How DeFi Will Change the Way Banks Create Money | Will Nuelle

[Music] all right thank you to that last panel um go hunt down a mean if you want if you want to find one of these masks uh I've got nothing but feedback that they're super creepy um but anyways let's keep it rolling um our next speaker is Will Nelly uh partner at partner Adventures at Galaxy and he he'll be talking to us of how deep will change the way Banks create money so round of applause please worries okay thanks everybody for coming on uh Friday afternoon um last year I gave a presentation about um block space and some of the economics about around block space um you know selling actually underlying compute power of blockchains um thankfully I feel like we moved on a year later I can now talk about applications of blockchains um in a way that I'm really excited about so the rough structure of the presentation I'm going to walk you through three converging phenomena that I think are making up what will be a a multi-decade um mega Trend uh with the adoption of stable coins and defi collectively and then I'm going to talk about two sort of underd discussed uh second order effects um you know of of this trend um so first one thing I'll highlight is uh the degree to which stable coins are now being used as a savings instrument globally um I think it's well understood uh but I want to highlight it and I think it's quite important um the graph is a um a survey that was done by Castle Island Ventures thanks Castle Island that asks Emerging Market stable coins stable coin users why they hold stable coins the the second largest reason was um to save money in dollars right people want access to Dollars to save in their local currency um and we think this is a an immense and growing Trend um exemplified by one of the portfolio companies in uh Galaxy's portfolio who sort of index to this trend uh growing 14 times year-over-year um in you know their their ability to allow people to save stable coins in Emerging Markets um the second one I'll highlight is the use of stable coins as a payments instrument um I think it's underd discussed uh to what degree um you know blockchains are being being used as a crossb payment rail um the you know existing system for moving crossb payments across the world is you know you start at a sender at at at a local bank um you eventually uh through the correspondent banking system or a local domestic payment rail like a uh or fedwire in the US you get you know your payment to a swift terminal um then once it's on a swift terminal you pass the payment over Swift which is really like a a routing system and a messaging system at which point banks in that Swift Network reconcile with one another um and you can do three three four hops before eventually Landing back in a sort of recipient country and then finally uh you know in a domestic payment rail back to the end recipient um and that process can take you know two business days one business day three or four business days and lesser served market and you can be charged you know a percent of the actual payment uh you know or more um which is quite expensive um just to speak to the size of the trend so I keep a a bit of a record of some of the companies which are generally called payment uh stable coin payment orchestrators um and I keep a record of kind of the the volumes that each are doing and so this is an aggregated view of of the volumes uh and and the growth rates in this uh crossb payment Market um the the two Orange um you know bars there are my Q4 2023 and Q q1 2024 actual numbers and then the black line is the the black lines are the the sort of implied growth rate if you just or the implied size of uh the the market if you just kept the growth rates from q1 and uh or Q4 and q1 last year the green bar is actually what we observed um in talking with custodians and other players in the market in terms of how much volume there is uh annually we think that's about a 100 billion conservatively um annual Market uh in terms of passing stable coins cross border for non- crypto use cases so businesses around the world paying suppliers and vendors um with stable coins so this is a huge Trend and I think this is going to be um a trillion dollar a year annual payment volume Market uh within the next few years and then the upside case is eventually this is a $40 trillion a year market in terms of B2B crossb payments over some time frame and stable coins are fundamentally better at doing this um the final Trend uh which a phenomenon which I think is worth highlighting uh beyond the first two which are more stable coin focused is sort of um defi as a long term source of above Market yields uh for for the time being so if you look at the graph you can see uh the a usdc uh interest rate the a usdt interest rate and in the yellow line that's the d uh stability rate um the green line is Athena um so recently Athena not to say that's a a risk-free yield per se but um it is an example of uh sort of onchain yield and then the black line is uh the one-year treasury yield so US government one-ear treasury yield and you can see you know there are substantial periods and I consider a uscc about as risk-free as you can get with respect to onchain yield and you can see a for for vast periods of the last couple years has substantially under or overperformed the um you know the one-year treasury yield rate um and if you look at you know on the right side uh there's two charts which are the ethereum tvl in Defi and the salana tvl in defi but normalized for the price of eth and the price of soul so it takes uh the prices the price fluctuations of the assets out of the out of the picture you can see since sort of you know Midway through 2023 we've been on a essentially linear uptrend uh after we drew down after you know the kind of 2021 uh Market cycle um really interesting as I was looking at the the data uh behind you know interest rates and defi you can see that clearly in periods where um a interest rates are below the uh one-year treasury yield that's substantially uh restrictive in terms of onchain assets and you can see that period that in in purple went from about 25 million eth equivalents on chain to about 12 a. half million so during that period where uh one-year treasury yields were outperforming a interest rates um you know onchain onchain interest rate or onchain participation essentially went down by 50% and then when you see periods of expansion um where interest rates on a are above the one-year treasury rate um you get massive periods of of inflows of capital I think long term because of systems like Athena and other things on chain the interest rates on a will generally outperform the one-year treasury yield and so I think of defi as a long-term capital sync as well in addition to the two um you know prior Trends I mentioned so just to give you initial takeaways um stable coins are are being used as a savings instrument in global markets that's happening you know from our index that grew 14 times year-over-year I think from some other indices it's probably growing a little bit slower than 14 times year-over-year the compounding on that would be out of control but um you know this is a really important Trend uh about the adoption of stable coins in Emerging Markets secondly the use of stable coins in payments it's cheaper faster uh to do you know payments crossb payments with stable coins than uh than over Swift in a lot of cases not uniformly but in a lot of cases and there's a lot of great businesses Bridge uh which was obviously acquired by stripe in the fall um our portfolio company rail used to be called layer 2 um is along those lines and then the third takeaway defi can be a long-term capital sync um because of its ability to produce above Market yields versus sort of risk-free us treasuries um you know in in a and so that all gets you to um the actual adoption of stable coins if you look at the chart we peaked sort of north of 150 million in 2021 um and then you had a sort of draw down as as the market was was impacted through 2022 2023 and you know early 2024 but then through the back half of the year I think the these three Trends are combining to ultimately just continue to increase stablecoin AUM um and I think there's no reason that this trend uh slows down I think this is a macro decade long Trend where uh my projection is there will be more than 300 billion in stable coins by the end of year this year and then you know the question from there is at what point do we eventually reach sort of a trillion an outstanding Supply uh of stable coins and and what year that is I don't have projections over that I think the other uh thing I'd like to you know bring up um which ties into the rest of the presentation is the degree to which stable coins at this scale become a really interesting buyer of us treasuries um and the sort of distortions that that can create in the long term you see in the um you know the the right hand chart over here and thanks again Castle Island for for publishing this one um China is degross their stable coin or their US Treasury exposure at a rapid rate because of the sort of trade Wars between the US and China and and meanwhile stable coins are essentially filling the Gap uh that China's leaving in the US Treasury Market and so without China de grossing um the impact of stable coins as a buyer for us treasuries actually has the impact of reducing interest rates um for the US government to borrow um and then ultimately Downstream to the consumer potentially reducing mortgage rates and other and other things like that um so I want to talk about the two second order effects now of this trend if I if we say okay it's 300 billion by the end of the year what are the second order effects of of this trend getting big one is there's a substitution that's implied um in the adoption of stable coins as a savings instrument in emerging markets in particular it's a substitution of Bank deposits in countries like Argentina to um you know ultimately Capital that flows into the US and into different places so um where before an Argentinian peso deposit in an Argentinian bank account would be 100% allocated to um you know credit Creation in in an emerging market now that capital is essentially being substituted um 0% of which is going to fund or to finance US Government debt 20% is going to US Banks uh which underly uh businesses like Circle so uh bony melon customers bank and the sort of um aggregation of other banks that that sort of sit under circle's usdc product and then for tether as many know caner Fitzgerald and uh Deltech bank and others um uh you don't always know now what's the impact of this um the impact is banks are in the business of creating money and so taking deposits out of an Emerging Market uh you know banking system could have sort of corrosive effects and what I mean is banks are in the business of making money or uh creating money every deposit um in a bank as many people here will know uh ultimately becomes a loan which as long as that uh uh borrower is a customer of the bank then it also becomes a deposit and so so on and so forth the cycle goes historically there's a concept of a reserve rate ratio that was 10% in the US which meant that you could leverage your your deposit base up 10x so every dollar becomes a maximum of $10 of of credit creation the Practical case post uh 2008 is um Reserve ratio reserves uh at banks are are are slightly higher kept with the fed and so the Delta between or the ratio between M1 money supply and monetary base m0 is about 3.3 times in the US and in a country like Argentina is about 1 two times um so if you just think about the impact of that right now there's an added uh component of credit creation you've taken $100 of deposits in the Argentinian banking system which created 120 uh $120 of credit to Argentinian consumers and businesses you instead financed $80 of us treasuries and then you put $20 of deposits in the US banking system which have a 3 3 times multiplier for $66 of credit in the US uh banking system right so I think this has um is kind of a bit of a a challenging story um there's maybe the even more nuanced view which is it's not a simple substitution every conversion of an Argentinian peso into um a US dollar is a sale of Argentinian Pesos right you have to sell pesos to buy dollars which are then converted to stable coins on the back end and so every time you do that it has the effect of pushing the price of the peso down which then reinforces the desire to hold stable coins now at at small scales that's not problematic um my calculation suggests based on a a lemon uh a lemon cash report that uh stable coins in crypto are about 1% of the Argentinian sort of M1 uh monetary base so Bank deposits and and other things and so it's small percentages now but as that percentage grows that has really material impacts on local economies in Emerging Markets um the other second order effect I'll highlight and I have to move quickly here um is the Dual the the one problem is the dual function of banks is to be both a custodian and A lender and that's broken in Defi and so if defi were to continue to scale and stable coins were to continue to scale to the levels that I'm talking about it actually substantially impacts the amount of credit and money that's created in the financial system um because every deposited you know every metamask is essentially a non-custodial custodian more or less that then you put a deposit into a system like a and you're lending it out on a one:1 basis a bank you put a dollar of a deposit and you're lending out on a on a really in the US on a 3 to1 basis and so um it substantially impacts the ability to create credit um in in markets that that where defi is broadly um adopted so one proposal I have and I think you know as as we continue continue to go on this adoption curve um I think the 8020 sort of Reserve ratio between us treasuries and and Bank deposits may end up getting uh shifted where you get so much Distortion of the US Treasury Market with price and sensitive buyers who are willing to pay or earn lower interest rates than they otherwise should while there's a dir of capital then for private businesses and consumers that eventually the stable coin reserves um that you know sit behind Circle actually get reallocated to more complex portfolios that include things like Commercial Credit um and and mortgages Etc which then you've essentially used the backing of stable coins to recreate A bank's you know loan portfolio um and so I think that's going to be one of the really interesting things we uh you know we see in the future so that's that's it um the three phenomena savings payments and defi as a capital sync and then the two um you know the two second order effects which which I talked about which are the you know removal of deposits in Emerging Markets uh into stable coins which benefit us treasuries and US Banks and then the long-term impact of uh defi not really actually creating money in the process Banks create money a does not create money and I think that's a risk uh as we reconstruct the financial system so that's it for today two two thoughts to leave you on and uh and thank you very much St