According to the American Institute of Economic Research, monetary premium correlates to the market's interest in assets capable of fulfilling the functions of money while maintaining value over time. In any society, the primary role of money is to serve as a medium of exchange. However, for a currency to gain widespread acceptance, it must either maintain value or appreciate over time. This ensures that holding the currency does not result in a loss of value. This principle explains why assets like gold remain relevant while currencies in hyperinflationary economies lose significance.

The concept of economic premium has played a significant role in perpetuating the value of assets such as gold or real estate, that people buy to have a reserve of value while processing some degree of liquidity. In this article, we intend to show that stablecoin projects that excel in their intended application have only done so due to attaining a high monetary premium. Beyond this, we’ll explore the role monetary premium has in creating network effects, and how the stablecoin model will drive blockchain growth, making protocols to seek this path. But first, we should take a look at the stablecoin issuance trilemma.

Issuance Trilemma: Centralization vs. Collateralizations vs. Price Stability

At first glance, these dimensions might seem uncorrelated, but not entirely. So far no stablecoin has been able to maintain high degrees of decentralization, capital efficiency, and price stability at the same time:

• Decentralization: It refers to the degree of centralization of the issuer. USDT and USDC are highly centralized stablecoins, since their issuers, respectively Tether and Circle, are monolithic entities that have custody over the assets backing the token. On the other hand, DAI is a decentralized stablecoin, since MakerDAO, the token issuer, is a decentralized protocol with a diverse range of validators.

• Capital Efficiency: This dimension is hardwired with the stablecoin collateralization. When backed by fiat or fiat-like assets, due to the inherent parity, the issuing entity only needs a 1:1 proportion between token collateral. However, with volatile assets, an over-collateralization is needed, usually with a proportion of at least 1:1.5 between token and collateral. There are undercollateralized stablecoins but we’ll not cover them due to their recurrent failure. One clear problem related to overcollateralized stablecoins is that the output value is inferior to the input, presenting reduced economic premium since capital is locked, creating problems with opportunity cost. There is of course the use of such stables as a leverage mechanism, but thinking from a layperson's stand, there is not much demand.

• Price Stability: It refers to how stable the price is, whatever the market conditions might be. By definition, monetary premium is given to assets that can somewhat hold their value over time. Instability equals less interest from a monetary point of view.

The trilemma implies that it’s only possible to achieve high degrees in two of the dimensions. For example, the best price stability and capital efficiency are present in fiat-backed stablecoins, which require a high degree of centralization, since a regulated company taking responsibility for the management/allocation of the assets becomes necessary. With higher stability and decentralization, capital efficiency is lost, as in the previously mentioned example of DAI. And, to achieve a higher degree of capital efficiency and decentralization, price stability is lost, as could be observed with the Terra-Luna crash.

In short, so far, the stablecoin projects that so far have attained more capital efficiency are the somewhat centralized ones. However, there are still other dimensions of stablecoin projects that need to be taken into account, and they are deeply entangled with utility.

The three functionality dimensions: Medium of Exchange vs. Store of Value vs Unit of Account

Stablecoins also have three different dimensions regarding functionality, they represent the end goal of a stablecoin project, thus heavily influencing its design and utility. These dimensions don’t interact with each other as in a trilemma but tradeoffs/concessions are unavoidable while optimizing one or more dimensions.

• Medium of Exchange: Refers to the stablecoin capability of enabling trade. So it needs to possess high acceptance, accessibility, liquidity and low transaction costs.

• Store of Value: Refers to the maintenance of purchasing power, or even better appreciation over time. That can be achieved through different mechanisms such as scarcity, increase in demand, or inherent yield.

• Unit of Account: This dimension refers to the ability of a currency to measure the value of a product in the market.

Here are some examples of how these dimensions can interact with each other:

• To enhance a stablecoin's effectiveness as a medium of exchange, it requires low transaction costs and broad accessibility across various networks. However, if a project aims to issue the stablecoin extensively across different networks while maintaining abundant supply, it may encounter inflationary pressures. This can undermine its price stability and, consequently, its utility as a unit of account.

• Optimizing the store of value aspect involves balancing scarcity, which affects its function as a medium of exchange. And providing asset appreciation or yield generation, impacts its role as a unit of account.

So it becomes obvious that in order to optimize one aspect of utility, others end up hindered. Beyond this, decisions regarding issuance are critical in obtaining the desired results and in constructing real monetary premium for the applications. For instance, fiat-backed stablecoins are the most prominent product in the Blockchain space, according to DefiLlama, stablecoins have a collective market capitalization of $156 billion, with fiat-backed stablecoins accounting for nearly 93% of this total. They facilitate substantial transaction volumes and are prevalent across various blockchains.

Fiat-backed stablecoins offer clear utility as a medium of exchange and are characterized by two key components: price stability and capital efficiency (whereby users avoid losing purchasing power when minting currency). However, achieving these attributes often requires sacrificing decentralization, necessitating a trade-off.

The success of fiat-backed stablecoins as a means of exchange

Stablecoins have undergone rapid evolution as a medium of exchange, surpassing traditional payment giants like Paypal and Mastercard in transactional volume. According to the Brevan Howard Digital Report, which analyzed stablecoin movements on blockchain networks (excluding Centralized Exchanges), the total transacted volume in 2022 exceeded $11 trillion. By comparison, Paypal, Mastercard, and Visa transacted $1.4 trillion, $6.57 trillion, and $11.6 trillion respectively. It's noteworthy that both Paypal and Visa are embracing this technology, with projects like PYUSD and VisaNet Stablecoin Settlement.

There are several reasons for this movement:

• They are a convenient way to make 24/7 near real-time transactions and remittances (e.g. PYUSD).

• They are a convenient way for companies to make custody of fiat-like assets without the necessity of banking licenses.

• Inner/inter-protocol settlements are more convenient when made using stablecoins.

So they become a convenient substitute for fiat in many different applications. Thus obtaining high monetary premium.

Stablecoins as a store of value

Stablecoins have emerged as significant stores of value, particularly in regions struggling with high inflationary pressures like Argentina, despite being the third-largest economy in Latin America (we discussed this subject more in this article).

However, in areas with greater political and financial stability, simply holding fiat-backed stablecoins may not be appealing enough, as it mirrors holding local fiat currency. Moreover, the purchasing power of the dollar has steadily declined since the end of the gold standard when compared to other assets.

To address this issue, yield-bearing stablecoins were created. Issuers like Ondo Finance and Mountain Protocol provide stablecoins that inherently generate yield, effectively integrating money with yield. These stablecoins are primarily collateralized by US Treasury bills, allowing them to share yields with users, offering Annual Percentage Yields (APYs) of around 5%. These projects share the common trait of providing capital efficiency, maintaining a peg to the dollar while generating yield.

Yet again, there are important centralizing forces here, in order to maintain the pegg of the underlying token, a high capital efficiency and price stability approach has been used. These projects are yet small, but given the potential for high monetary premium, we believe that this kind of approach will succeed. So, it is not a surprise that despite the regulatory uncertainty, this market is presenting breathtaking growth. The two market leaders, Ondo Finance and Mountain Protocol combined achieved 530% YoY growth, reaching US$ 256 million in marketcap. With the evolution of regulation and tokenization infrastructure, these assets will become more relevant.

There are also other projects, that mainly use liquid staking tokens as collateral to issue yield-bearing stablecoins. However, this model lacks capital efficiency, since it has as a premise overcollateralization. For this reason, we don’t believe that it will become in the short or medium term as relevant as RWA-backed tokens. But still represents an evolution of the model, especially given its full decentralized nature.

Stablecoins as a unit of account

The Mesopotamian Shekel stands as one of the earliest examples of currency functioning as a unit of account, representing a specific quantity of goods (around 11g of “good looking grains”) alongside its role as a form of currency. This historical precedent provides a fitting analogy for stablecoins designed to serve as units of account.

In practical terms, in the same way the Shekel worked, these stablecoins operate much like futures contracts, guaranteeing ownership of an asset or commodity at a predetermined price, one Shekel buys 11g of grains. For instance, they could be utilized to represent tokens for various commodities such as solar energy credits or agricultural produce.

These stablecoins could serve as financing instruments for companies engaged in producing these commodities, providing collateral equivalent to the physical goods. With widespread adoption, they have the potential to become a staple in various industries.

Final thoughts

Given the market observations, it’s not a stretch to think that some stablecoin models are the most successful in the DeFi space in attaining monetary premium. The protocols that are succeeding or will succeed (achieve mass adoption) need to attain it and consider it by design.

This effect has the potential to spread throughout the whole ecosystem. Monetary premium serves as a key driver of network effects within blockchain ecosystems. Blockchain networks require both social and financial capital to thrive. When balanced effectively, financial capital can attract social capital, leading to a self-reinforcing cycle. In this context, monetary premium works as the intermediary particle between these two forces, making in the long term, many protocols to adapt to a stablecoin-like model or integrate stablecoins as a central component.

For example, within the Ethereum network, several prominent protocols function as stablecoin issuers, including Lido, AAVE, and Aigenlayer. Lido's stETH, for instance, acts as an Ethereum-backed stablecoin with capital efficiency and a degree of price stability. As blockchain technology becomes increasingly relevant in everyday life, assets like Ether, used for transactions within the Ethereum ecosystem, may gain significant monetary premium. In this context, we anticipate that over time, many protocols will either adopt a stablecoin model or become closely intertwined with stablecoins, guided by the principle of monetary premium.

While centralized stablecoins have thus far achieved this premium, it does not imply that crypto-backed stablecoins are destined to fail. On the contrary, they will continue to serve as vital tools within the DeFi space and may experience a surge in relevance as cryptocurrencies become more integrated into daily life. However, centralized stablecoins or stablecoins capable of generating monetary premium may still dominate the market.

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