Original Title: Stablecoin Playbook: Flipping Billions to Trillions

Author: Rui Shang, SevenX Ventures

Translation: Mensh, ChainCatcher

Overview: Eight key opportunities related to stablecoins—

The younger generation is digital natives, and stablecoins are their natural currency. As artificial intelligence and the Internet of Things drive billions of automated microtransactions, global finance needs flexible currency solutions. Stablecoins, as "currency APIs," transfer seamlessly like internet data, reaching a transaction volume of $4.5 trillion in 2024, a figure expected to grow as more institutions realize that stablecoins represent an unparalleled business model—Tether made $5.2 billion in profits in the first half of 2024 by investing its dollar reserves.

In the competition for stablecoins, complex crypto mechanisms are not key; distribution and real adoption are crucial. Their adoption is primarily reflected in three key areas: crypto-native, fully banked, and unbanked worlds.

In the $29 trillion crypto-native world, stablecoins serve as the gateway to DeFi, essential for trading, lending, derivatives, liquidity farming, and RWA. Crypto-native stablecoins compete through liquidity incentives and DeFi integration.

In the fully banked world of 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 the unbanked world, stablecoins provide access to the dollar, promoting financial inclusion. Stablecoins are used for savings, payments, foreign exchange, and yield generation. Grassroots market promotion is crucial.

Natives of the Crypto World

In the second quarter of 2024, stablecoins accounted 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 nature of on-chain applications.

The Battle for Dollar Pegging

• Fiat-backed stablecoins rely on banking relationships:

93.33% are fiat-backed stablecoins. They have greater stability and capital efficiency, with banks having the final say through control of 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 with scalability and volatility. By 2024, CDPs have improved their risk resistance by accepting broader liquidity and stable collateral, with Aave's GHO accepting any asset in Aave v3, and Curve's crvUSD recently adding USDM (real assets). Partial liquidations are 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 declines after large-scale liquidations, leading to a decrease 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 cap of $3 billion. It is a delta-neutral synthetic dollar that hedges against volatility by opening short positions in derivatives. It is expected to perform well in the upcoming bull market, even after seasonal fluctuations. However, its long-term viability largely depends on centralized exchanges (CEX), which raises questions. As similar products increase, the impact of small funds on Ethereum may diminish. These synthetic dollars may be vulnerable to black swan events and can only maintain low funding rates during bear markets.

• Algorithmic stablecoins have dropped to 0.56%.

Liquidity Guidance Challenges

Crypto stablecoins attract liquidity through yields. 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 have already seen stablecoin borrowing costs decrease 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 uses Mountain's USDM as collateral, while Ondo's USDY and Ethena's USDtb are backed by Blackstone's BUIDL.

Based on T-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 (tied to borrowing and perpetual contract trading volumes); volatility arbitrage (falling when volatility decreases); and reserve utilization, such as staking or re-staking (which may lack appeal).

In 2024, innovative liquidity strategies are emerging:

• Maximizing on-chain yields: While many yields currently stem from self-consuming DeFi inflation as incentives, more innovative strategies are emerging. By treating reserves as banks, projects like CAP aim to direct MEV and arbitrage profits directly to stablecoin holders, providing a sustainable and more substantial potential yield source.
• Compounding with T-bill yields: Utilizing the new composability of RWA projects, initiatives like Usual Money (USD0) offer "theoretically" unlimited yields, benchmarked against T-bill yields—attracting $350 million in liquidity providers and entering Binance's launch pool. Agora (AUSD) is also an offshore stablecoin with T-bill yields.
• Balancing high yields against volatility: Newer stablecoins adopt a diversified basket approach to avoid single yield and volatility risks, providing balanced high yields. For example, Fortunafi's Reservoir allocates T-bills, Hilbert, Morpho, PSM, and dynamically adjusts portions, incorporating other high-yield assets as needed.
• Is Total Value Locked (TVL) a fleeting phenomenon? Stablecoin yields often face scalability challenges. While fixed budget yields can bring initial growth, as total value locked increases, yields may be diluted, leading to diminishing yield effects over time. Without sustainable yields or true utility in trading pairs and derivatives post-incentives, their total value locked is unlikely to remain stable.

The 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 trades 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. Additionally, stablecoins are struggling to become margin deposits on CEXs.

• Few stablecoins are used as trading pairs on DEX:

Currently, only USDT, USDC, and a small amount of DAI are used as trading pairs. Other stablecoins, such as Ethena, have 57% of their USDe staked in their own protocol, held purely as financial products to earn yields, far from being a medium of exchange.

• Makerdao + Curve + Morpho + Pendle, combined allocation:

Markets like Jupiter, GMX, and DYDX tend to use USDC for deposits, as the minting-redeeming process of USDT is more suspect. Lending platforms like Morpho and AAVE prefer USDC due to 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 territories:

While 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 activities or seek new utility beyond this realm.

Outliers in the Fully Banked World

Key Players are Taking Action

• Global regulation is gradually becoming clearer:

99% of stablecoins are backed by the US dollar, with the federal government having the final influence. Following the crypto-friendly presidency of Donald Trump, a clear regulatory framework in the US is expected, as he has promised to lower interest rates and ban CBDCs, which could be beneficial for stablecoins. The US Treasury report highlights the impact of stablecoins on the demand for short-term government bonds, with Tether holding $90 billion in US debt. Preventing crypto crime and maintaining the dominance of the dollar are also motivating factors. By 2024, multiple countries have established regulatory frameworks under common principles, including approval for stablecoin issuance, reserve liquidity and stability requirements, restrictions on the use of foreign currency stablecoins, and generally prohibiting interest generation. Key examples include: MiCA (EU), PTSR (UAE), Sandbox (Hong Kong), MAS (Singapore), PSA (Japan). Notably, Bermuda has become the first country to accept tax payments in stablecoins and license interest-bearing stablecoin issuance.

• Licensed issuers gain trust:

The issuance of stablecoins requires technical capability, cross-regional compliance, and strong management. Key players include Paxos (PYUSD, BUSD), Brale (USC), and Bridge (B2B API). Reserve management is handled by trusted institutions like BNY Mellon, which safely generates returns by investing 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 deposits (fiat to stablecoin) have become easier, challenges remain for withdrawals (stablecoin to fiat) 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 high-reputation banks like Standard Chartered have begun accepting 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 US 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 its business model is unparalleled—Tether, a company with 100 employees, made $5.2 billion in profits from investing its reserves in the first half of 2024. Banks like JPMorgan have already launched JPM Coin for institutional trading. Payment application Stripe's acquisition of Bridge shows interest in owning a stablecoin stack, rather than 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 the banked world

With trusted issuers, healthy banking relationships, and distributors as foundational support, stablecoins can improve the efficiency of large-scale financial systems, particularly in payments.

Traditional systems face limitations in efficiency and cost. In-app or intra-bank transfers provide instant settlement but are limited to their ecosystems. The cost of interbank payments is about 2.6% (70% to the issuing bank, 20% to the receiving bank, 10% to the card network), and settlement times exceed one day. Cross-border transaction costs are even higher, around 6.25%, with settlement times reaching up to five days.

Stablecoin payments eliminate intermediaries, providing point-to-point instant settlement. This accelerates the flow of funds, reduces capital costs, and offers programmable features such as conditional automatic payments.

• B2B (annual transaction volume of $120-150 trillion): Banks are in the best position to promote stablecoins. JPMorgan has developed JPM Coin on its Quorum chain, with JPM Coin being used for approximately $1 billion in transactions daily as of October 2023.
• P2P (annual transaction volume of $1.8-2 trillion): E-wallets and mobile payment applications are well-positioned, 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 of $5.5-6 trillion): Stablecoins need to collaborate with POS, banking APIs, and card networks, with Visa becoming the first payment network to settle transactions using USDC in 2021.

Innovators in the Underbanked World

Shadow Dollar Economy

Due to severe currency devaluation and economic instability, emerging markets have an urgent need for 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 the dollar and promote financial inclusion.

Tether dominates this space, boasting a reliable 10-year track record. Even amid 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 established a robust shadow dollar economy: in emerging markets, people rarely convert USDT to fiat; they view 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 long-standing presence and continued utility, enhancing its credibility and acceptance. This should be the ultimate goal for every stablecoin.

Dollar Acquisition

• Remittances: Remittance inequality hinders economic growth. In Sub-Saharan Africa, individuals sending remittances to low- and middle-income countries and developed nations pay an average of 8.5% of the total remittance amount. For businesses, the situation is even more dire, as high fees, long processing times, bureaucracy, and exchange rate risks directly impact the growth and competitiveness of businesses in the region.
• Dollar acquisition: From 1992 to 2022, currency fluctuations 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 crucial for local financial development. Many crypto projects are dedicated to entry, with ZAR focusing on grassroots "DePIN" approaches. These approaches leverage local agents to facilitate cash and stablecoin transactions in Africa, Latin America, and Pakistan.
• Foreign exchange: Today, the foreign exchange market has a daily trading volume exceeding $7.5 trillion. In the Global South, individuals often rely on the black market to exchange local fiat for dollars, primarily because the black market rates are more favorable than official channels. Binance P2P is beginning to be adopted, but its order book approach lacks flexibility. Many projects like ViFi are building on-chain automated market maker foreign exchange solutions.
• Humanitarian aid distribution: Ukrainian war refugees can receive humanitarian aid 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 medical workers used USDC to pay for medical supplies during the COVID-19 pandemic.

Conclusion: Interwoven

Interoperability

• Currency swaps:

Traditional foreign exchange systems are highly inefficient and face multiple challenges: counterparty settlement risk (CLS has improved but is cumbersome), costs of multi-bank systems (involving six banks when purchasing yen from an Australian bank to a London dollar office), global settlement time zone differences (Canadian and Japanese bank systems overlap for less than five hours daily), and limited access to foreign exchange markets (retail users pay fees 100 times that 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 trading costs to 0.15-0.25%—about 90% lower than traditional foreign exchange. Shifting from T+2 bank settlements to instant settlements allows arbitrageurs to adopt various strategies to correct mispricing.

Flexibility and accessibility: On-chain foreign exchange enables corporate treasurers and asset managers to access a wide range of products without needing multiple bank accounts for specific currencies. Retail users can obtain the best foreign exchange prices using crypto wallets with embedded DEX APIs.

Separation of currency and jurisdiction: Transactions no longer require domestic banks, detaching them from the underlying jurisdiction. This approach leverages the efficiency of digitalization 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 unified interfaces with on- and off-chain systems. Despite these barriers, on-chain foreign exchange still presents enticing opportunities. For example, Citibank is developing blockchain foreign exchange solutions under the guidance of the Monetary Authority of Singapore.

• Stablecoin swaps:

Imagine a world where most companies are issuing their own stablecoins. Stablecoin exchanges present a challenge: using PayPal's PYUSD to pay merchants at JPMorgan. While on- and off-chain solutions can address this issue, they lose the efficiency promised by cryptocurrencies. On-chain automated market makers (AMM) provide optimal real-time low-cost stablecoin-to-stablecoin trading. For instance, 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 becomes essential, and there must be sufficient liquidity depth and instant performance to support real-world activities.

• Cross-chain swaps:

Major blockchains have diverse advantages and disadvantages, leading to stablecoins being deployed across multiple chains. This multi-chain approach introduces cross-chain challenges, with bridging posing significant security risks. In my view, the best solution is for stablecoins to launch their own layer 0, such as USDC's CCTP, PYUSD's layer 0 integration, and the actions we witness with USDT recalling bridged locked tokens, potentially launching similar layer 0 solutions.

Meanwhile, several unresolved questions remain:

Will compliant stablecoins hinder "open finance," as compliant stablecoins could potentially monitor, freeze, and withdraw 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 massive funds?

Will the separation of currency and jurisdiction introduce more chaos or opportunity?

The financial revolution led by stablecoins is both exciting and unpredictable before us—this is a new chapter where freedom and regulation dance in a delicate balance.

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