analysts Says

• Potential slowdown in stablecoin inflows and de-inversion of the U.S. Treasury yield curve could breed downside volatility in bitcoin.
• Dips in risk assets are likely to be well supported ahead of the U.S. elections, one observer said.

While the crypto community continues to obsess about the daily flows into the U.S.-listed spot bitcoin BTC$89,447.32 exchange-traded funds (ETFs), some market observers are focusing on stablecoins and shenanigans in the U.S. government bond market.

"Stablecoin inflows have been a pillar of strength for the crypto market. While most have focused on the ETF inflows, stablecoin inflows have been a more meaningful driver and have kept crypto prices high," Thielen told CoinDesk in an interview.

"If stablecoins inflows slow down, then we could see a meaningful correction," Thielen added.

Over the years, stablecoins, or tokens with values pegged to an external reference like the U.S. dollar, have been widely used to fund cryptocurrency purchases and derivatives trading. Hence, the supply of stablecoins is widely seen as a proxy for net capital inflows into the crypto market.

The capital has flown into the crypto market via stablecoins at a faster pace than spot ETFs. That's evident from the fact that the combined market capitalization of the top two stablecoins, tether USDT$1.0002 and USD Coin (USDC), has increased by $25.6 billion to a record $143.8 billion since the spot ETFs began trading in the U.S. on Jan. 11. Meanwhile, the ETFs have amassed over $12 billion since going live on Nasdaq, according to data tracked by 10x Research.

The chart shows that while inflows into the spot ETFs have slowed in recent weeks, the supply of the top two stablecoins has continued to expand, keeping prices elevated between $60,000 and $70,000.

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

The yield curve, or the term structure of interest rates, shows the yield on bonds with different terms to maturity. Normally, the curve is upward-sloping as investors demand a higher yield for investing or lending money to the government over long periods.

Nearly two years ago, the curve inverted, with the two-year note offering a higher yield than the 10-year note as the Federal Reserve rapidly raised interest rates.

Now, the curve is de-inverting, led by a faster rise in the 20-year yield (also called bear steepening). As of writing, the spread between the 10- and two-year yields stood at -0.28 basis points, the least since January. In other words, the curve is just 28 bps short of normalizing.

"There's always nuance interpreting the curve, but take at face value, it [bear steepening] can imply loss of confidence in either fiscal or monetary policy – or both. For example, it could mean markets see a greater risk the Fed is falling behind the curve or borrowing is becoming unhinged without corresponding demand," Solot told CoinDesk.

"That's not a good environment for risk in general, and, at least initially, should weigh on the crypto market as well," Solot added, saying the dip would be an opportunity for bitcoin to prove it is a hedge against fiscal and monetary instability.

The chart shows the spread between the 10- and two-year yields since 1980, with vertical shaded area representing economic recessions or consecutive quarterly contracts in the growth rate.

Historically, de-inversions have marked the onset of economic recessions and risk aversion in stocks.

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

The overnight RRP is the Fed's tool to remove excess cash from the money market. Since early last year, the RRPP facility has been drained, meaning the once dormant cash is being redeployed, supporting risk-taking in financial markets.

"The Fed is continuing to support the market via overnight reverse repo facility, and although sticky inflation is a problem, there are now even talks of rate cuts given ballooning fiscal deficits and pressure from the government to curb the cost of financing its debts. Risk assets will oscillate here and there with geopolitical flare-ups or upticks in yields, but, in general, risk assets and crypto should be well supported for this year ahead of U.S. elections," Gillespie told CoinDesk.