Editor's Note: Stablecoins are driving a revolution in the financial system, particularly in improving payment efficiency, cross-border transactions, and the foreign exchange market. The traditional foreign exchange system faces high costs, low efficiency, and settlement risks, while blockchain-based foreign exchange provides low-cost, instant settlement and transparency, significantly improving the efficiency of capital circulation. The widespread adoption of stablecoins not only enhances the convenience of cross-border payments but also provides financial inclusion for underbanked markets.

The following is the original content (edited for easier reading):

Preface:

The younger generation is a digital native, and stablecoins are their natural currency. As artificial intelligence and the Internet of Things drive billions of automated micro-transactions, the global financial system needs more adaptable currency solutions. Stablecoins, as a "currency API", can be transmitted seamlessly like internet data, and reached a transaction volume of $4.5 trillion in 2024, a figure that is expected to grow as more institutions recognize stablecoins as an unparalleled business model - Tether generated $5.2 billion in profit through its reserve investments in the first half of 2024.

In the competition of stablecoins, distribution and true adoption, not complex cryptographic mechanisms, are the key. Their adoption is unfolding in three critical areas: the native crypto world, the fully banked world, and the unbanked world.

In the $2.9 trillion native crypto world, stablecoins serve as the gateway to DeFi, widely used for trading, lending, derivatives, yield farming, and RWA. Crypto-native stablecoins compete through liquidity incentives and DeFi integration. In the over $400 trillion fully banked world, stablecoins improve financial efficiency, primarily used for B2B, P2P, and B2C payments.

Stablecoins focus on regulation and permissioning, and are distributed through banks, card networks, payments, and merchants. In the unbanked world, stablecoins provide access to the US dollar, promoting financial inclusion. Stablecoins are used for savings, payments, foreign exchange, and yield generation, and entry strategies for grassroots markets are crucial.

Outline

Preface:

·Natives of the native crypto world

·The battle of stable pegging

Challenges of liquidity bootstrapping

DeFi gateway: trading pairs, lending, derivatives, yields, RWA

·Foreigners in the fully banked world

Dynamics of key players

Efficiency drivers: B2B, P2P, C2B payments

·Pioneers in the unbanked world

Shadow dollar economy

Dollar access: savings, payments, foreign exchange

·Conclusion: Intertwined

Interoperability: cross-currency, cross-token, and cross-chain

Bright spots and unsolved mysteries

Natives of the crypto world

In Q2 2024, stablecoins accounted for 8.2% of the entire crypto market capitalization. Maintaining peg stability remains a challenge, and unique incentive mechanisms are key to expanding on-chain distribution, with the current core issue being the limited on-chain use cases.

The Battle of Stable Pegging

·Fiat-backed stablecoins rely on banking relationships:

93.33% of stablecoins are fiat-backed stablecoins, which have higher stability and capital efficiency, with banks having the final say through controlling redemptions. Regulated issuers like Paxos, due to their ability to successfully redeem billions of dollars of BUSD, have become the dollar issuer for PayPal.

·CDP stablecoins improved collateral and liquidation mechanisms to enhance peg stability:

3.89% of stablecoins are CDP-based stablecoins. They use cryptocurrencies as collateral but face challenges in scalability and volatility. By 2024, CDPs have improved resilience by accepting a wider range of liquid and stable collateral. Aave's GHO accepts any asset in Aave v3, and Curve's crvUSD recently added USDM (RWA). Partial liquidation mechanisms have been improved, especially the soft liquidation of crvUSD, utilizing its custom AMM to provide a buffer for further bad debt. However, the ve-token incentive model faces difficulties as CRV valuation drops during large-scale liquidations, shrinking the market cap of crvUSD.

·Synthetic dollars maintain stability through hedging:

Ethena USDe captured a 1.67% stablecoin market share with a $3 billion market cap in a year. It is a delta-neutral synthetic dollar, taking short positions in the derivatives market to counteract volatility. Its financing rates are expected to perform well in the upcoming bull market and even after the "point season".

However, its heavy reliance on the long-term viability of CEXes remains questionable. As similar products proliferate, the impact of small capital on Ethereum may diminish. These synthetic dollars may face black swan events and struggle with low financing rates during bear markets.

·Algorithmic stablecoins declined to 0.56%

Challenges of Liquidity Bootstrapping

Crypto stablecoins attract liquidity through yields, and fundamentally, their liquidity costs include the risk-free rate and risk premium. To remain competitive, stablecoin yields must at least match T-bill rates - we've seen that as T-bill rates reach 5.5%, stablecoin borrowing costs have declined.

sFrax and DAI are leading in T-bill exposure, and by 2024, multiple RWA projects have improved 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 BlackRock's BUIDL.

Based on T-bill rates, stablecoins have adopted various strategies to increase the risk premium, including fixed-budget incentives (like DEX issuance, facing constraints and death spirals), user fees (correlated with lending and perpetual contract volumes), volatility arbitrage (declining when volatility weakens), and reserve utilization like staking or re-staking (less appealing).

In 2024, innovative liquidity strategies start to emerge:

Maximizing in-block yields:
Currently, many yields come from self-consuming DeFi inflation as incentives, but more innovative strategies are emerging. By leveraging reserves as a bank, projects like CAP aim to directly channel MEV and arbitrage profits to stablecoin holders, providing a sustainable and potentially more favorable yield source.

Compounding with T-bill yields:
Utilizing the new composability of RWA projects, plans like Usual Money (USD0) offer "theoretically" unlimited yields based on their governance tokens, with T-bill yields as the benchmark - it attracted $350 million in liquidity providers (LPs) and entered the Binance Launch Pool. Agora (AUSD) is another offshore stablecoin based on T-bill yields.

Balancing high-yield anti-volatility:
Newer stablecoins have adopted diversified basket strategies to avoid single-yield and volatility risks while providing a balanced high yield. For example, Fortunafi's Reservoir allocates across T-bills, Hilbert, Morpho, and PSM, dynamically adjusting the ratios and incorporating other high-yield assets as needed.

Is your TVL just a passing fad? The yields of stablecoins often face scalability issues. While fixed-budget yields can trigger an initial yield peak, as TVL grows, the returns will be diluted and the yield effect will diminish over time. If there is no sustainable yield or true utility in trading pairs and derivatives after the incentive period, its TVL may be difficult to maintain. The Dilemma of DeFi Gateways On-chain visibility allows us to examine the true nature of stablecoins: are stablecoins truly used as a medium of exchange, or are they just financial products for the sake of yield? Only the best-interest stablecoins are used as trading pairs on CEXs: Nearly 80% of trading still occurs on centralized exchanges, with top CEXs supporting their "preferred" stablecoins (e.g., Binance uses FDUSD, Coinbase uses USDC). Other CEXs rely on the spillover liquidity of USDT and USDC. Additionally, stablecoins are striving to become margin deposits for CEXs. Few stablecoins are used as trading pairs on DEXs: Currently, only USDT, USDC, and a small amount of DAI are used as trading pairs. Other stablecoins, such as Ethena's USDe, have 57% staked in their own protocols, entirely held as financial products to earn yield, far from becoming a medium of exchange. Makerdao + Curve + Morpho + Pendle, Allocation Portfolio: Platforms like Jupiter, GMX, and DYDX prefer USDC as deposits because USDT has a more questionable minting and redemption process. Lending platforms like Morpho and AAVE prefer USDC because it has better liquidity on Ethereum. On the other hand, PYUSD is primarily used for Solana's Kamino lending, especially when Solana Foundation provided incentives. Ethena's USDe is mainly used for yield activities on Pendle. RWAs are Underestimated: Most RWA platforms, such as BlackRock, use USDC as the minting asset for compliance reasons, and BlackRock is also a shareholder of Circle. DAI has found success in their RWA products. Expand the Pie or Seek New Domains: While stablecoins can attract major liquidity providers through incentives, they face a bottleneck - DeFi usage is already declining. Stablecoins now face a dilemma: they either wait for the expansion of crypto-native activities or seek entirely new use cases beyond crypto. Outsiders in a Fully Banked World Key Player Dynamics Global Regulation is Gradually Clarifying: 99% of stablecoins are US dollar-backed, and the federal government has ultimate influence over them. It is expected that under the Trump administration, the US regulatory framework will become more clear, and Trump's policies of lowering interest rates and banning CBDCs may benefit stablecoins. The US Treasury report points out the impact of stablecoins on the demand for short-term US debt, with Tether holding $90 billion in US debt. Preventing crypto crimes and maintaining the dominance of the US dollar are also motivations. By 2024, multiple countries have developed stablecoin-related regulations under common principles, including approving stablecoin issuance, liquidity and stability requirements, and restrictions on the use of foreign currency stablecoins, and often prohibiting interest-bearing. Key examples include the EU's MiCA, the UAE's PTSR, Hong Kong's sandbox, Singapore's MAS, and Japan's PSA. Notably, Bermuda became the first country to accept stablecoin tax payments and license interest-bearing stablecoin issuers. Licensed Issuers Gain Trust: Stablecoin issuance requires technical capabilities, cross-jurisdictional regulatory 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, such as USDC, safely generating yields by investing in BlackRock-managed funds. BUIDL now allows more on-chain projects to access yields. Banks are the Exit Gatekeepers: While onboarding (fiat to stablecoin) has become easier, offboarding (stablecoin to fiat) still poses challenges, as banks find it difficult to verify the source of funds. Banks tend to prefer licensed exchanges like Coinbase and Kraken, which perform KYC/KYB and have similar AML frameworks. While high-reputation banks like Standard Chartered have started accepting offboarding, smaller banks like DBS in Singapore are accelerating this process. B2B services like Bridge aggregate offboarding channels, managing billions in transactions for high-profile clients including SpaceX and the US government. Distributors Have the Final Say: As the compliance stablecoin leader, Circle relies on Coinbase and is now seeking global licenses and partnerships. However, this strategy may be challenged as more institutions issue their own stablecoins, as this business model is unparalleled - Tether, a company with 100 employees, generated $520 million in profits from investing its reserves in the first half of 2024. Banks, such as JPMorgan, have already launched JPM Coin for institutional transactions. Payment apps like Stripe acquired Bridge, indicating their 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 testing the market by accepting stablecoins. Efficiency Enablers With trusted issuers, healthy banking relationships, and distributors as a foundation, stablecoins can improve efficiency in large-scale financial systems, especially in the payments domain. Traditional systems face efficiency and cost constraints. Intra-application or bank transfers provide instant settlement, but only within their own ecosystems. Cross-bank payments cost around 2.6% (70% to the issuing bank, 20% to the acquiring bank, 10% to the card network), with settlement taking more than a day. Cross-border transactions are even more expensive, around 6.25%, with settlement times up to five days. Stablecoin payments provide peer-to-peer instant settlement by eliminating intermediaries. This accelerates fund circulation, reduces capital costs, and provides programmable features like conditional auto-payments. · B2B (annual transaction volume of $120-150 trillion): Banks are in the best position to drive stablecoin adoption. In October 2023, JPM Coin developed by JPMorgan Chase was used for around $1 billion in daily transactions on its Quorum chain. · P2P (annual transaction volume of $1.8-2 trillion): E-wallets and mobile payment apps are in the best position, with PayPal launching PYUSD, currently with a market cap of $604 million on Ethereum and Solana. PayPal allows end-users to register and send PYUSD for free. · B2C E-commerce (annual transaction volume of $5.5-6 trillion): Stablecoins need to integrate with POS systems, bank APIs, and card networks. Visa became the first payment network to settle transactions using USDC in 2021. Pioneers in the "Underbanked" World, the Shadow Dollar Economy Due to severe currency devaluation and economic instability, emerging markets have an urgent need for stablecoins. In Turkey, stablecoin purchase volumes account for 3.7% of its GDP. People and businesses are willing to pay a premium above the fiat US dollar for stablecoins, with a stablecoin premium of 30.5% in Argentina and 22.1% in Nigeria. Stablecoins provide access to the US dollar and financial inclusion.

Tether dominates this field with a reliable 10-year track record. Even in the face of complex banking relationships and redemption crises - Tether once admitted in April 2019 that USDT was only 70% reserve-backed - its stability has remained intact.

This is because Tether has built a powerful shadow US dollar economy: in emerging markets, few people convert USDT back to fiat, they view it as the US dollar, a phenomenon particularly pronounced in Africa and Latin America, used to pay employees, bills, etc. Tether has achieved this without providing incentives, through long-term presence and consistent utility, enhancing its credibility and acceptance. This should be the ultimate goal for every stablecoin.

US Dollar Access

·Remittances: Unequal remittances slow economic growth. Individuals in sub-Saharan Africa are charged an average of 8.5% in remittance fees when sending money to low and middle-income countries and developed countries. For businesses, high remittance costs, long processing times, bureaucratic practices, and exchange rate risks directly impact the growth and competitiveness of businesses in the region.

·US Dollar Access: Currency volatility has cost 17 developing countries $1.2 trillion in GDP losses, or 9.4% of their total GDP, between 1992 and 2022. Access to the US dollar is crucial for local financial development. Many crypto projects focus on onboarding via "DePIN" methods, which leverage local agents to facilitate cash-to-stablecoin transactions in Africa, Latin America, and Pakistan.

·Foreign Exchange: Today, the daily trading volume in the foreign exchange market exceeds $7.5 trillion. In the Global South, individuals often exchange their local fiat currencies for US dollars on the black market, as the black market exchange rate is more favorable than official channels. Binance's P2P trading is starting to be adopted, but its order book-based approach lacks flexibility. Many projects, such as ViFi, are building on-chain automated market maker foreign exchange solutions.

·Humanitarian Aid Disbursement: Ukrainian war refugees can receive humanitarian aid in the form of USDC, which can be stored in digital wallets or cashed out locally. In Venezuela, frontline healthcare workers used USDC to pay for medical supplies during the pandemic, despite the worsening political and economic crisis.

Conclusion: Interoperability

Interoperability: As stablecoins see widespread adoption and different ecosystems converge, interoperability becomes a core challenge and opportunity in the future development of stablecoins. Enhancing cross-currency, cross-chain, and cross-monetary liquidity will be key to driving progress in this field.

The traditional foreign exchange system is inefficient and faces multiple challenges:

·Counterparty settlement risk (CLS has improved but is still cumbersome)

·Costs of multi-bank systems (e.g., 6 banks involved in JPY purchases in Australia, cleared through the London USD office)

·Global settlement time zone differences (e.g., CAD and JPY banking systems overlap less than 5 hours per day)

·Limited access to the FX market (retail users pay 100x the fees of large institutions)

Blockchain-based foreign exchange (Onchain FX) offers significant advantages:

·Cost, Efficiency, and Transparency: Oracle providers like Redstone and Chainlink offer real-time price quotes. Decentralized exchanges provide efficient cost control and transparency, with Uniswap's Concentrated Liquidity Market Maker (CLMM) reducing trading costs to 0.15-0.25%, about 90% lower than traditional FX. Shifting from T+2 bank settlement to instant settlement allows arbitrageurs to employ various strategies to correct pricing imbalances.

·Flexibility and Accessibility: Blockchain-based foreign exchange allows corporate treasurers and asset managers to access a variety of products without the need for multiple currency-specific bank accounts. Retail users can access the best FX rates using crypto wallets with embedded DEX APIs.

·Separation of Currency and Jurisdiction: Transactions no longer require domestic banks, allowing for the separation of currency and jurisdiction. This method leverages the efficiency of digitization while maintaining monetary sovereignty, but still has pros and cons.

However, challenges remain, including the scarcity of non-USD denominated digital assets, the security of oracles, support for long-tail currencies, regulatory issues, and unified on-chain/off-chain interfaces. Nevertheless, blockchain-based foreign exchange still offers tremendous opportunities. For example, Citi is developing a blockchain-based FX solution under the guidance of the Monetary Authority of Singapore.

Stablecoin Exchanges

Envisioning a world where most companies issue their own stablecoins, stablecoin exchanges pose a challenge: how to use PayPal's PYUSD to pay a JP Morgan merchant. While on-/off-ramp bridges can solve this problem, they lose the efficiency promised by cryptocurrencies. Blockchain-based automated market makers provide the optimal real-time, low-cost stablecoin-to-stablecoin trading.

For example, Uniswap offers some such liquidity pools with fees as low as 0.01%. However, once billions of dollars flow into blockchains, they must rely on the security of smart contracts and have sufficient depth and instant performance to support real-world activities.

Cross-Chain Exchanges

Major blockchains have their own pros and cons, leading to the need for stablecoins to be deployed across multiple chains. The multi-chain approach brings the challenge of cross-chain interoperability, with bridge technologies posing significant security risks. My view is that stablecoins should launch their own Layer 0 (base layer) protocols, such as CCTP for USDC, Layer 0 integration for PYUSD, and a similar Layer 0 solution for USDT's redemption bridge tokens.

Meanwhile, there are still some open questions:

·Will regulation undermine "open finance" given that compliant stablecoins may monitor, freeze, and seize funds?

·Can compliant stablecoins still avoid providing yield that may be viewed as securities, preventing on-chain decentralized finance from benefiting from their massive scaling?

·Can any open blockchain handle massive amounts of capital given Ethereum's slow transactions, its L2 dependence on a single sequencer, Solana's imperfect launch record, and the lack of long-term stability in other hyped blockchains?

·Will the separation of currency and jurisdiction lead to more chaos or opportunities?

The prospects of the financial revolution led by stablecoins are both exciting and uncertain - a new chapter where regulation and freedom dance in a delicate balance.

Original Link

Join BlockBeats' official community:

Telegram Subscription Group: https://t.me/theblockbeats

Telegram Discussion Group: https://t.me/BlockBeats_App

Twitter Official Account: https://twitter.com/BlockBeatsAsia