why hedge funds and stablecoins are riding high

As interest rates go up, the spread earned by the broker, or platform goes up with it.

The same goes for companies like Link and Computershare that earn margin income on cash held on behalf of companies that use their share registry services that is due to be paid out in dividends and distributions.

High rates are great for insurance companies too, that invest premiums into safe assets. A higher interest rate environment makes it easier for them to match their expected liabilities without taking as much investment risk.

Volatility winners

Another category of rising cash rate winners is macro hedge funds.

The first order benefit is that rising interest rates create volatility, which hedge funds can capitalise on.

But the other benefit is that many funds use derivative positions to implement their views, which require only a marginal outlay of capital. The remainder can be held in cash, collecting the interest rate carry.

That’s why hedge fund veterans say these funds – which have had such a tough time until now – are delivering double-digit returns to investors.

But perhaps the biggest winners from higher cash rates are stablecoins.

These cryptocurrencies have been immensely popular, if not controversial, after the big Terra blow up earlier this year.

Stablecoins are designed to be pegged to a currency, typically the US dollar, and tend to be backed by real-world collateral. The attraction of stablecoins is that investors can keep their capital in the crypto world but reduce their exposure to crypto movements.

So, as capital has poured into stablecoins, that’s been invested in safe cash-like assets, that are now paying higher interest rates, that the stablecoin operators are keeping.

Rising interest rates have triggered a bit of a war among stablecoin operators.

Late last month, Binance said it was converting all stablecoin holdings on its platform to its stablecoin, which means it will have a bigger asset pool earning interest.

And last week, Tether, the biggest stablecoin, announced that it had de-risked its portfolio, selling out of corporate commercial paper in favour of good old government US T-Bills.

T-bill income

That makes total sense. If it can demonstrate that it has a solid asset backing it should address any lingering anxiety that it can’t meet a run on the coin. If that allows it to raise more assets, it will boost interest income which is healthy enough given short-term interest rates.

Tether says it has $US68 billion of assets of which 79 per cent is invested in cash and cash-like securities (about 12 per cent is in corporate bonds and secured loans, and 9 per cent in tokens). If that’s the case based on the US 1-year interest rate of 4.5 per cent, it’s netting in $US2.5 billion.

That is why there’s a stablecoin cash grab. But it also highlights the rising opportunity cost of these investments: investing in a real world US dollar now pays 4.5 per cent, so opting for the digital format comes at a price in the form of forgone income.

What’s happening at Tether neatly illustrates that as risk-free rates go up, so too does the cost of taking risk, and increasingly, the bet with the superior pay-out turns out to be the safest one.