🪙 THE RISE OF STABLECOINS: TRANSFORMING GLOBAL FINANCE

By Axel Guyon ― at Reference Capital

Stablecoins have emerged as a pivotal force in the landscape of crypto, offering a bridge between the volatility of digital assets and the stability of traditional fiat currencies. While cryptocurrencies such as Bitcoin and Ether offer several benefits, including the ability to send payments anywhere and to anyone without requiring trust in an intermediary institution, they also have a significant drawback: their prices are unpredictable and can fluctuate wildly. This makes them hard for everyday people to use. Generally, people expect to be able to know how much their money will be worth a week from now, both for their security and their livelihood.

At their core, stablecoins represent a digital form of currency whose value is pegged to another asset, often being fiat currencies like the US dollar. 
 
 The rise of stablecoins is clearly illustrated by their annual transaction volumes, which have surged significantly in recent years. Since 2016, stablecoins have experienced exponential growth, surpassed traditional remittance systems, and rivalled well-established payment networks like Visa and PayPal in transaction volume.

Source: Allium

🔎 Types of Stablecoins

• Fiat-collateralized: Backed by fiat currency reserves, such as US Dollars or Euros. For every unit of stablecoin issued, an equivalent amount of fiat currency is held in a bank account or custodian.
• Crypto-collateralized: Backed by other cryptocurrencies.
• Algorithmic: Stabilized by algorithms and smart contracts without direct collateral.
• Hybrid: Combining elements of collateralization for reserves while also using algorithms to stabilize the coin’s value.
• Commodity-collateralized: Backed by physical assets, such as precious metals, real estate, or commodities.

🏛️ History of Stablecoins

Early Concepts and Precursors

• E-gold (1996): One of the earliest attempts to create a digital currency backed by a stable asset was E-gold. Founded by Douglas Jackson and Barry Downey, E-gold was a digital currency backed by physical gold. Although it wasn’t a blockchain-based stablecoin, it set the precedent for asset-backed digital currencies ​(Coincub)​.

The Birth of Blockchain-based Stablecoins

• BitUSD (2014): The concept of stablecoins truly began to take shape with the introduction of BitUSD on the BitShares blockchain. Created by Dan Larimer, BitUSD was pegged to the US dollar and backed by BitShares (BTS) as collateral. This was one of the first attempts to create a stablecoin using blockchain technology and smart contracts​ (CryptoGlobe)​.
• Tether (2014): Tether (USDT) is often credited with popularizing the concept of stablecoins. Launched by Brock Pierce, Reeve Collins, and Craig Sellars, Tether was initially built on the Bitcoin blockchain via the Omni Layer protocol. It is pegged to the US dollar on a 1:1 basis and claims to be backed by fiat reserves. Tether quickly gained traction as a reliable medium for trading and transferring value within the cryptocurrency ecosystem.

Growth and Evolution

• DAI (2017): Introduced by MakerDAO, DAI is a decentralized stablecoin pegged to the US dollar but backed by a variety of cryptocurrencies rather than fiat money. DAI is created through a system of smart contracts on the Ethereum blockchain, which manage the collateral and ensure the stability of the peg. This model showcased a novel approach to stablecoins, emphasizing decentralization and transparency.
• USD Coin (USDC, 2018): Launched by Circle and Coinbase, USDC is a fiat-collateralized stablecoin built on the Ethereum blockchain. USDC is fully backed by US dollars held in reserve and regularly audited to ensure transparency. It has become one of the most widely used stablecoins, especially in the DeFi ecosystem.

📊 Stablecoin Use Cases and Developments

One of the key use cases for stablecoins is to facilitate easier and faster transactions compared to traditional banking systems. They can be used for cross-border payments, remittances, and peer-to-peer transfers with lower fees and quicker settlement times. However, this also has the impact of compressing banking margins, reduce bank deposits, and consequently limit banks’ lending capacity, potentially leading to tighter credit conditions, and affecting economic growth, but also disrupt the more traditional financial institutions (e.g., remittances).
 
 We are seeing some of the world’s largest banks pre-actively adopt these strategies to stay ahead of the adoption curve. For example, several U.S. banks have formed consortia to support bank-minted stablecoins. The USDF Consortium includes FDIC-insured banks such as New York Community Bank, NBH Bank, and First Bank, aiming to create a network for issuing and redeeming stablecoins on a one-to-one basis for cash. This consortium seeks to leverage the security and reliability of traditional banking while integrating the benefits of blockchain technology​ (ABA Banking Journal)​.
 
 Several other recent developments highlight the growing adoption of stablecoins among banks, reflecting a significant trend in the financial industry:

1. Deutsche Bank is developing a euro-backed stablecoin in collaboration with Galaxy Digital and Flow Traders. This stablecoin aims to support various applications, including IoT-powered services, supply-chain transactions, and consumer payments. The project will be regulated by Germany’s financial authority, Bafin, and is expected to launch within the next 18 months​ (American Banker)​.
2. PayPal launched its own stablecoin, PayPal USD (PYUSD), backed by U.S. dollars and short-term U.S. Treasuries. This initiative allows PayPal to leverage its extensive user base and existing crypto activities, potentially differentiating it in the stablecoin market​ (American Banker)​.
3. Ripple is working on stablecoin projects in various countries, including a government-affiliated stablecoin in Palau called PSC, backed by U.S. dollars. This project aims to facilitate local merchant payments and could serve as a model for other emerging economies seeking stability amidst economic turbulence​ (American Banker)​.

These examples underscore the growing integration of stablecoins into mainstream banking, driven by their potential to enhance financial transactions and stability in the digital currency ecosystem​​.
 
 Other reasons for the adoption:

1. The rise of decentralized finance (DeFi) and decentralized applications (DApps) has led to the use of stablecoins as collateral, for lending, borrowing, and earning interest.
2. Institutional investors for their operations and investment portfolios, driven by the need for a reliable digital asset that can seamlessly integrate with existing financial systems while leveraging the benefits of blockchain technology.
3. Cryptocurrency trading for managing risk and executing arbitrage strategies. Traders use stablecoins to quickly move in and out of volatile crypto assets without having to convert to fiat currency, which can be slower and more costly.
4. Innovations in payment solutions, including merchant acceptance and integration with various payment platforms, have made stablecoins more user-friendly and accessible.
5. Global economic uncertainty and inflation concerns have also driven the adoption of stablecoins in emerging geographies.

🚧 Positive Strides Amid Roadblocks

While there are many promising applications, the evolution of stablecoins has been marked by significant challenges and adaptations. In May 2022, the collapse of Terra’s UST highlighted the vulnerabilities in algorithmic stablecoin designs, leading to a catastrophic $40 billion wipeout. This event underscored the importance of robust design and risk management in the stablecoin space. 
 
 The fallout from the FTX scandal further emphasized the need for transparency, with the industry increasingly calling for proof of reserves to ensure stability and trust. The recent bear market added to the pressure, exemplified by the bankruptcy of Silicon Valley Bank (SVB), which temporarily caused Circle’s USDC to depeg, shaking confidence in even the most established stablecoins. 
 
 These incidents have naturally led major stablecoin issuers to adopt more conservative strategies, significantly reducing their reliance on cash and bank deposits to mitigate risk. This shift reflects a broader trend towards greater risk aversion and the adoption of more resilient financial practices. As such, stablecoin issuers have enhanced their transparency measures: Tether now publishes a quarterly audited statement of their holdings, Circle offers a public proof of reserves, and BUSD provides monthly reserve statements attested by Paxos. 
 
 Despite these challenges, today, these collapses seem distant, and the success of stablecoins is undeniable. Nic Carter, a partner at Castle Island VC, highlights that on-chain activity is now predominantly driven by stablecoins. Over time, stablecoins have become increasingly prominent, capturing a larger share of on-chain transaction value. While Bitcoin (BTC) and Ethereum (ETH) remain significant players, the rising dominance of stablecoins, as shown in the graph below, underscores their essential role in providing liquidity and stability in digital transactions.

Source: Nic Carter

📈 Long Term Positive Economic Implications For The US

As discussed by Nic Carter, USD stablecoins have several significant implications for the U.S. economy. Their widespread use enhances access to U.S. securities in a cost-effective manner, driving higher demand for USD-backed products. This demand acts similarly to modern Eurodollars, allowing issuers to operate outside direct U.S. regulatory oversight while promoting USD-denominated products globally. Increased demand for USD can help reduce the U.S. debt deficit by attracting more investments into U.S. securities. Moreover, this can also insulate the U.S. economy from macroeconomic shocks, reinforcing the U.S.’s global monetary influence. As of today, the total market cap of all stable coins (~150B) would rank them as the 16th largest US debtholder.

Source: Visa, Allium

That said, while it may help increase the demand for USD, the adoption of stablecoins can pose significant challenges to economic sovereignty. The phenomenon of “dollarization” may cause local monetary authorities to lose control over their monetary policies. This shift can undermine local currencies and complicate efforts to regulate financial flows, potentially leading to economic instability.

➡️ Reference Viewpoint
 
 While political stances on stablecoins diverge in the U.S., it is evident that onshoring stablecoin issuers would provide the U.S. with greater control over these digital assets. This increased control can help ensure that stablecoins are backed by reliable reserves and managed with transparency and integrity, thereby enhancing consumer protection and financial stability. Domestic operations subject to local regulatory scrutiny and reporting requirements can build trust among users and investors, promoting the integration of stablecoins into the broader financial system.

In the meantime, the European Union recently adopted MiCA — a regulatory framework for crypto assets and companies — and we expect to see the first iteratives derive from it. The case for a strong, regulated euro-stablecoin under MiCA is compelling as it could unlock new markets in real-world assets (e.g., EU bonds, real estate). This would remove the natural foreign exchange (FX) friction and provide native liquidity within the Eurozone.
 
 Overall, we are excited about the potential of stablecoins to revolutionize global financial systems. We think that stablecoins could become the new “Banks 2.0”, optimized for margins thanks to their on-chain nature. And while some banks might launch their own blockchains for transaction settlements, their permissioned nature — controlled by the managing bank — makes global integration unlikely. In contrast, stablecoins can be integrated across any transaction designs and accepted globally by any stakeholder, making them more attractive for mainstream adoption. Nonetheless, regulatory barriers currently protect banks from the unfair advantages stablecoins have. Despite this, we expect legacy systems to struggle to keep pace with the innovation driven by ultra-optimized systems build on modern public networks.

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