Stablecoins are one of the most exciting innovations that the crypto ecosystem offers. By offering stability of value to its holders, stablecoins have achieved product-market fit in the volatile crypto ecosystem. It may be one of the first products that the DeFi ecosystem exports to traditional finance.

There has been so much research and discussion about stablecoins in the ecosystem, and there are several emerging projects that try to capture a market share. However, I don’t believe that there is a clear vision and consensus among the crypto enthusiasts and stablecoin maxis for the future of stablecoins. This comes from a lack of understanding regarding the value proposition that stablecoins should offer, thus shaping the future of this market.

In this article, I will share my thoughts regarding what kind of a value proposition stablecoins should offer, thus, also explaining my thoughts on how I envision the future of the stablecoin landscape.

However, to do so, we need to understand the essence of money. Then, I will introduce the concept of stablecoin functionality as a solution to the stablecoin value proposition question and will explain my reasoning.

Understanding Money

Money is a universally accepted medium of exchange that serves as a way for people to buy, sell, and trade goods and services. It holds value because society collectively agrees that it can be used to settle transactions.

There are several functions of money:

1. Money as a Medium of Exchange: Money is used to buy and sell goods and is also a value indicator for all kinds of goods and services

2. Money as a Store of Value: Money must be able to be reliably saved, stored, and retrieved. The value of the money must also remain stable over time and it should maintain its purchasing power against inflation.

3. Money as a Standard of Deferred Payment: Money needs to be accepted as a way to settle a debt.

4. Money as a Measure of Value: Money acts as a standard measure and a common denomination of trade to act as a basis for quoting and bargaining prices.

What is a stablecoin? What should be the value proposition of stablecoins?

I believe that the definition of stablecoin is crucial to understanding what kind of value proposition stablecoins should offer.

Thus, my stablecoin definition is very simple:

A stablecoin is the digital version of an off-chain asset to which it is pegged.

I believe that, for example, a USD-backed stablecoin’s value proposition should only be related to being the digital version of the cash USD, nothing more. Thus, the value proposition that a stablecoin offers needs to be in line with the value proposition of USD. Adding new utilities is a fruitless way while also disturbing the focus and benefits of the underlying stablecoin.

In line with this conclusion, I believe that building a stablecoin to offer collateralized debt positions, yield-bearing assets, internet bond, leveraged yield farming, etc. are limited solutions as they do not point out the main value proposition that a stablecoin should offer.

As you may realize, almost all of the crypto-backed stablecoins offer the aforementioned benefits to the users. However, considering that crypto-backed stablecoins only represent 4%-5% of the stablecoin market while fiat-backed stablecoins including $USDT and $USDC represent 95%, it is clear that crypto-backed stablecoins have not achieved product-market fit.

You may ask ‘’So, what is the point? We can just continue to use $USDT and $USDC, and the problem is solved.’’

You may be right, however, I believe that DeFi can’t rely on a stablecoin that can censor an address when a centralized party demands it to do so. This is completely against the ethos of DeFi.

Moreover, I also believe that there can be more scalable and product-market fit solutions to issue a decentralized stablecoin that can both work for DeFi and act as a digital representation of cash USD.

However, to develop such a product, we need to understand what the value proposition of stablecoins should be.

Value Proposition of Stablecoins

As stated, a stablecoin is a digital representation of money. Therefore, digital money should offer a similar value proposition to traditional money, tailored for use in the digital space. I call this ‘’stablecoin functionality’’.

Stablecoins should have 5 main functionalities:

1. Medium of Exchange

2. Store of Value/Peg Stability

3. Capital Efficiency

4. Fiat On-Ramp/Off-Ramp

5. Censorship Resistance

Analysis of the Stablecoin Functionality Framework

1. Medium of Exchange: The principal utility of a stablecoin is its facilitation of transactions. Without effectively serving as a medium of exchange, a stablecoin's scalability and success are inherently limited. Currently, only $USDT, $USDC, and to some extent, $DAI are widely used for purchasing other cryptocurrencies or making any transactions. Other stablecoins do not have the necessary liquidity, network effect, holders, or capital efficiency to provide a scalable solution to be a medium of exchange.

2. Store of Value/Peg Stability: Stablecoins are invaluable tools for storing assets in the highly volatile crypto environment. Consequently, maintaining their peg is crucial, and most stablecoins achieve varying degrees of success in this regard. Also, most of the new stablecoin projects that are categorized as yield-bearing stablecoins provide yield to their holders/stakers via LSTs or governance tokens. Thus, they’re protecting their users against inflation.

3. Capital Efficiency: Capital efficiency refers to the amount of capital a user needs to generate a given quantity of stablecoins. While fiat-backed stablecoins offer a 1:1 ratio with centralized solutions, crypto-backed stablecoins require over-collateralization (ranging from 110% to 600%) accompanied by liquidation risks, which affects scalability. This makes them less scalable compared to fiat-backed stablecoin, however, they are more decentralized and offer a permissionless solution to the stablecoin ecosystem.

4. Fiat On-Ramp/Off-Ramp: As stated, stablecoins are digital versions of an off-chain asset to which they are pegged. Thus, seamless conversion between bank holdings and stablecoins is essential for fostering adoption and user-friendliness. Without offering on-ramp/off-ramp solutions, decentralized stablecoins would not be able to survive in this competitive landscape.

5. Censorship Resistance: Censorship resistance aligns with the crypto ethos, recognizing the importance of shielding users from potential misuse by centralized actors. Considering that both $USDT and $USDC show flaws in this regard, censorship-resistant stablecoins can find a product-market fit in the ecosystem.

The Importance of Stablecoin Functionality

Most people may think that my argument is not something new and doesn’t add any insightful takes to existing conversations among the stablecoin community. However, there is a major problem that no one wants to discuss.

Crypto-backed stablecoins are broken. They do not add real and sustainable value to the ecosystem. Excluding fiat-backed stablecoins such as $USDT and $USDC, DeFi native stablecoins are only used for:

1. collateralized debt positions

2. yield-bearing

3. internet bond

4. leveraged yield farming

I don’t claim that these are unnecessary utilities, however, I suggest that this shouldn’t be the landscape that decentralized finance has. Ethereum launched 8 years ago, but still, we do not have a stablecoin that achieves stablecoin functionality. I am quite shocked that no stablecoin maxi or DeFi degen tries to solve this issue. It is a shame that DeFi depends on $USDT and $USDC.

This means that crypto-backed stablecoins are not used as a medium of exchange, the main value proposition of money. Thus, we can claim that they are not stablecoins but protocols that offer you financial leveraged primitives.

Considering that after years of innovation in the crypto-backed stablecoin landscape, excluding $DAI, there are around 20k people with around 2 billion TVL, no one can believe that without a unique improvement in the crypto-backed stablecoin models, the decentralized stablecoin ecosystem will thrive and has the potential to be adopted by millions.

It is clear that you won’t buy $SOL with $LUSD on a CEX, you will not use $DAI to interact on Avalanche and you will not use crvUSD to send the salaries of your team. Why? Because existing crypto-backed stablecoins are not digital representations of money. They don’t have such an aim and also, the current models lack the technological capacity to scale and issue stablecoin in a capital-efficient way.

The Future of Decentralized Stablecoins

As stated, we need builders to focus on building a stablecoin that offers 1:1 ratio collateral without any liquidation risks with deep liquidity so that this stablecoin can be used as a medium of exchange, thus, reducing DeFi’s dependency on $USDT and $USDC.

Unfortunately, most of the builders have accepted the dominance of fiat-backed stablecoins and not even try to challenge their dominance. However, they should be aware that without building the digital representation of money, you won’t have a product-market fit in the stablecoin landscape and your product won’t exist in the next 5 years.

To achieve this, we need to work on new methods of minting stablecoins as the current models lack to provide a capital efficiency way of doing this and also new tokenomics models that will help the protocol to boost liquidity.

We need to build the next generation of money in the digital, not a leveraged finance primitive. Here, I believe that delta-neutral stablecoin models can be very effective in solving the aforementioned issues, however, it is a topic for another day.

In my next articles, I will talk more about the stablecoin ecosystem, share my suggestions, and brainstorm new models of stablecoin minting and tokenomics models tailored for stablecoins.