Author: YBB Capital Researcher Zeke
Preface
According to CoinGecko data, the total market cap of stablecoins has surpassed $200 billion. Compared to when we mentioned this field last year, the overall market cap has nearly doubled and surpassed the historical peak. I once likened stablecoins to a key component in the crypto world, serving as a stable store of value and acting as a crucial entry point in various on-chain activities. Now stablecoins are starting to enter the real world, demonstrating financial efficiency that surpasses traditional banks in retail payments, business-to-business (B2B) transactions, and international remittances. In emerging markets like Asia, Africa, and Latin America, the application value of stablecoins is gradually being realized, with strong financial inclusivity enabling residents of third-world countries to effectively cope with high inflation caused by government instability. Through stablecoins, they can also participate in some global financial activities and subscribe to cutting-edge virtual services (such as online education, entertainment, cloud computing, and AI products).
Entering emerging markets and challenging traditional payments is the next step for stablecoins. In the foreseeable future, the regulation and accelerated adoption of stablecoins will become inevitable, and the rapid development of AI will further strengthen the demand for stablecoins (computing power purchases, subscription services). Compared to the developments of the past two years, the only constant is that Tether and Circle still have a high dominance in this field, and more startups are beginning to focus on the upstream and downstream of stablecoins. But what we are still going to talk about today is the issuers of stablecoins—who else can take a piece of the cake in this extremely competitive hundred-billion-dollar market?
1. The Evolution of Trends
In the past, when we mentioned the classification of stablecoins, we generally divided them into three categories:
Fiat-collateralized stablecoins: These stablecoins are backed by fiat currencies (such as USD or EUR) as reserves, typically issued at a 1:1 ratio. For example, each USDT or USDC corresponds to one dollar stored in the issuer's bank account. The characteristics of these stablecoins are relatively simple and direct, and in theory, they can provide a high degree of price stability;
Overcollateralized stablecoins: These stablecoins are created by overcollateralizing other volatile and liquid quality crypto assets (such as ETH, BTC). To cope with potential price fluctuation risks, these stablecoins often require a higher collateral ratio, meaning the value of the collateral must significantly exceed the value of the minted stablecoins. Typical examples include Dai and Frax;
Algorithmic stablecoins: These stablecoins adjust their supply and circulation completely through algorithms, which control the supply and demand relationship of the currency, aiming to peg the stablecoin's price to a reference currency (usually the USD). Generally, when the price rises, the algorithm issues more coins, and when the price falls, it repurchases more coins from the market. The representative of this category is UST (the stablecoin of Luna).
In the years following the collapse of UST, the development of stablecoins has mainly revolved around Ethereum LST, making minor innovations and constructing some quasi-overcollateralized stablecoins through different risk balances. The term 'stablecoin' has not been mentioned again. However, with the emergence of Ethena earlier this year, stablecoins have gradually defined a new development direction, that is, combining quality assets with low-risk financial products, thus attracting a large number of users through relatively high yields and creating an opportunity to take a piece of the pie in a relatively fixed stablecoin market structure. The three projects I will mention below all belong to this direction.
2. Ethena
Ethena is the fastest-growing non-fiat collateralized stablecoin project after the collapse of Terra Luna, with its native stablecoin USDe surpassing Dai to take third place with a scale of $5.5 billion. The overall idea of the project is based on delta hedging with Ethereum and Bitcoin collateral, and the stability of USDe is achieved by Ethena shorting Ethereum and Bitcoin on Cex, equivalent to the value of the collateral. This is a risk-hedging strategy aimed at offsetting the impact of price fluctuations on the value of USDe. If both prices rise, the short position will incur losses, but the value of the collateral will also rise, offsetting the loss; conversely, if the prices fall. The entire operation process relies on off-chain settlement service providers to realize it, meaning the protocol's assets are held by multiple external entities. The project's revenue sources are mainly threefold:
Ethereum staking rewards: Users' staked LST will generate Ethereum staking rewards;
Hedging trading earnings: Ethena Labs' hedging trades may generate funding rates or basis spread earnings;
Fixed rewards of Liquid Stables: Earn deposit interest either in USDC on Coinbase or in other stablecoins on other exchanges.
In other words, the essence of USDe is a packaged Cex low-risk quantitative hedging strategy financial product. Considering the above three points, Ethena can provide floating annualized yields of up to several dozen percentage points (currently at 27%) when the market is good and liquidity is excellent, which is even higher than the 20% APY of the Anchor Protocol (the decentralized bank in Terra) back in the day. Although it is not a fixed annualized yield, it is still extremely exaggerated for a stablecoin project. So, in this situation, does Ethena carry extremely high risks like Luna?
Theoretically, the biggest risk for Ethena comes from the potential failure of Cex and custody, but such black swan events are unpredictable. Another risk that needs to be considered is a bank run; a large-scale redemption of USDe requires sufficient counterparties. Given Ethena's rapid growth, this situation is not impossible. Users rapidly sell USDe, causing a decoupling of the secondary market price. To restore the price, the protocol needs to close positions and sell spot collateral to repurchase USDe, which may turn unrealized losses into actual losses and ultimately exacerbate the entire vicious cycle. Of course, this probability is far smaller than the probability of a single-layer barrier collapse like UST, and the consequences are not as severe, but the risk still exists.
Ethena also experienced a long period of low valley during the year. Although its yield dropped significantly and its design logic was questioned, there has indeed been no systemic risk. As a key innovation in this round of stablecoins, Ethena provides a design logic that integrates on-chain and Cex, bringing a large number of LST assets generated from the mainnet into exchanges, becoming scarce short liquidity in the bull market, and providing exchanges with a lot of transaction fees and fresh blood. This project represents a compromise but is an extremely interesting design idea that achieves high yields while maintaining good security. In the future, with the rise of order book Dex matched with more mature chain abstractions, will there be a chance to achieve a fully decentralized stablecoin based on this idea?
3. Usual
Usual is an RWA stablecoin project created by former French parliamentarian Pierre PERSON, who was also an advisor to French President Macron. The project has seen a significant surge in popularity due to news of its listing on Binance Launchpool, with its TVL rapidly rising from the millions to around $700 million. The project's native stablecoin USD0 adopts a 1:1 reserve system. Unlike USDT and USDC, users no longer exchange fiat for equivalent virtual currencies, but rather exchange fiat for equivalent US Treasury bonds, which is the core selling point of the project, sharing the profits that Tether obtains.
As shown in the above image, the left side is the operational logic of traditional fiat-collateralized stablecoins. Taking Tether as an example, users do not earn any interest when converting fiat into USDT. To some extent, Tether's fiat can also be seen as obtained through 'playing tricks'. The company purchases low-risk financial products (mainly US Treasury bonds) with a large amount of fiat, and last year's earnings reached as high as $6.2 billion, which are then reinvested into high-risk areas to achieve passive income.
On the right side is the operational logic of Usual, with the core concept being Become An Owner, Not Just A User. The project's design revolves around this concept, redistributing infrastructure ownership to Total Value Locked (TVL) providers, meaning users' fiat will be converted into RWA of ultra-short-term US Treasury bonds, and the entire implementation process will be conducted through USYC (USYC is operated by Hashnote, which is currently one of the leading on-chain institutional asset management companies supported by partners from DRW), with the final proceeds entering the protocol's treasury and governed by the protocol token holders.
The protocol token USUAL will be allocated to locked USD0 holders (locked USD0 will be converted to USD0++), achieving profit sharing and early alignment. It is worth noting that this locking period lasts four years, consistent with the redemption time of some mid-term US Treasury bonds (US mid- to long-term Treasury bonds generally last 2 to 10 years).
The advantage of Usual lies in breaking the control of centralized entities like Tether and Circle over stablecoins while maintaining capital efficiency and distributing profits equitably. However, the relatively long locking period and lower yields compared to the crypto circle may make it difficult to achieve large-scale growth like Ethena in the short term. For retail investors, the appeal may be more concentrated on the token value of Usual. In contrast, in the long run, USD0 has more advantages: first, it facilitates citizens from other countries without American bank accounts to invest in US Treasury bond portfolios more easily; second, it has better underlying assets as support, enabling it to scale much larger than Ethena; third, the decentralized governance method also means that this stablecoin will not be so easily frozen, making it a better choice for non-trading users.
4. f(x) Protocol V2
f(x) Protocol is currently the core product of Aladdindao, which we provided a detailed introduction to in last year's article. Compared to the two star projects mentioned above, f(x) Protocol is relatively lesser known. Its complex design has also brought quite a few defects, such as vulnerability to attacks, low capital efficiency, high trading costs, and complex user access, etc. However, I still believe this project is one of the most noteworthy stablecoin projects birthed during the bear market of 2023, and I will provide a brief introduction to it here (for details, refer to the white paper of f(x) Protocol v1).
In the V1 version, f(x) Protocol created a concept known as 'floating stablecoins', which dismantles the underlying asset stETH into fETH and xETH. fETH is a 'floating stablecoin' whose value is not fixed but fluctuates slightly with the price of Ethereum (ETH). xETH is a leveraged ETH long position that absorbs most of the ETH price volatility. This means that xETH holders will bear more market risks and rewards, but it also helps stabilize the value of fETH, making fETH relatively smoother. Earlier this year, following this idea, a rebalancing pool was designed, where only one highly liquid stablecoin pegged to the dollar, namely fxUSD, exists. All other stable leverage pairs' stable derivative tokens no longer have independent liquidity but can only exist within the rebalancing pool or as supporting parts of fxUSD.
A basket of LSDs: fxUSD is supported by multiple liquid staking derivatives (LSDs) such as stETH and sfrxETH. Each LSD has its own stable/leverage pair mechanism;
Minting and Redemption: When users want to mint fxUSD, they can provide LSD or withdraw stable currency from the corresponding rebalancing pool. In this process, the LSD is used to mint the stable derivative tokens of that LSD, which are then deposited into the fxUSD reserves. Similarly, users can also redeem LSD with fxUSD.
In simple terms, this project can also be seen as a super complex version of early hedging stablecoins like Ethena, but in the on-chain scenario, the process of balancing and hedging is extremely complicated. First, there is the decomposition of volatility, followed by various balancing mechanisms and margin for leverage, and the negative impacts on user access have already exceeded the positive attraction. In the V2 version, the entire design focus shifted to eliminating the complexities brought about by leverage and providing better support for fxUSD. In this version, xPOSITION is introduced, which is essentially a high-leverage trading tool, that is, a non-homogeneous product with a high beta value (i.e., highly sensitive to market price changes). This function allows users to engage in high-leverage on-chain trading without worrying about individual liquidations or paying funding costs, and the benefits are evident.
Fixed leverage ratio: xPOSITION provides a fixed leverage ratio, and users' initial margin will not incur additional requirements due to market fluctuations, nor will unexpected liquidations occur due to changes in leverage ratios;
No liquidation risk: Traditional leveraged trading platforms may force users' positions to be liquidated due to severe market fluctuations, but the design of f(x) Protocol V2 avoids this situation;
Exemption from funding costs: Typically, using leverage involves additional funding costs, such as interest incurred when borrowing assets. However, xPOSITION does not require users to pay these costs, reducing overall trading costs.
In the new stable pool, users can deposit USDC or fxUSD with one click, providing liquidity support for the protocol's stability. Unlike the V1 version's stable pool, the V2 version's stable pool acts as an anchor between USDC and fxUSD, allowing participants to engage in price arbitrage within the fxUSD—USDC AMM pool and help stabilize fxUSD. The entire protocol's revenue sources are based on position opening, closing, liquidation, rebalancing, funding fees, and collateral earnings.
This project is one of the few non-overcollateralized and fully decentralized stablecoin projects. For stablecoins, it still seems somewhat too complex and does not conform to the minimalist design premise of stablecoins. Users must also have a certain foundation to comfortably get started. In extreme market scenarios, when a bank run occurs, various resistance barriers may also inadvertently harm users' interests. However, the goal of this project aligns with every crypto enthusiast's ultimate vision for stablecoins—a native decentralized stablecoin backed by top-tier crypto assets.
Conclusion
Stablecoins will always be a battleground, and they are also a highly demanding field in crypto. In last year's article (In a Critical State, But Stablecoins Have Not Stopped Innovating), we briefly introduced the past and present of stablecoins and hoped to see more interesting decentralized non-overcollateralized stablecoins emerge. Now, a year and a half has passed, and we have not seen any startups besides f(x) Protocol working in this direction. However, it is reassuring that Ethena and Usual provide some compromise ideas, allowing us to at least choose some more ideal and more Web3-compatible stablecoins.
Reference Articles
1. Mario Looks at Web3: An In-depth Analysis of the Success Factors and Death Spiral Risks of Ethena
2. fxUSD: The Nuts and the Bolts
3. What is Usual?
