Original Author: YBB Capital Researcher Zeke
Introduction
According to CoinGecko data, the total market capitalization of stablecoins has now exceeded $200 billion. Compared to when we mentioned this track last year, the overall market capitalization has nearly doubled and surpassed historical highs. I once compared stablecoins to a critical link in the crypto world, serving as a stable value storage tool in various on-chain activities. Now, stablecoins are beginning to move toward the real world, demonstrating financial efficiency that surpasses traditional banks in retail payments, business-to-business transactions, and international transfers. In emerging markets such as Africa, Asia, and Latin America, the application value of stablecoins is gradually being realized, and their strong financial inclusivity allows residents of third-world countries to effectively cope with hyperinflation caused by government instability, while also participating in global financial activities and subscribing 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, compliance and accelerated adoption of stablecoins will become inevitable, and the rapid development of AI will further strengthen the demand for stablecoins (for computational power purchases, subscription services). Compared to the development over the past two years, the only constant is that Tether and Circle still hold significant dominance in this field, and more startups are beginning to focus on the upstream and downstream of stablecoins. However, what we still want to discuss today are the issuers of stablecoins. In this intensely competitive multi-billion-dollar sector, who will be able to take a slice of the next cake?
1. Evolution of Trends
In the past, when we classified stablecoins, we generally divided them into three categories:
Fiat-collateralized Stablecoins: These stablecoins are backed by fiat currencies (like USD, EUR) and are usually 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 they can theoretically provide high price stability;
Over-collateralized Stablecoins: These stablecoins are created by over-collateralizing other volatile and liquid high-quality crypto assets (like ETH, BTC). To cope with potential price volatility risk, these stablecoins often require a higher collateralization rate, meaning the value of the collateral must significantly exceed the value of the minted stablecoins. Typical representatives include Dai, Frax, etc.;
Algorithmic Stablecoins: These are completely regulated in supply and circulation by algorithms, controlling the supply and demand relationship of the currency, aiming to peg the price of the stablecoin to a reference currency (usually USD). Generally, when prices rise, the algorithm issues more coins, and when prices fall, it buys back more coins from the market. Its representatives include UST (the stablecoin of Luna).
In the years following the collapse of UST, the development of stablecoins has mainly revolved around Ethereum LST, making incremental innovations to build some quasi-over-collateralized stablecoins. The term 'algorithmic stability' has not been mentioned again. However, with the emergence of Ethena earlier this year, stablecoins have gradually determined a new development direction, namely the combination of high-quality assets with low-risk financial management, thus attracting a large number of users with higher yields, creating an opportunity to seize market share in a relatively solidified stablecoin market structure. The three projects I mention below all belong to this direction.
2. Ethena
Ethena is the fastest-growing fiat-collateralized stablecoin project since the collapse of Terra Luna, with its native stablecoin USDe surpassing Dai to temporarily rank third with a scale of $5.5 billion. The overall idea of the project is based on Delta Hedging of Ethereum and Bitcoin collateral. The stability of USDe is achieved through 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; and vice versa. The entire operation process relies on off-market settlement service providers to implement, meaning that the protocol's assets are entrusted to multiple external entities. The project's income mainly comes from three sources:
Ethereum Staking Rewards: Users' staked LSTs will generate Ethereum staking rewards;
Hedging Trading Gains: Ethena Labs' hedging trades may generate funding rates or basis spread gains;
Fixed Rewards of Liquid Stables: Earn deposit interest in the form of USDC when placed on Coinbase or in other stablecoins at other exchanges.
In other words, the essence of USDe is a packaged low-risk quantitative hedging strategy financial product from Cex. Combining the above three points, Ethena can provide floating annualized returns of up to several tens of points (currently 27%) when the market is good and liquidity is excellent, which is even higher than the 20% APY of Anchor Protocol (the decentralized bank in Terra) back in the day. Although it is not a fixed annualized return, it is still extremely exaggerated for a stablecoin project. So, in this case, does Ethena have extremely high risks like Luna?
Theoretically, Ethena's biggest risk comes from Cex and custodial blow-ups, but such black swan events are unpredictable. Another risk to consider is the run; large-scale redemptions of USDe require sufficient counterparty liquidity. Given Ethena's rapid growth, this situation is not impossible. Users selling USDe quickly could lead to a disconnection in the secondary market price. To restore the price, the protocol needs to close positions and sell spot collateral to buy back USDe, which could turn floating losses into actual losses, ultimately exacerbating the vicious cycle. "1" Of course, this probability is much lower than that of UST's single-layer barrier collapse, and the consequences are not as severe, but the risk still exists.
Ethena also experienced a long trough period mid-year. Although yields dropped significantly and its design logic was questioned, there was indeed no systemic risk. As a key innovation in this round of stablecoins, Ethena provides a design logic that integrates on-chain with Cex, bringing a large amount of LST assets from the mainnet to exchanges, becoming scarce short-squeeze liquidity in the bull market, and providing exchanges with a lot of transaction fees and fresh blood. The 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 matching with more mature chain abstractions, will there be an opportunity to realize a fully decentralized stablecoin based on this idea?
3. Usual
Usual is an RWA stablecoin project created by former French Member of Parliament Pierre PERSON, who was also an advisor to French President Macron. The project has seen a significant increase in popularity recently due to the news of its listing on Binance Launchpool, with its TVL rapidly rising from tens of millions to around $700 million. The project's native stablecoin USD 0 adopts a 1:1 reserve system, differing from USDT and USDC in that users no longer exchange fiat for equivalent virtual currency, but rather exchange fiat for equivalent US Treasury bonds, which is the project's core selling point, sharing the profits obtained from Tether.
As shown in the figure above, the left side is the operational logic of traditional fiat-collateralized stablecoins. Taking Tether as an example, users do not receive any interest when minting USDT from fiat, and to some extent, Tether's fiat can also be considered as obtained through 'empty-handed grasping'. The company purchases low-risk financial products (mainly US Treasury bonds) with a large amount of fiat, and last year's profits alone reached $6.2 billion, which are then reinvested in high-risk areas to achieve passive income.
On the right side is the operational logic of Usual, whose core concept is Become An Owner, Not Just A User. (Become an owner, not just a user.) The project design revolves around this concept, redistributing infrastructure ownership to total locked value (TVL) providers, meaning that users' fiat will be converted into ultra-short-term US Treasury RWA, and the entire implementation process is conducted through USYC (USYC is operated by Hashnote, a leading on-chain institutional asset management company supported by partners from DRW), and the final yield enters the protocol's treasury, which is owned and governed by the protocol token holders.
The protocol token USUAL will be distributed to locked USD 0 holders (locked USD 0 will be converted to USD 0++), achieving yield sharing and early alignment. Notably, this lock-up period lasts four years, consistent with the redemption time of some U.S. medium-term Treasury bonds (U.S. medium and long-term Treasury bonds generally last from 2 to 10 years).
Usual's advantage lies in breaking the control of centralized entities like Tether and Circle over stablecoins while maintaining capital efficiency and equally distributing profits. However, the longer lock-up period and relatively lower yield compared to the crypto sphere may make it difficult to achieve the kind of rapid growth seen in Ethena in the short term; for retail investors, the attraction may be more focused on Usual's token value. In contrast, in the long term, USD 0 has more advantages: first, it facilitates foreign citizens without U.S. bank accounts to invest more easily in U.S. Treasury bond portfolios; second, it has better underlying assets as support, with an overall scale much larger than Ethena; third, the decentralized governance also means that this stablecoin is not 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. We provided a more detailed introduction to this project in last year's article. Compared to the two star projects above, f(x)Protocol is somewhat less well-known. Its complex design has also brought it quite a few flaws, such as being prone to attacks, low capital efficiency, high trading costs, and complex user access. However, I still believe this project is one of the most noteworthy stablecoin projects born during the bear market of 2023, and I will provide a brief introduction to it here. (For detailed information, you can refer to the white paper of f(x)Protocol v1)
In version V1, f(x)Protocol created a concept known as 'floating stablecoins', which disassembles the underlying asset stETH into fETH and xETH. fETH is a 'floating stablecoin', meaning its value is not fixed but varies slightly with the price of Ethereum (ETH). xETH is a leveraged ETH long position that absorbs most of the ETH price fluctuations. This means that xETH holders will bear more market risk and returns, but it also helps stabilize the value of fETH, making fETH relatively smoother. Earlier this year, following this idea, a rebalancing pool was designed, within which there exists only one liquid and US dollar-pegged stablecoin, namely fxUSD. All other stable leverage pairs' stable derivative tokens no longer have independent liquidity but can only exist within the rebalancing pool or as part of the support for fxUSD.
A Basket of LSDs: fxUSD is supported by multiple liquid staking derivatives (LSDs) like stETH, sfrxETH, etc. Each LSD has its own stable/leverage pair mechanism;
Minting and Redemption: When users want to mint fxUSD, they can provide LSD or withdraw stablecoins from the corresponding rebalancing pool. In this process, LSD is used to mint the stable derivative of that LSD, which is then deposited into the fxUSD reserves. Similarly, users can redeem LSD using fxUSD.
So simply put, this project can also be seen as a super complex version of Ethena and early hedged stablecoins, but in the on-chain scenario, this balancing and hedging process is very complicated. First, it splits volatility, then various balancing mechanisms and margin for leverage, and the negative impact caused by user access has already surpassed the positive attraction. In the V2 version, the entire design focus shifts to eliminating the complexity brought by leverage and better supporting fxUSD. In this version, xPOSITION is introduced, which is essentially a high-leverage trading tool, a non-homogeneous, highly beta (i.e., sensitive to market price changes) leveraged long position product. This feature allows users to engage in high-leverage trading on-chain without worrying about individual liquidations or paying funding fees, and the benefits are evident.
Fixed Leverage Ratio: xPOSITION provides a fixed leverage ratio, meaning that users' initial margin will not be subject to additional requirements due to market fluctuations, nor will it result in unexpected liquidations 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 Fees: Typically, using leverage incurs additional funding costs, such as interest generated 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 stable pool in version V1, the stable pool in version V2 acts as an anchor between USDC and fxUSD, allowing participants to engage in price arbitrage in the fxUSD—USDC AMM pool and help stabilize fxUSD. The entire income of the protocol is based on opening positions, closing positions, liquidations, rebalancing, funding fees, and collateral income.
This project is currently one of the few non-over-collateralized and fully decentralized stablecoin projects. For stablecoins, it still seems somewhat too complex and does not meet the minimal design premise of stablecoins. Users must have a certain foundation to safely get started. In extreme market conditions, when a run occurs, the framework design of various resistance barriers may also harm users' interests. However, the project's goals indeed align with each crypto person's ultimate vision of a decentralized stablecoin backed by top crypto assets.
Conclusion
Stablecoins will always be a battleground and are a highly challenging track in Crypto. In last year's article (In a Near-Death Situation, but Algorithmic Stability Has Not Stopped Innovating), we briefly introduced the past and present of stablecoins and hoped to see some more interesting decentralized non-over-collateralized stablecoins emerge. Now, a year and a half has passed, and we have not seen any startup projects besides f(x)Protocol working in this direction. Fortunately, Ethena and Usual have provided some compromise ideas, allowing us to choose some more ideal, more Web3-oriented stablecoins.
Reference Article
1. Mario Looks at Web3: An In-depth Analysis of the Success of Ethena and the Risks of Death Spiral
2. fxUSD: The Nuts and the Bolts
3. What is Usual?
