By Rui Shang, investor of SevenX Ventures.

Starter: Distribution

Younger generations are digital natives, with stablecoins as their natural money. As AI and IoT drive billions of automated micro-transactions, global finance requires adaptable money solutions. Stablecoins act as a "Currency API," transferring as seamlessly as internet data, and have reached $4.5 trillion transaction volume in 2024, this figure is set to grow as more institutions realize stablecoins are an unparalleled business model—Tether profit $5.2 billion from investing its reserve in the H1 2024.

In the stablecoins race, distribution and genuine adoption matter, not the complex crypto mechanics. Their adoption unfolds across three key arenas: the Native Crypto, Fully-Banked, and Under-Banked worlds.

• In the $2.9 trillion Native Crypto world, stablecoins function as DeFi gateways, crucial for trading, lending, derivatives, yield farming and RWA. Crypto-native stablecoins compete through liquidity incentives and DeFi integration.

• In the $400+ trillion Fully-Banked world, stablecoins enhance financial efficiency, primarily for B2B, P2P, and B2C payments. Stablecoins focuses on regulation, licensing and leveraging banks, card networks, payments, merchants to distribute.

• In the Under-Banked world, stablecoins provide the dollar access, boosting financial inclusion. Stablecoins are used for savings, payments, foreign exchange, and yield generation. Grassroots go-to-market matters.

Content Outline

• Starter: Distribution

• Natives in the Native Crypto World

  • Constant Pegging Battle

  • Liquidity Bootstrapping Challenge

  • DeFi Gateway: Trading Pairs, Lending, Derivatives, Yield, RWA

• Aliens in the Fully-Banked World

  • Key Players on the Move

  • Efficiency Enabler: B2B, P2P, C2B Payments

• Mavericks in the Under-Banked World

  • Shadow Dollar Economy

  • Dollar Access: Saving, Payouts, Foreign Exchange

• Ending: Intertwined

  • Interoperability: Cross-currency, cross-coin and cross-chain

  • Opportunity Highlight

  • Open Questions

TL;DR

Natives in the Crypto World

In Q2 2024, stablecoins comprised 8.2% of the total crypto market cap. Maintaining peg stability remains challenging, and unique incentives are key to expanding on-chain distribution, the critical issue is the limited on-chain utility.

Constant Pegging Battle

• Fiat-backed stablecoins work on banking relationships:
  93.33% are fiat-backed stablecoins. they have greater stability and capital efficiency, with banks having the ultimate say by controlling redemption. Regulated issuers like Paxos became PayPal's USD issuer due to its reliability in successfully redeeming billions in BUSD.

• CDP stablecoins improve collateral and liquidation for better peg:
  3.89% are Collateralized debt positions (CDPs) stablecoins. They use crypto as collateral, but they face issues with scaling and volatility. In 2024, CDPs have improved resilience by accepting a wider range of liquid and stable collateral, Aave’s GHO accepts any assets in Aave v3, and Curve’s crvUSD recently added USDM(RWA). Partial liquidation is improving, especially crvUSD's soft liquidation, creating a buffer against further bad debt via their customized AMM. However, the ve-token incentive model falls, as witnessing the crvUSD market cap shrink when CRV's valuation drops after large liquidations.

• Synthetic dollar uses hedging to maintain stability:
  Ethena USDe single-handedly made up 1.67% stablecoin market cap at $3B in one year. It's a delta-neutral synthetic dollar that opens short positions in derivatives to counteract volatility. The funding rate is expected to perform well during the upcoming bull market, even post-point seasons. However, its long-term viability that relies heavily on CEXs, is questionable. As similar products proliferate, the impact of small funds on Ethereum will likely diminish. These synthetic dollars are potentially vulnerable to black swan events and persistently low funding rates during bear markets.

• Algorithm stablecoins diminished to 0.56%

Liquidity Bootstrapping Challenge

Crypto stablecoins leverage yield to attract liquidity. Fundamentally, their liquidity cost comprises the risk-free interest rate plus a risk premium. To remain competitive, stablecoin yields must at least match T-bill rates—we've seen stablecoin borrowing costs decline as T-bill rates reached 5.5%. sFrax and DAI led the way in T-bill exposure. In 2024, several Real World Asset (RWA) projects boosted on-chain T-bill composability: CrvUSD added USDM from Mountain as collateral, while Ondo's USDY and Ethena's USDtb are backed by BlackRock's BUIDL.

Based on T-bill rates, stablecoins employ various strategies to add risk premiums, including fixed-budget incentives like DEX emissions(constraint and death spiral); user fees (tied to lending and perp volume); arbitrage from volatility(Fall when volatility wanes); reserve utilization like staking or restaking (not appealing).

Innovative liquidity strategies are emerging in 2024:

• Maximize in-block yield: While lots of yields currently stem from self-consuming DeFi inflation as an incentive, more innovative strategies are emerging. By leveraging reserves as a bank, projects like CAP aim to funnel MEV and arbitrage profits directly to stablecoin holders, offering a sustainable and potentially more lucrative yield source.

• Compound with T-bill yield:
  Leveraging RWA projects' newfound composability, initiatives like Usual Money (USD0) offer “theoretically” unlimited yield through their governance token, with T-bill yields serving as a baseline- attracted $350M from LPs and got on Binance launchpool. Agora(AUSD) is also a t-bill yield-bearing off-shore stablecoin.

• Balanced high yield resists volatility:
  Newer stablecoins employ a diversified basket approach, avoiding singular yield and volatility risk and providing a balanced high yield. Fortunafi's Reservoir, for instance, allocated T-bills, Hilbert, Morpho, PSM and adapts the portion dynamically and incorporates other high-yield assets as needed.

• Is your TVL a flash in the pan?
  Stablecoin yield often struggles with scalability. While fixed-budget yield can trigger initial spikes, growing TVL dilutes returns, diminishing yield effectiveness over time. Without sustainable yields or genuine utility in trading pairs and derivatives post-incentive, their TVL is unlikely to be stuck around.

DeFi Gateway Dilemma

Onchain visibility allows us to examine the true nature of stablecoins: Are stablecoins genuine representations of money being used as mediums of exchange or merely financial products for yield?

• Only best-interest stablecoins are used as trading paris on CEXs:
  Nearly 80% of trades still occur on centralized exchanges, with top CEXs supporting their ‘preferred’ stablecoins (e.g., FDUSD for Binance, USDC for Coinbase). Other CEXs rely on USDT and USDC's overspilled liquidity. Moreover, stablecoins are trying hard to be the CEX’s margin deposits.

• Few stablecoins are used as trading pairs on DEXs:
  Only USDT, USDC, and a small amount of DAI are being used as trading pairs today. Other stablecoin, such as Ethena with 57% of USDe staked into its own protocol, are purely financial products held to earn yield, far from a medium of exchange.

• Makerdao + Curve + Morpho + Pendle, a set distribution combo:
  Markets like Jupiter, GMX, and DYDX prefer USDC as deposits since USDT has a more skeptical mint-redemption process. Lending platforms like Morpho, and AAVE prefer USDC since it has better liquidity on Ethereum. On the other hand, PYUSD is mainly used for lending on Solana’s Kamino, especially when there are incentives being offered by the Solana Foundation. Ethena’s USDe is mainly used in Pendle for yield activities.

• RWA is under-valued:
  Most of the RWA platforms like BlackRock use USDC as minting assets out of compliance consider, also BlockRock is a shareholder of Circle. DAI success in their RWA products.

• Growing the pie or venturing beyond:
  Although stablecoins can attract major liquidity providers through incentives, they face a bottleneck- DeFi usage has been declining. Stablecoins now face a dilemma: they must either wait for crypto-native activities to expand or seek new utility beyond it.

Aliens in the Fully-Banked World

Key Players on the Move

• Global regulation is gaining clarity:
  99% of stablecoins are USD-backed, with the Federal having ultimate influence. The U.S. regulatory framework is expected to clarify after crypto-friendly Trump's presidency, with his promises to lower interest rates and ban CBDCs potentially benefiting stablecoins. The U.S. Treasury report notes stablecoins' impact on short-dated Treasuries demand, with Tether holding $90 billion in U.S. debt. Crypto crime prevention and maintaining dollar dominance also are the motivations.In 2024, several countries established regulations under common principles, including approval for stablecoin issuance, reserve liquidity and stability requirements, foreign-currency stablecoin usage limitations, and often, banned interest generation. Key examples: MiCA (E.U), PTSR (U.A.E.), sandbox (HongKong), MAS (Singapore), PSA (Japan) Notably, Bermuda became the first nation to accept stablecoin tax payments and license interest-bearing stablecoin issuers.

• Licensed issuers are getting trust:
  Stablecoin issuance requires technical prowess, regulatory compliance across regions, and robust management. Key players include Paxos (PYUSD, BUSD), Brale (USC) and Bridge(B2B API). Reserve management is handled by trusted institutions like BNY Mellon for USDC, and securely generating yield by investing in its BlackRock-managed fund. BUIDL now allows broader onchain projects to get yield.

• Banks are the off-ramp gatekeepers:
  While on-ramping(fiat-to-stablecoin) has become easier, off-ramping(stablecoin-to-fiat) challenges persist as banks struggle to verify the source of incoming funds. Banks favor licensed exchanges like Coinbase and Kraken, which conduct KYC/KYB and have similar AML frameworks. While high-reputation banks like Standard Chartered start to embrace off-ramping, small and medium-sized banks are moving fast, like DBS bank in Singapore. B2B services like Bridge aggregates off-ramp channels, and managed billions in volume for high-profile clients including SpaceX and the US government.

• Distributors has the ultimate say:
  Circle, as the compliant stablecoin leader, relies on Coinbase and is now pursuing global licenses and partnerships. However, this strategy could be undermined as institutions issue their own stablecoins due to the unparalleled business model—Tether, a 100-employee company profited $5.2 billion from investing its reserve in H1 2024. Banks, like JPMorgan, have already launched JPM Coin for institutional transactions. Payment apps, Stripe's acquisition of Bridge showed interest in owning the stablecoin stack rather than merely integrating USDC. PayPal, too, issued PYUSD to capture reserve yield. Card networks, Visa and Mastercard are testing the water by accepting stablecoins.

Efficiency Enabler

With trusted issuers, healthy banking relationships, and distributors as foundations, stablecoins can enhance efficiency in large-scale financial systems, particularly in payments.

Traditional systems face efficiency and cost limitations. Inner-app or inner-bank transfers offer instant settlements, but only within their ecosystems. Inter-bank payments incur fees of about 2.6% (70% to issuer bank, 20% to acquirer bank, 10% to card networks) and take over a day to settle. Cross-border transactions are even costlier at roughly 6.25%, with settlement times up to five days.

Stablecoin payments, by eliminating intermediaries, provide peer-to-peer instant settlement. This accelerates money velocity and reduces capital costs, while offering programmability features such as conditional auto-payments.

• B2B (annual $120-150 trillion):
  Banks are at best position pushing stablecoins. JPMorgan Chase has developed JPM Coin on its Quorum chain, as of October 2023, JPM Coin is used for about $1 billion of transactions each day.

• P2P (annual $1.8-2 trillion):
  E-wallet and mobile payment apps are in the best position, PayPal has launched PYUSD, with currently $604 million market cap on Ethereum and Solana. PayPal enables end users to onboard and send PYUSD for free.

• B2C commerce (annual $5.5-6 trillion):
  Stablecoins need to work with POS, entry point with Banking API, and card network, Visa became the first payment network to settle transactions in USDC back to 2021.

Mavericks in the Under-banked World

Shadow Dollar Economy

Emerging markets desperately need stablecoins due to severe currency devaluation and economic instability. In Turkey, stablecoin purchases accounted for 3.7% of its GDP. People and businesses are willing to pay a premium for stablecoins over fiat USD, with Argentina's stablecoin premium reaching 30.5% and Nigeria's 22.1%. Stablecoins offer dollar access and financial inclusion.

Tether dominates this space with a reliable 10-year track record. Even with their tricky banking relationships and redemption crisis—Tether admitted in April 2019 that USDT was only 70% backed by reserves—the peg remains stable. This is because Tether built a robust shadow dollar economy: In emerging markets, people rarely off-ramp USDT; they view it as dollars, this phenomenon is evident in regions like Africa and Latin America for paying employees, invoices, etc. Tether achieved this without incentives, solely through prolonged existence and consistent utility, enhancing its credibility and acceptance. This should be every stablecoin's ultimate goal.

Dollar Access

• Remittance:
  Remittance inequality slows economic growth. On average, an economically active individual in sub-Saharan Africa is charged 8.5% of the total remittance when sending money into LMICs and developed countries. For business even harder, high fees, long processing times, bureaucracy, and exchange rate risk are barriers that directly affect the growth and competitiveness of companies in the region.

• Dollar access:
  Currency volatility cost 17 emerging market countries $1.2 trillion in GDP from 1992 to 2022—a staggering 9.4% of their total GDP. Access to dollars is crucial for local financial development. Many crypto projects are dedicated to on-ramping, with ZAR focusing on grassroots "DePIN" methods. These methods leverage local agents to facilitate cash-to-stablecoin transactions in Africa, Latin America, and Pakistan.

• Foreign exchange:
  Today, the FX market facilitates over $7.5 trillion in daily volumes ****In the Global South, individuals often resort to the black market to convert local fiat currencies into U.S. dollars, primarily due to more favorable rates compared to official channels. Binance P2P has started to be adopted, but due to its order book manner, it lacks flexibility. Many projects like ViFi are building onchain AMM FX solutions.

• Humanitarian aid disbursement:
  Ukraine war refugees can receive humanitarian assistance in the form of USDC, which they can store in a digital wallet or cash out locally. In Venezuela, frontline healthcare workers used USDC to pay for medical supplies during the COVID-19 pandemic amid a deepening political and economic crisis.

Ending: Intertwined

Interoperability

• Foreign Exchange(FX):

  Traditional FX system is highly inefficent, it faces several challenges: counterparty settlement risk (CLS enhanced but cumbersome), cost of multi-banking system(Six banks are involved in an Australian bank's JPY purchase to a London USD office), global settlement timezone differences(CAD and JPY banking systems overlap for fewer than 5 hours a day), limited access to FX markets (Retail users pay up to 100 times more than large institutions). Onchain FX offers significant advantages:

  • Cost, Efficiency, and Transparency: Oracles like Redstone and Chainlink provide real-time price quotes. DEXs offer cost efficiency and transparency, with Uniswap CLMM enabling trading costs of 0.15-0.25%—roughly 90% lower than traditional FX. The shifting from T+2 banking settlement to instant settling provides arbitrageurs can employ various strategies to correct mis-pricing.

  • Flexibility and Accessibility: Onchain FX gives corporate treasurers and asset managers exposure to a wide range of products without requiring multiple currency-specific bank accounts. Retails can use a crypto wallet with embedded DEX API to get the best FX price.

  • Separation of Currency and Jurisdiction: Transactions no longer require domestic banks, divorcing them from the underlying jurisdiction. This approach harnesses the efficiencies of digitization while maintaining currency sovereignty, though pros and cons remain.

  However, challenges remain, including the scarcity of non-USD-denominated digital assets, oracle security, support for long-tail currencies, regulatory, and unified interfaces with on/off-ramp. Despite these obstacles, onchain FX presents lucrative opportunities. For instance, Citi is developing a blockchain FX solution under the guidance of the Monetary Authority of Singapore.

• Stablecoin Exchange:

  Imagine a world where most companies are issuing their own stablecoins. A stablecoin exchange proposes a challenge: Paying JP Morgan’s merchant using PayPal’s PYUSD. Although off-and-on ramps can solve the problem, they lose the efficiency crypto promises. Onchain AMMs provide the best real-time and low-cost stablecoin-to-stablecoin. For instance, Uniswap offers a number of such pools with fees as low as 0.01%. However, once a multi-billion is brought onchain, they have to trust the smart contract security, and there must be deep enough liquidity with instant performance to support in-real-life activities.

• Cross-chains Exchange:

  Major blockchains have diverse strengths and weaknesses, leading stablecoins to deploy across multiple chains. This multi-chain approach introduces cross-chain challenges, with bridges posing HUGE security risks. In my view, the optimal solution is for stablecoins to launch their own layer 0, as seen with USDC's CCTP, PYUSD's Layer0 integration, and we’ve witness USDT's move to recall bridge-locked tokens potentially launch a Layer0-like solution.

Meanwhile, several open questions remain:

• Will regulations compromise "open finance," given that compliant stablecoins are able to potentially monitor, freeze, and withdraw funds?

• Will compliant stablecoins still avoid providing yields that could be classified as security products, thereby preventing onchain DeFi from benefiting from their massive expansion?

• Can any open blockchain truly handle vast sums of money, considering Ethereum's slow speed and its L2s' reliance on single sequencers, Solana's imperfect uptime record, and the lack of long-term track records for other hyped chains?

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

The financial revolution led by stablecoin ahead of us is as exciting as it is unpredictable—a new chapter where freedom and regulation dance in a delicate balance.