The Evolution of Stablecoins: New Opportunities and Challenges

1. Introduction

In the previous article, we explored the key characteristics of major stablecoins like USDT, USDC, and DAI, analyzed failed stablecoin projects and the reasons behind their collapse, and reviewed the rapidly evolving regulatory landscape for stablecoins across different countries.

As of September 11, 2024, the total market capitalization of stablecoins exceeded $170 billion, marking its highest point since November 2022. As mentioned earlier, regulatory frameworks for stablecoins are advancing in many countries, leading to the rise of more stablecoin projects.

In this article, we will delve into the features and concerns of newly emerged stablecoins, highlighting their points of differentiation from existing ones. We will also discuss the potential growth of the stablecoin market in comparison to the traditional foreign exchange market.

2. The Rapid Growth of New Stablecoin Projects

The number of stablecoin projects in the cryptocurrency market has been increasing at an impressive rate. According to data from DeFiLlama, the number of stablecoin projects surged from 27 in April 2021 to 182 by July 2024, representing a 574% growth in just three years.

As mentioned in the previous article, Tether’s Q4 2023 report revealed a net profit of approximately $2.9 billion and a net operating income of around $1 billion. Circle, too, reported revenues of about $779 million for the first half of 2023. Notably, Tether's total revenue for 2023 reached $6.2 billion, surpassing BlackRock’s annual revenue of $5.5 billion for the same period.

Despite generating significant profits from their collateral assets, stablecoin issuers have yet to distribute these earnings to their stablecoin holders. Recognizing this, new stablecoin projects are emerging with strategies aimed at sharing the profits from collateralized assets with holders of their stablecoins.

Additionally, stablecoins built on decentralized finance (DeFi) protocols are adopting various innovative strategies. One key feature of these new stablecoins is the use of Liquid Staking Tokens (LSTs) as collateral to boost profitability.

In the past, MakerDAO’s DAI was collateralized with ETH, but users who staked ETH as collateral couldn’t receive staking rewards. In contrast, recent stablecoin projects are utilizing LSTs as collateral, allowing users to earn staking rewards while enhancing capital efficiency. This approach is driving innovation in the stablecoin market, offering more value to users.

2.1. Detailed Overview of Key New Stablecoin Projects

2.1.1. USDY (Ondo Finance)

Ondo Finance, launched in August 2022, raised $20 million in a Series A funding round led by Pantera Capital and Founders Fund, with notable participation from Coinbase Ventures, Wintermute, and Tiger Global. One of Ondo Finance’s flagship products is USDY.

USDY is a "tokenized note" backed by short-term U.S. Treasury bonds and bank deposits. Ondo Finance offers two types of tokens: USDY and rUSDY, both of which can be easily swapped on their platform. rUSDY is a *rebase token that maintains its $1 value while distributing interest. In contrast, USDY retains a fixed token supply, with its value increasing over time, while rUSDY preserves its $1 value by adjusting the token quantity held by users.

The key features of USDY are:

• USDY token holders receive interest earned from collateral assets, with a variable interest rate of around 5.3%.
• Tokens can be transferred on-chain 40-50 days after purchase.
• Daily and monthly reports are provided through Ankura Trust, ensuring full transparency.
• To reduce U.S. regulatory risks, USDY is exclusively available to non-U.S. investors.
• A separate legal entity, Ondo USDY LLC, ensures bankruptcy remoteness.
  • Bankruptcy remoteness means that assets are safeguarded from being included in the issuer’s estate in the event of bankruptcy, protecting the value for token holders.
• USDY is registered with the U.S. Treasury’s Financial Crimes Enforcement Network (FinCEN) as a Convertible Virtual Currency (CVC) manager and financial services provider.

• USDY value: Approximately $384.64 million
• Collateral asset market value: Approximately $395.49 million (collateralization ratio of 102.8%)
• Collateral assets: 100% U.S. Treasury bonds, $12,406 in cash
• Expected yield: 4.41%

USDY operates across seven blockchain networks: Ethereum, Arbitrum, Aptos, Sui, Cosmos (Noble), Solana, and Mantle, with ongoing plans to expand its reach. According to RWA.xyz, as of September 18, 2024, USDY has a market capitalization of $396.69 million, ranking it as the third-largest tokenized bond-backed stablecoin, following BlackRock’s BUIDL and Franklin Templeton’s FOBXX.

2.1.2. USDM (Mountain Protocol)

In June 2024, Mountain Protocol raised $8 million in a Series A funding round led by Multicoin Capital, with participation from Coinbase Ventures, Castle Island Ventures, Bankless Ventures, and Wormhole. The protocol’s flagship product is USDM, an ERC-20 rebasing token backed by short-term U.S. Treasury bonds.

The key features of USDM are:

• USDM distributes yield to token holders by adjusting the token supply, similar to other rebasing tokens.
• KYC-verified users can issue and redeem USDM without permission.
• Monthly proof of reserves is provided by Nephos Group, a UK-based accounting firm, ensuring transparency in collateral management.
• Like other stablecoins, Mountain Protocol ensures bankruptcy remoteness through a separate legal entity.
• USDM is targeted at non-U.S. investors, reducing exposure to U.S. regulatory risks.
• Mountain Protocol has obtained a Digital Asset Business License (license #202302512) from the Bermuda Monetary Authority (BMA).

• Issuance and reserves
  • USDM circulating supply: Approximately $53.12 million
  • USDM reserve assets value: $54.47 million (collateralization ratio of 102.55%)
• Collateral assets
  • U.S. Treasury bonds: Around $26.95 million (49.47%)
  • Tokenized short-term U.S. Treasury funds: Approximately $16.92 million (31.06%)
  • Tokenized money market funds: Roughly $10.28 million (18.87%)
  • Stablecoin: About $230,000 (0.42%)
  • Cash: Roughly $98,742 (0.18%)

Mountain Protocol’s USDM follows a stable expansion strategy and currently supports several EVM-compatible blockchains, including Ethereum, Arbitrum, Optimism, Polygon, and Base. A key differentiator between USDM and Ondo’s USDY is its use of tokenized funds like BUIDL and USTB in its reserves. Currently, USDC is the only currency that can be used to issue USDM. However, there are plans to introduce a bank wire transfer option in the future.

2.1.3. USDe (Ethena Labs)

Etena Labs successfully completed a strategic funding round of $14 million, led by Dragonfly Capital and Maelstrom, with additional support from Binance Labs. The company further accelerated its market entry through a launchpool on the Binance exchange. Etena Labs' flagship product, USDe, is designed to be a crypto-native stablecoin solution that does not rely on traditional banking systems.

USDe, described as a "crypto-native synthetic dollar," uses stETH as its primary collateral. As of September 19, 2024, USDe has a market capitalization of $2.6 billion, making it the largest among new stablecoin projects.

The key features of USDe are:

• Synthetic dollar: USDe is backed by cryptocurrency assets, such as LSTs, and maintained through short futures positions, creating a synthetic dollar system.
• Delta-neutral strategy: This strategy combines collateral assets with an equivalent-sized short derivative position, stabilizing the portfolio’s value.
  • The delta-neutral strategy combines its collateral assets, primarily stETH, with an equivalent-sized short derivatives position, maintaining a stable value in U.S. dollars. This allows USDe to maintain its $1 peg while still utilizing volatile crypto assets like stETH as collateral.

• Revenue generation: USDe offers users the ability to generate income by staking their USDe to receive sUSDe.
  • Etena Protocol derives revenue from two primary sources:
1. Staking rewards from staked assets like stETH.
2. Funding and basis spread profits from the delta-hedging derivatives positions.
• Censorship resistance: Due to its independence from the traditional banking system, USDe has high censorship resistance

However, despite its innovative approach, USDe carries certain risks, which are outlined in Etena Labs' official documentation:

• Funding risk: Prolonged negative funding rates could lead to losses.
• Liquidation risk: Price discrepancies between collateral assets and derivative positions may result in liquidations.
• Custody risk: USDe relies on "Off-Exchange Settlement (OES)" providers, such as Copper, Ceffu, and Fireblocks, for safekeeping of collateral assets, creating operational dependency.
• Exchange failure risk: There is a risk associated with the failure of centralized exchanges involved in derivative trading.
• Collateral risk: The reliability and integrity of ETH LSTs are crucial for maintaining the system’s stability.

USDe represents an innovative approach in the stablecoin market by utilizing crypto assets like LST as collateral and implementing a delta-neutral strategy to ensure price stability. This method sets USDe apart from traditional fiat-backed stablecoins, offering a decentralized and efficient alternative. However, it also introduces unique risks, balancing innovation with risk in the evolving cryptocurrency ecosystem. USDe's approach is a significant experiment in the stablecoin market, potentially shaping the future of stablecoin market.

2.1.4. LISUSD (Lista DAO)

Lista DAO recently completed a successful undisclosed funding round of $10 million, led by Binance Labs. The project operates as an open-source liquidity protocol that generates yield from crypto assets and offers decentralized stablecoin loans through its flagship product, LISUSD.

The key features of LISUSD are:

1. De-Stablecoin: LISUSD is described as a "decentralized stablecoin" or "De-Stablecoin," allowing for mild price fluctuations rather than aiming for strict price stability.
2. Collateral Assets: LISUSD accepts a variety of crypto assets as collateral, including BNB, ETH, BTCB, slisBNB, and WBETH. A key feature is the use of LST and Liquid Restaking Tokens (LRT) as collateral, which enhances yields and capital efficiency.
3. Decentralization: LISUSD aims to be a fully decentralized stablecoin, contrasting with assets like DAI that depend on centralized assets such as USDC.
4. Flexible Pegging: LISUSD allows for slight market-driven price fluctuations rather than maintaining a strict $1 peg.

The risk factors of LISUSD are:

1. Collateral volatility: The use of various volatile crypto assets, including LST and LRT, as collateral introduces the risk that changes in these asset values could affect LISUSD’s stability.
2. Smart contract risks: The complexity of the protocol could expose users to risks stemming from vulnerabilities in its smart contracts.

LISUSD offers a distinct approach to stablecoins with its "De-Stablecoin" model, focusing on decentralization, capital efficiency, and flexible price stability. By using LST and LRT tokens as collateral, it presents opportunities for higher returns and scalability. However, this also brings risks related to asset volatility and smart contract reliability.

As the stablecoin market continues to evolve, innovations like LISUSD provide users with more options and yield potential. Yet, they also introduce new risks, particularly regarding regulatory uncertainty and the stability of crypto-based collateral. The response from regulators and the market’s adoption of these innovations will be critical in determining the success of projects like Lista DAO's LISUSD.

3. Concerns Regarding New Stablecoin Projects

3.1. Ambiguity in Definitions and Regulatory Uncertainty

The rise of new digital assets such as USDY, USDM, USDe, and LISUSD introduces challenges due to their differing characteristics from traditional stablecoins, potentially causing confusion among investors.

• USDY and USDM: These tokens provide yield from U.S. Treasury bonds, increasing the likelihood of being classified as securities under existing laws, rather than stablecoins.
  • Notably, both avoid explicitly labeling themselves as "stablecoins."
  • Ondo Finance defines USDY as a "tokenized note collateralized by short-term U.S. Treasury bonds and demand deposits."
  • Mountain Protocol describes USDM as an "ERC20 rebase token."
• USDe and LISUSD: Built on LST infrastructures, these tokens may be classified as algorithmic stablecoins.
  • Etena Labs refers to USDe as a "crypto-backed synthetic dollar" supported by real assets and on-chain storage.
  • Lista DAO defines LISUSD as a "decentralized stablecoin (De-Stablecoin) soft-pegged to the U.S. dollar, supported by collateral."

This lack of clear definitions presents regulatory risks. How these assets are classified will significantly affect their operations and future growth. If regulators define them as securities or algorithmic stablecoins, these projects may face operational restrictions or compliance hurdles that could limit their expansion.

3.2. Limited Utility and Increasing Competition

New stablecoin projects also face the challenge of limited utility and an increasingly competitive landscape. If these projects fail to gain recognition as traditional stablecoins under regulatory frameworks, they may struggle to perform key functions like international remittances, payments, and exchange support. This limitation could confine their utility primarily to DeFi ecosystems, restricting broader adoption and long-term growth potential.

Moreover, the continuous emergence of projects with similar strategies is intensifying competition in the stablecoin market. For example, Elixir’s deUSD, which employs a delta-neutral strategy like Etena Labs’ USDe, is just one of many new entrants. This increased competition can put significant pressure on the profitability and growth of individual projects, further emphasizing the need for each project to develop a unique value proposition and sustainable business model.

3.3. Controversy over Governance Token Overvaluation

There is ongoing controversy surrounding the overvaluation of governance tokens issued by new stablecoin projects, highlighting a disconnect between market expectations and the actual business scale.

According to Coindesk on July 30, 2024, while USDC had a market capitalization of $33.5 billion, its issuer, Circle, was valued at only $5 billion. This places Circle's value at approximately 15% of USDC's market cap, which is seen as a standard ratio for major stablecoin issuers.

However, new projects are showing a notably different trend:

• USDY and ONDO: USDY's market cap is around $340 million, while ONDO’s fully diluted value (FDV) is approximately $6.9 billion—20 times USDY's market cap.
• USDe and ENA: USDe’s market cap is about $2.5 billion, whereas ENA's FDV is around $3.9 billion—1.56 times USDe's market cap.

This trend reflects the market’s heightened expectations for new stablecoin and Real World Assets (RWA) projects. Investors are placing high value on their innovative potential, but this also carries significant risk. The current valuations of ONDO and ENA may be considered excessively high relative to their actual business scale and potential, suggesting the possibility of future market corrections.

3.4. Risks Associated with Governance Token Issuance

Most new stablecoin projects, except for Mountain Protocol, issue governance tokens. This represents a significant departure from traditional stablecoins like USDT and USDC.

While governance tokens can effectively drive early-stage growth and foster community engagement, they also introduce regulatory and operational complexities.

3.5. Structural Risks

The innovative approaches adopted by new stablecoin projects present opportunities, but they also come with inherent structural risks that could affect the stability and long-term sustainability of these projects.

3.5.1. USDY and USDM: Collateral Asset Management Risks

USDY and USDM both use U.S. Treasury bonds and bank deposits as collateral. While this structure provides a layer of stability, it exposes the projects to risks similar to those faced by USDC during the failures of Silvergate Bank and Silicon Valley Bank.

• Bank failure risk: If the financial institutions holding the bank deposits used as collateral fail, the stability of the stablecoin’s value could be seriously compromised.
• Treasury value fluctuation risk: Interest rate changes can directly affect the value of the treasury bonds used as collateral. Rising interest rates, for instance, can reduce bond values, posing a risk of collateral devaluation.
• Liquidity risk: In the event of large-scale redemption requests, liquidating short-term Treasury bonds quickly could result in losses, particularly during periods of market stress.

3.5.2. USDe and LISUSD: Risks of Cryptocurrency Collaterals

USDe and LISUSD employ a collateral structure based on cryptocurrency assets, which exposes them to unique risks.

• Hacking risk: These projects are vulnerable to hacking attacks that exploit weaknesses in smart contracts, potentially leading to significant losses of collateral. A notable example is Prisma Finance, which suffered a hacking attack on March 28, 2024, resulting in a loss of approximately $11.6 million in LST-based stablecoins.
• Structural risk:
  • USDe’s delta-neutral strategy: USDe uses a delta-neutral strategy, which can become vulnerable during periods of extreme market volatility or liquidity shortages. If market conditions shift rapidly, maintaining hedge positions may become challenging, threatening the token’s value stability. This risk is particularly pronounced in the inherently volatile cryptocurrency market.
  • LISUSD’s multi-collateral system: LISUSD’s approach involves using a variety of cryptocurrency assets as collateral, which offers potential risk diversification. However, at the same time, the individual risks of each asset can accumulate, increasing the complexity and vulnerability of the overall system. When the price volatility of multiple crypto assets is acting simultaneously, it can be difficult to maintain the stability of the system as a whole.
• Depegging risk: The token’s value could deviate from its $1 target during extreme market volatility, large-scale redemption requests, or algorithmic failures. Depegging erodes user trust and can destabilize the entire system, potentially threatening the project's survival. Algorithmic stablecoins are particularly vulnerable to this risk, as demonstrated by the collapse of the Terra/Luna ecosystem.
• Oracle dependency risk: Oracle systems, which provide external price data, are critical for maintaining stability in these projects. Errors or manipulation of oracle data can jeopardize the entire system. Since oracles are essential for calculating collateral ratios and triggering liquidations, inaccuracies or tampering could lead to significant disruptions across the platform.

Despite these risks, new stablecoin projects continue to draw attention with their innovative approaches. They have the potential to serve as a bridge between traditional finance and the DeFi ecosystem. However, regulatory uncertainties, limited utility, and the complexities of governance models will be key factors in determining their long-term success.

4. The Next Phase of the Stablecoin Market: Digital Innovation in the Forex Market

4.1. Current State of the Stablecoin Market

Currently, the stablecoin market is predominantly dominated by USD-backed tokens. According to Kaiko, approximately 90% of all cryptocurrency transactions are conducted using USD-backed stablecoins. In 2024, the average weekly trading volume of these stablecoins reached $270 billion—70 times the volume of Euro-based stablecoins.

While stablecoins pegged to other fiat currencies hold a smaller market share, they are showing steady growth.

• Euro-based stablecoins now account for 1.1% of total transactions, a significant increase from 2020.
• Stablecoins tied to the British Pound, Japanese Yen, and Singapore Dollar have also emerged, though their market share remains minimal.

4.2. Potential for Stablecoin Market Expansion

As regulatory frameworks solidify, the growth of stablecoins backed by a wider range of fiat currencies is expected. Several factors contribute to this potential expansion:

• Structure of the Forex Market:
  • According to a 2022 report from the Bank for International Settlements (BIS), various currencies dominate the global forex market, with USD accounting for 88.5% of trades, followed by EUR (30.5%), JPY (16.7%), and GBP (12.9%).
  • This indicates strong potential demand for stablecoins backed by multiple fiat currencies.
• Regulatory clarity:
  • The regulatory framework for stablecoins in major countries is taking shape including the EU’s Markets in Crypto-Assets (MiCA) regulation and the UK’s Financial Services and Markets Act amendments.
  • These developments could reduce regulatory uncertainty and encourage institutional participation in the stablecoin market.
• Stablecoin initiatives by major financial institutions:
  • Japan’s three largest banks—Mitsubishi UFJ (MUFJ), Sumitomo Mitsui (SMBC), and Mizuho—plan to pilot an international stablecoin transfer platform called "Project Pax."
  • This project is set to launch commercially by 2025 and will use stablecoins issued via MUFJ’s Progmat platform.
  • The participation of major financial institutions signals the potential for stablecoins to enter mainstream finance and spur market growth.
• Advantages of digitalization:
  • Stablecoins offer benefits like 24/7 trading, rapid settlement, and lower transaction costs.
  • These features are especially useful in areas such as international remittances and trade finance.
• Growing adoption in emerging markets:
  • Recent surveys show that 69% of cryptocurrency users in emerging markets, including Brazil, Nigeria, Turkey, and Indonesia, have exchanged fiat currency for stablecoins. Furthermore, 39% have used stablecoins to purchase goods or services.
  • Factors such as economic instability, greater financial inclusion, and the efficiency of cross-border transfers are driving this growing adoption.
  • The growing use of stablecoins in emerging markets is further increasing the potential for expansion of the global stablecoin market.

A range of factors is converging to fuel the potential expansion of the stablecoin market. The high adoption rate in emerging markets, combined with active participation from major financial institutions, suggests that stablecoins may evolve beyond their current role within the cryptocurrency ecosystem to become an integral part of the global financial system.

4.3. Market Stability and Arbitrage Opportunities with Enhanced Stablecoin Regulation

The clarification and strengthening of stablecoin regulatory frameworks are expected to significantly improve market stability and reliability. This will likely lead to increased arbitrage opportunities between fiat currencies and stablecoins, while also facilitating the entry of large-scale institutional investments.

4.3.1. Key Impacts of Regulatory Enhancements

• Increased transparency: Enhanced reserve disclosure requirements will boost confidence in the actual value backing stablecoins.
• Reduced operational risks: The implementation of strict capital requirements and risk management policies will help mitigate systemic risks across the market.

4.3.2. Expansion of Arbitrage Opportunities

As regulation improves price stability, various arbitrage opportunities are expected to emerge:

• Exploiting price discrepancies: Arbitrageurs can profit from small price differences between fiat currencies and stablecoins.
• Exchange arbitrage: Traders can exploit price variations of the same stablecoin across different exchanges.
• Geographical arbitrage: Arbitrage opportunities may arise from price differences driven by regional regulatory environments or market conditions.
• Cross-chain arbitrage: Price discrepancies between the same stablecoin on different blockchain networks could present arbitrage opportunities.
• Arbitrage between stablecoins: Traders can benefit from price differences between different stablecoins.
• Interest rate arbitrage: Differences in interest rates between traditional finance and the stablecoin market offer further arbitrage opportunities.

These arbitrage activities are expected to enhance market efficiency and improve the price discovery mechanism.

4.3.3. Development of the Derivatives Market

As the stablecoin market matures, various derivatives commonly seen in traditional finance are expected to be introduced, offering investors more diverse options and risk management tools.

• Futures Trading: Contracts to trade stablecoins at a predetermined price on a future date, useful for hedging against value fluctuations or speculating on future price movements. For example, a contract could involve trading 1 USDC for 1.01 USDT three months from now.
• Swap Trading: Agreements where two parties exchange different types of cash flows over a set period. Interest rate swaps or currency swaps can manage interest rate risks on DeFi platforms or currency exposure for multinational corporations. For instance, exchanging fixed interest on USDC for floating interest on DAI could be a viable strategy.
• Options Trading: Contracts granting the right (but not the obligation) to buy or sell stablecoins at a predetermined price in the future. Call and put options can be used for volatility trading or complex hedging strategies. For example, purchasing a call option to buy 1 USDC at 1.02 USDT three months from now could be a strategic move.
• Forward Contracts: Customized contracts to exchange stablecoins at a fixed price on a future date. These are useful for managing exchange rate risks in international trade settlements or cross-border investments. For instance, entering into a forward contract to exchange 1 million USDC for 950,000 EURC six months later is one possible application.

The introduction of these derivatives will add sophistication and efficiency to the stablecoin market. Investors will gain access to a wider range of strategies, and businesses will be better equipped to manage risks.

5. Conclusion

The stablecoin market is rapidly evolving, increasingly serving as a bridge between traditional finance and digital finance. The emergence of new projects, the establishment of regulatory frameworks in various countries, and the proactive engagement of market participants all underscore the dynamic nature of the stablecoin ecosystem.

Innovative stablecoin projects like USDY, USDM, USDe, and LISUSD offer new opportunities but also bring unique risks. Their success will largely depend on effective risk management and their ability to adapt to regulatory changes.

Major regions such as Hong Kong, the EU, and the UAE are actively introducing regulations that are expected to formalize and stabilize the stablecoin market. This regulatory clarity is likely to encourage institutional investment and enhance the credibility of the market.

Stablecoins are poised to go beyond their traditional role as a store of value, potentially driving the digital transformation of the foreign exchange market. The introduction of diverse derivatives is expected to make the market more sophisticated and efficient. However, several challenges must be addressed, including regulatory compliance, technological stability, and the establishment of user trust. Additionally, external factors such as the introduction of central bank digital currencies (CBDCs) will play a crucial role in shaping the future of stablecoins.

In conclusion, stablecoins have the potential to become a key infrastructure of the digital economy. Monitoring developments in this space and analyzing their implications from multiple perspectives will be essential. Understanding how stablecoins will evolve and reshape the global financial system will be critical to anticipating the future of the financial industry.