Original title: Stablecoin Playbook: Flipping Billions to Trillions
Author: Rui Shang, SevenX Ventures
Compiled by: Mensh, ChainCatcher
Overview: Eight major stablecoin-related opportunities—
The younger generation are digital natives, and stablecoins are their natural currency. As artificial intelligence and the Internet of Things drive billions of automated microtransactions, global finance requires flexible currency solutions. Stablecoins act as a 'currency API', transferring seamlessly like internet data, reaching a transaction volume of $45 trillion by 2024, a figure expected to grow as more institutions recognize stablecoins as an unparalleled business model—Tether gained $5.2 billion in profits in the first half of 2024 by investing its dollar reserves.
In the competition among stablecoins, complex cryptographic mechanisms are not key; distribution and genuine adoption are crucial. Their adoption is primarily reflected in three key realms: crypto-native, fully banked, and unbanked worlds.
In a $29 trillion crypto-native world, stablecoins serve as an entry point for DeFi, critical for trading, lending, derivatives, liquidity farming, and RWA. Crypto-native stablecoins compete through liquidity incentives and DeFi integration.
In a fully banked world worth over $400 trillion, stablecoins enhance financial efficiency, primarily used for B2B, P2P, and B2C payments. Stablecoins focus on regulation, licensing, and leveraging banks, card networks, payments, and merchants for distribution.
In an unbanked world, stablecoins provide access to the dollar, promoting financial inclusion. Stablecoins are used for savings, payments, foreign exchange, and yield generation. Grassroots marketing is crucial.
Natives of the crypto world
By the second quarter of 2024, stablecoins are expected to account for 8.2% of the total crypto market capitalization. Maintaining exchange rate stability remains challenging, and unique incentives are key to expanding on-chain distribution, with the core issue being the limited application of on-chain.
The battle for dollar-pegging
Fiat-backed stablecoins rely on banking relationships:
93.33% are fiat-backed stablecoins. They offer greater stability and capital efficiency, with banks having the final say on redemptions. Regulated issuers like Paxos have become PayPal's dollar issuer due to their successful redemption of billions in BUSD.
CDP stablecoins improve collateral and liquidation to enhance exchange rate stability:
3.89% are collateralized debt position (CDP) stablecoins. They use cryptocurrencies as collateral but face issues in scaling and volatility. By 2024, CDPs improve risk resilience by accepting a broader range of liquidity and stable collateral, with Aave's GHO accepting any asset in Aave v3, and Curve's crvUSD recently adding USDM (real assets). Partial liquidation is improving, especially with crvUSD's soft liquidation, providing a buffer for further bad debt through its customized automated market maker (AMM). However, the ve-token incentive model faces issues, as the valuation of CRV drops after large liquidations, leading to a shrinkage in crvUSD's market cap.
Synthetic dollars use hedging to maintain stability:
Ethena USDe alone captured 1.67% of the stablecoin market share within a year, with a market capitalization of $3 billion. It is a delta-neutral synthetic dollar that hedges against volatility by taking short positions in derivatives. It is expected to perform well in the upcoming bull market, even after seasonal volatility. However, its long-term viability largely depends on centralized exchanges (CEX), raising concerns. As similar products increase, the impact of small funds on Ethereum may diminish. These synthetic dollars may be vulnerable to black swan events and only maintain depressed funding rates during bear markets.
Algorithmic stablecoins drop to 0.56%.
Liquidity guide challenges
Cryptocurrency stablecoins leverage yield to attract liquidity. Fundamentally, their liquidity costs include the risk-free rate plus a risk premium. To remain competitive, stablecoin yields must at least match Treasury bill (T-bill) rates—we've already seen stablecoin borrowing costs decline as T-bill rates reached 5.5%. sFrax and DAI are leading in T-bill exposure. By 2024, multiple RWA projects have enhanced the composability of on-chain T-bills: CrvUSD will use Mountain's USDM as collateral, while Ondo's USDY and Ethena's USDtb are backed by Blackstone's BUIDL.
Based on Treasury bill rates, stablecoins adopt various strategies to increase risk premiums, including fixed budget incentives (such as distributions from decentralized exchanges, which may lead to constraints and death spirals); user fees (linked to lending and perpetual contract volumes); volatility arbitrage (falling when volatility diminishes); and reserve utilization, such as staking or re-staking (which lacks attractiveness).
Innovative liquidity strategies are emerging in 2024:
Maximizing on-chain yields: While many yields currently stem from self-consuming DeFi inflation as incentives, more innovative strategies are emerging. By using reserves as banks, projects like CAP aim to direct MEV and arbitrage profits directly to stablecoin holders, providing sustainable and more substantial potential yield sources.
Compounding yields with Treasury bill returns: Leveraging the new composability of RWA projects, initiatives like Usual Money (USD0) provide 'theoretically' unlimited yields, benchmarked against Treasury bill returns—attracting $350 million in liquidity providers and entering Binance's launch pool. Agora (AUSD) is also an offshore stablecoin with Treasury bill yields.
Balancing high yields against volatility: Newer stablecoins adopt diversified basket approaches to avoid single-yield and volatility risks while providing balanced high yields. For instance, Fortunafi's Reservoir allocates Treasury bills, Hilbert, Morpho, PSM, and dynamically adjusts portions, incorporating other high-yield assets as necessary.
Is Total Value Locked (TVL) a flash in the pan? Stablecoin yields often face scalability challenges. While fixed budget yields can yield initial growth, as total locked value increases, yields become diluted, leading to diminishing yield effects over time. Without sustainable yields or genuine utility in trading pairs and derivatives post-incentives, its total locked value is unlikely to remain stable.
DeFi gateway dilemma
On-chain visibility allows us to examine the true nature of stablecoins: Are stablecoins a genuine representation of currency as a medium of exchange, or merely financial products for yield?
Only the best-yielding stablecoins are used as trading pairs on CEX:
Nearly 80% of transactions still occur on centralized exchanges, with top CEXs supporting their 'preferred' stablecoins (e.g., Binance's FDUSD, Coinbase's USDC). Other CEXs rely on the overflow liquidity of USDT and USDC. Moreover, stablecoins are striving to become margin deposits for CEX.
There are few stablecoins used as trading pairs on DEXs:
Currently, only USDT, USDC, and a few DAI are used as trading pairs. Other stablecoins, such as Ethena, with 57% of USDe staked in its own protocol, are held purely as financial products for earning yields, far from being mediums of exchange.
Makerdao + Curve + Morpho + Pendle, combined allocation:
Markets like Jupiter, GMX, and DYDX are more inclined to use USDC for deposits because the minting-redeeming process of USDT is more suspect. Lending platforms like Morpho and AAVE prefer USDC for its better liquidity on Ethereum. On the other hand, PYUSD is primarily used for lending on Solana's Kamino, especially when incentives are provided by the Solana Foundation. Ethena's USDe is mainly used for yield activities on Pendle.
RWA is undervalued:
Most RWA platforms, like Blackstone, use USDC as minting assets for compliance reasons, and Blackstone is also a shareholder of Circle. DAI has achieved success in its RWA products.
Expanding markets or exploring new domains:
Although stablecoins can attract major liquidity providers through incentives, they face bottlenecks—DeFi usage is declining. Stablecoins now face a dilemma: they must wait for the expansion of crypto-native activity or seek new utility beyond this realm.
Anomaly in a fully banked world
Key players are taking action
Global regulation is gradually becoming clearer:
99% of stablecoins are dollar-backed, with the federal government having the final say. Following a crypto-friendly Trump presidency, the U.S. regulatory framework is expected to be clarified, with promises to lower interest rates and ban CBDCs, which could be beneficial for stablecoins. The U.S. Treasury report notes the impact of stablecoins on demand for short-term Treasury bonds, with Tether holding $90 billion in U.S. debt. Preventing crypto crime and maintaining the dominance of the dollar are also motivating factors. By 2024, several countries have established regulatory frameworks under common principles, including approvals for stablecoin issuance, reserve liquidity and stability requirements, restrictions on foreign currency stablecoin usage, and generally prohibiting interest generation. Key examples include: MiCA (EU), PTSR (UAE), Sandbox (Hong Kong), MAS (Singapore), PSA (Japan). Notably, Bermuda became the first country to accept stablecoin tax payments and permit the issuance of interest-bearing stablecoins.
Licensed issuers gain trust:
The issuance of stablecoins requires technical capability, compliance across regions, and strong governance. Key players include Paxos (PYUSD, BUSD), Brale (USC), and Bridge (B2B API). Reserve management is handled by trusted institutions like BNY Mellon, generating yields securely through investments in funds managed by Blackstone. BUIDL now allows a broader range of on-chain projects to earn yields.
Banks are the gatekeepers for withdrawals:
While depositing (fiat to stablecoin) has become easier, withdrawal (stablecoin to fiat) challenges remain, as banks struggle to verify the source of funds. Banks prefer to use licensed exchanges like Coinbase and Kraken, which conduct KYC/KYB and have similar anti-money laundering frameworks. While reputable banks like Standard Chartered are starting to accept withdrawals, smaller banks like Singapore's DBS are acting quickly. B2B services like Bridge aggregate withdrawal channels and manage billions in transaction volume for high-end clients including SpaceX and the U.S. government.
Issuers have the final say:
As a leader in compliant stablecoins, Circle relies on Coinbase and is seeking global licenses and partnerships. However, as institutions issue their own stablecoins, this strategy may be impacted, as their business model is unparalleled—Tether, a company with 100 employees, made $5.2 billion in profits in the first half of 2024 from investing its reserves. Banks like JPMorgan have already launched JPM Coin for institutional trading. The payment application Stripe's acquisition of Bridge indicates interest in owning a stablecoin stack, not just integrating USDC. PayPal has also issued PYUSD to capture reserve yields. Card networks like Visa and Mastercard are tentatively accepting stablecoins.
Stablecoins enhance efficiency in a banked world
With trusted issuers, healthy banking relationships, and distributors as foundational support, stablecoins can enhance the efficiency of large-scale financial systems, particularly in payments.
Traditional systems face limitations in efficiency and cost. Intra-app or intra-bank transfers provide instant settlement, but only within their ecosystems. Interbank payment fees are about 2.6% (70% to the issuing bank, 20% to the receiving bank, 10% to the card network), and settlement times exceed a day. Cross-border transaction costs are higher, around 6.25%, with settlement times taking up to five days.
Stablecoin payments provide peer-to-peer instant settlement by eliminating intermediaries. This accelerates the flow of funds, reduces capital costs, and offers programmable features like conditional automatic payments.
B2B (annual transaction volume $120-150 trillion): Banks are in the best position to push stablecoins. JPMorgan developed JPM Coin on its Quorum chain, which is used for about $1 billion in transactions daily as of October 2023.
P2P (annual transaction volume $1.8-2 trillion): E-wallets and mobile payment apps are in the best position, with PayPal launching PYUSD, currently valued at $604 million on Ethereum and Solana. PayPal allows end-users to register for free and send PYUSD.
B2C commerce (annual transaction volume $5.5-6 trillion): Stablecoins need to collaborate with POS, bank APIs, and card networks, with Visa becoming the first payment network to settle transactions using USDC in 2021.
Innovators in an underbanked world
Shadow dollar economy
Due to severe currency depreciation and economic instability, emerging markets urgently need stablecoins. In Turkey, stablecoin purchases account for 3.7% of its GDP. People and businesses are willing to pay a premium for stablecoins above the legal dollar, with stablecoin premiums reaching 30.5% in Argentina and 22.1% in Nigeria. Stablecoins provide access to dollars and financial inclusion.
Tether dominates this space with a reliable 10-year track record. Even in the face of complex banking relationships and redemption crises—Tether admitted in April 2019 that USDT was only 70% backed by reserves—its peg remains stable. This is because Tether has built a robust shadow dollar economy: in emerging markets, people rarely convert USDT to fiat; they regard it as the dollar, a phenomenon particularly evident in regions like Africa and Latin America for paying employees, invoices, etc. Tether achieved this without incentives, relying solely on its longevity and ongoing utility, enhancing its credibility and acceptability. This should be the ultimate goal for every stablecoin.
Dollar acquisition
Remittances: Remittance inequality slows economic growth. In sub-Saharan Africa, individuals sending remittances to low-income countries and developed nations pay an average of 8.5% of the total remittance amount. For businesses, the situation is even more severe; high fees, long processing times, red tape, and exchange rate risks directly impact the growth and competitiveness of businesses in the region.
Dollar acquisition: From 1992 to 2022, currency volatility resulted in a GDP loss of $1.2 trillion for 17 emerging market countries—an astonishing 9.4% of their total GDP. Acquiring dollars is critical for local financial development. Many crypto projects are keen to enter this space, with ZAR focusing on grassroots 'DePIN' approaches. These approaches utilize local agents to facilitate cash and stablecoin transactions in Africa, Latin America, and Pakistan.
Foreign exchange: Today, the forex market has a daily trading volume exceeding $7.5 trillion. In the Global South, individuals often rely on black markets to exchange local fiat for dollars, primarily because black market rates are more favorable than official channels. Binance P2P is starting to gain traction, but its order book approach lacks flexibility. Many projects, such as ViFi, are building on-chain automated market maker forex solutions.
Disbursement of humanitarian aid: Ukrainian war refugees can receive humanitarian assistance in the form of USDC, which they can store in digital wallets or cash out locally. In Venezuela, amid deepening political and economic crises, frontline healthcare workers used USDC to pay for medical supplies during the COVID-19 pandemic.
Conclusion: Interwoven
Interoperability
Swapping between different currencies:
Traditional forex systems are highly inefficient, facing multiple challenges: counterparty settlement risk (CLS has improved but is cumbersome), costs of multi-bank systems (involving six banks for a yen purchase from an Australian bank to a London dollar office), global settlement timezone differences (Canadian and Japanese bank systems overlap for less than five hours daily), and limited forex market access (retail users pay 100 times the fees of large institutions). On-chain foreign exchange offers significant advantages:
Cost, efficiency, and transparency: Oracles like Redstone and Chainlink provide real-time price quotes. Decentralized exchanges (DEX) offer cost efficiency and transparency, with Uniswap CLMM reducing transaction costs to 0.15-0.25%—about 90% lower than traditional foreign exchange. Transitioning from T+2 bank settlements to instant settlements enables arbitrageurs to adopt various strategies to correct mispricing.
Flexibility and accessibility: On-chain foreign exchange allows corporate treasurers and asset managers to access a wide range of products without needing multiple bank accounts in specific currencies. Retail users can obtain the best foreign exchange rates using crypto wallets with embedded DEX APIs.
The separation of currency and jurisdiction: Transactions no longer require domestic banks, detaching them from underlying jurisdictions. This approach leverages the efficiency of digitization while maintaining currency sovereignty, although drawbacks still exist.
However, challenges remain, including the scarcity of non-dollar-denominated digital assets, oracle security, support for long-tail currencies, regulation, and a unified interface for on-and-off solutions. Despite these obstacles, on-chain foreign exchange still presents enticing opportunities. For instance, Citibank is developing blockchain forex solutions under the guidance of the Monetary Authority of Singapore.
Swapping between different stablecoins:
Imagine a world where most companies issue their own stablecoins. Stablecoin exchanges pose a challenge: paying merchants at JPMorgan with PayPal's PYUSD. While on-and-off solutions can address this, they lose the efficiency promised by cryptocurrency. On-chain automated market makers (AMM) provide optimal real-time low-cost stablecoin-to-stablecoin trading. For example, Uniswap offers multiple such pools with fees as low as 0.01%. However, once billions of funds enter on-chain, trust in the security of smart contracts is necessary, and sufficient liquidity depth and instant performance must support real-world activities.
Cross-chain swapping:
Major blockchains have diverse advantages and disadvantages, leading to stablecoins being deployed across multiple chains. This multi-chain approach introduces cross-chain challenges, and bridging poses significant security risks. In my view, stablecoins launching their own Layer 0 is the best solution, such as USDC's CCTP, PYUSD's Layer 0 integration, and the recent actions we witnessed with USDT recalling bridged locked tokens, potentially launching similar Layer 0 solutions.
Meanwhile, several unresolved issues remain:
Will compliant stablecoins hinder 'open finance,' as compliant stablecoins can potentially monitor, freeze, and extract funds?
Will compliant stablecoins still avoid providing yields that could be classified as securities products, thereby preventing on-chain decentralized finance (DeFi) from benefiting from its large-scale expansion?
Given Ethereum's slow speed and its L2 reliance on a single sequencer, Solana's imperfect track record, and other popular chains lacking long-term performance records, can any open blockchain truly handle large sums of money?
Will the separation of currency and jurisdiction introduce more chaos or opportunity?
The financial revolution led by stablecoins is both exciting and unpredictable—a new chapter where freedom and regulation dance in delicate balance.