Rip currents, often unseen, move thousands of gallons of water and possess the power to carry away even the most vigilant. They are forged as waves push water towards the shore, which then must retreat to the sea, creating a concentrated, fast-moving channel away from the coast. Much like many ocean phenomena, the key to navigating rip currents lies in understanding and working with them, rather than resisting.
“The Stable Rip Current” illuminates a transformation within the stablecoin landscape, driven by three recent developments: the emergence of composable stablecoins with yield-bearing capabilities, the evolution and integration of account abstraction, and the improving backdrop of regulatory foundations. This convergence is not just reimagining stablecoin design space but is also creating the powerful rip current that will rapidly cause an accelerated adoption of stablecoins.
Notably, this surge in stablecoin activity has the potential to bolster the US Dollar's global dominance, mirroring the impact once made by the petrodollar system. Should US provide regulatory friendly boundaries on the use of stablecoins, they have the potential to further cement the US Dollar's role as the cornerstone of global finance.
Over the past five years, the stablecoin sector has laid a robust groundwork for supply expansion. This journey of growth began with Tether reaching a milestone of $100 million of circulating supply in 2017, followed by USDC hitting the $100 million mark in 2018, and DAI achieving this milestone in 2020. Since these pivotal moments, the stablecoin landscape has been a testing ground for a diverse array of models, encompassing fiat-backed, crypto-collateralized, commodity-based, algorithmic, and hybrid systems.
Today, we have a wealth of data at our disposal, offering deep insights into the ecosystem. The findings of industry experts like Peter Johnson and Sai Nimmagadda of Brevan Howard Digital, Nic Carter of Castle Island Ventures, and Austin Campbell of Zero Knowledge Consulting - who are among the most insightful and vocal crusaders in the space - provide valuable perspectives on stablecoins. Their analyses not only shed light on the current state of stablecoins but also help chart the course for their future trajectory.
By the numbers, stablecoins have demonstrated a remarkable transaction volume, settling more than $11 trillion on-chain in 2022, a figure just shy of Visa's $11.6 trillion. In exchange level activity, stablecoin volume accounts for 70% of all activity across various blockchain networks, underscoring the growing preference for stablecoins in exchange transactions. Notably, USDC is increasingly used for economic activities on Ethereum, while USDT is becoming the stablecoin of choice in emerging markets. The preference for fiat-backed stablecoins is clear, with these types comprising 93% of the total stablecoin market cap. Of these, an overwhelming majority - over 98% - are backed by USD assets, according to data from Defillama. This trend isn’t entirely surprising as it reflects the global market's trust and familiarity with the US Dollar.
One cornerstone of stablecoin activity is adoption in high-inflation environments. While exact numbers on stablecoin usage on a user-by-user basis at a country level are elusive, data suggests a significant trend towards their adoption. TradingEconomics’ latest data reports that 79 countries have an inflation rate higher than 5%, 33 above 10%, and 21 exceeding 25%. These high inflation environments are ripe for stablecoin adoption and many of these countries have had formal and informal exchanges for stablecoins operating for years.
Stablecoins are often cited as the first product-market-fit in crypto. While the data shows that there has been strong adoption in exchange volumes for speculation and transactional activity in emerging markets, the outlook for stablecoins is continuing to improve. In this section we explore these factors that point to increased stablecoin adoption in the near term, specifically yield bearing stablecoins, account abstraction, and regulation.
1. Yield Bearing Stables
Fiat Backed. The business behind fiat-backed stablecoins have seen remarkable growth, especially as interest rates have risen. Issuers like Circle (USDC) and iFinex Inc. (USDT), who exchange fiat for stablecoins without offering a yield to the underlying holders of the stablecoin, have become incredibly profitable enterprises. This is because they invest the fiat received (much in US Treasuries), and they retain the profits from these investments. For example, a very conservative estimate suggests that Tether, with $70 billion issued, could be earning around $2.5 billion at a 3.5% return rate (that actual rate is probably 5%+). Although USDT and USDC do not currently pay out yields to holders, the emergence of competitors offering fiat-backed, yield-bearing stablecoins is imminent. Innovations like Ondo Finance have popularized earning treasury yields on stablecoins through fund-structures for KYC-compliant parties. The next wave of stablecoins, may be issued in non-US jurisdictions and could not require KYC. This would democratize access to these yields and put immense pressure on incumbent stablecoin providers. A new model passing yield to the stablecoin holders not only eliminates the opportunity cost of missing out on traditional finance yields but also allows holders to take advantage of blockchain composability by earning additional yield in places like lending markets or being a liquidity provider on an AMM. Furthermore, it opens the door to disrupting incumbents with transparent proof of reserve systems that the market can trust.
Crypto Backed. Concurrently, the crypto-backed yield-bearing stablecoin space is evolving rapidly. Post the Ethereum merge, the introduction of ETH staking yields has provided a new avenue for earning on digital assets. These yields are being leveraged to benefit stablecoin holders in innovative ways. For instance, companies like Ethena are creating synthetic USD stablecoins, such as USDe, by utilizing the stETH yield. They achieve a delta-neutral stablecoin through a strategy that involves going long on stETH yields while shorting futures. This approach represents a significant evolution in the stablecoin space, offering new yield-generating models and broadening the spectrum of financial opportunities available to crypto investors. As more real-yields are introduced into the crypto arena, new stablecoin models will be unlocked. There is a general attraction to crypto-backed stablecoins due to the inherent centralization that fiat-backed stablecoins retain. However with the advent of real crypto-native yields, there are now more reasons than just decentralization that are attracting the market towards this stablecoin design, which should not be underestimated.
2. Account Abstraction
Account abstraction, a revolutionary technology within Ethereum, is reshaping how user accounts and smart contracts interact. It removes the traditional boundaries between them, offering more flexible and programmable user experiences.
Safety Improvements for Applications. With the increased adoption of ERC-4337, the user experience will be enhanced with transacting by providing more flexibility and programmability in user accounts which can offer functionalities like multi-factor authentication and custom rules for transactions. This ultimately makes DeFi apps easier and safer to use, which will naturally bring more consumers to crypto and increase the broader adoption of stablecoins.
Gas Paid with Stablecoins. Another groundbreaking aspect of account abstraction is the ability to pay gas fees with stablecoins, such as USDC. This shift from the conventional requirement of Ethereum's native currency for gas fees to stablecoins greatly simplifies the user experience. It's particularly advantageous for those new to the crypto space, as it removes the need to maintain ETH balances solely for transactions. This change is expected to significantly boost stablecoin demand, as it makes entering and operating within the crypto ecosystem more seamless and user-friendly, appealing to a wider range of participants.
3. Regulation
Progressive regulatory landscapes in countries like Hong Kong, the Netherlands, the UAE, and Bermuda are laying the groundwork for the stablecoin sector. By establishing clear frameworks, these countries are enabling stablecoin companies to operate, issue, and manage their digital assets with greater legitimacy and efficiency. This evolution is crucial for enhancing trust in stablecoins and improving on-ramps into the digital currency space, fostering a more robust and reliable ecosystem for users and investors alike.
While stablecoins are on track to become a systemic linchpin globally, a complex and evolving relationship between the U.S. and the broader crypto landscape must be closely observed. U.S. regulators have increasingly tightened their grip on crypto, which Nic Carter detailed his viral piece, “Operation Choke Point 2.0.” Although regulation is essential and beneficial for widespread crypto adoption, the landscape is complicated by a myriad of competing interests, both personal and professional. This complexity leads to ambiguity regarding the timeline for establishing clear and effective regulation in the U.S. Such a multifaceted environment underscores the challenge of navigating towards consensus-driven and comprehensive regulatory frameworks.
A discerning faction within the U.S. government acknowledges the potential of stablecoins in enhancing security and geopolitical strategies. Regulating these digital assets will lead to increased transaction oversight, aligning with U.S. interests through the transparency blockchains provide. However, the challenge intensifies when there are stablecoins issued offshore, out of the purview of US regulators. This in fact is the reason why stablecoins could be deemed systematically important in the US. Another huge benefit to the adoption of stablecoin under clear US regulation means a massive increase in demand for US treasuries, as market participants become de facto buyers, contributing to significant global demand for the dollar. The increasing influx of new forced buyers in the treasury market is important because it injects consistent and substantial demand, stabilizing and potentially bolstering the treasury market. Spearheading the U.S. response, Patrick McHenry, Chair of the House Financial Services Committee, champions the 'Clarity for Payment Stablecoins Act', underscoring the inevitable systemic relevance of stablecoins in the U.S. financial ecosystem.
Independent of U.S. legislative progress on a stablecoin bill or a broader pro-crypto regulatory environment, stablecoins are set to carve their niche, propelled by their inherent efficiency gains, much like the emergence of eurodollars without direct U.S. sanction. The shutdown of SEN and Signet Networks' 24/7 fiat settlement systems has catalyzed the development of interim solutions to address weekend liquidity mismatches in stablecoin redemption. Robust proof of reserves systems ensures asset availability within a maximum of two days, while collaborations with major banks offer an alternative, leveraging their substantial balance sheets to provide immediate liquidity to customers.
Emerging Markets
When one lives in a country with secure banking, a steady currency, and regulatory checks and balances, it is sometimes hard to grasp the idea that hard earned money can disappear or become worthless overnight. In emerging and frontier markets, the rapid adoption of stablecoins, particularly USDT, is a testament to their growing demand, often driven by the need for financial stability and security. Increasingly accessible through emergent exchange onramps, these stablecoins provide a straightforward way to convert local currency into fiat-backed assets like USDT or USDC. This adoption serves key functions: protecting earnings from local currency devaluation, earning yields on holdings, and circumventing hefty remittance fees.
The landscape is buzzing with activity, from startups to major money transmitters, all navigating intricate political and regulatory environments to integrate stablecoins into their services. These entities are increasingly focusing on mobile applications with consumer-friendly interfaces. As these companies gain traction, the issuance of stablecoins is set to rise, signaling a significant shift in how value is stored and transferred in these markets.
Legacy Fintech Infrastructure
The existing financial infrastructure in many markets is rooted in outdated systems, with processes established decades ago. This legacy infrastructure often leads to inefficiencies, particularly in settlements, where the gap between a trade and its settlement can span up to two days – a foreign concept to crypto-native participants accustomed to immediate settlements. The integration of stablecoins and blockchain technology promises to revolutionize these archaic systems by enhancing speed, reducing costs, enabling 24/7 operations, and minimizing errors. Currently, major institutions are initiating pilot programs to explore these benefits, transitioning towards beta testing and eventually full public release. Stablecoins, particularly with their yield-bearing potential, are poised to play a pivotal role in this transformation, acting as a critical link between large financial institutions.
AI Infrastructure
As next-generation AI agents are developed and trained, they will require advanced tools to maximize their utility. A key capability will be asset transfer, where the intrinsic properties of cryptocurrency, including its transparency, efficiency, and trustless nature, are ideally suited. These characteristics lay the foundation for AI agents to interact seamlessly, paving the way for a new era of global communication and operation. Particularly in financial contexts, these AI agents are likely to prefer stablecoins for transactions due to their stability and reliability. This preference is anticipated to trigger a Cambrian explosion in the minting and transactional velocity of stablecoins, reshaping the landscape of digital currency usage.
Consumer Financial Management
The advent of yield-bearing stablecoins marks a pivotal shift in financial accessibility. Consumers can now mint assets with these capabilities and subsequently borrow against them, a strategy traditionally limited to high net worth investors. This approach offers a multitude of benefits: it enables tax reduction strategies, allows investors to retain yields on their stablecoin investments, and often results in lower interest rates on borrowed funds. It democratizes financial strategies that were once exclusive, offering more individuals the opportunity for flexible financial planning and the ability to adapt investment strategies to align with changing market conditions and personal financial objectives. At the heart of this transformation are stablecoins, poised to replace traditional cash held in bank savings accounts, which currently yields less than 0.1%, cementing their position as a cornerstone of modern financial systems.
The fast growing stablecoin sector is attracting a wide array of investments across various industries, from both public and private entities. Venture capital firms are actively involved, with significant investments in areas such as innovative stablecoin models featuring yield-bearing and account abstraction, companies targeting emerging markets, and stablecoin initiatives backed by substantial partnerships with legacy institutions with massive balance sheets. Notably, Circle, the issuer of USDC, is contemplating a public offering in 2024, while Coinbase, a major platform for minting and redeeming USDC through Circle, is bridging the transition from Web 2.0 to Web 3.0. Public neobanks are experimenting with stablecoins in their operations, and MakerDao is diversifying its yield strategy by investing across a broad suite of assets. This landscape presents numerous opportunities for investment, whether one is a seed-stage, public market, or crypto-token investor, highlighting the expansive growth and potential of the stablecoin market.
The stablecoin sector, akin to a powerful rip current, is rapidly transforming the landscape of global finance. The emergence of innovative stablecoin models, particularly those offering yield-bearing capabilities and leveraging account abstraction, alongside progressive regulatory frameworks, are key factors driving this transformation. The increasing adoption of stablecoins in high-inflation environments and their integration into legacy financial systems, consumer applications, and AI infrastructure highlight their growing importance. As the sector continues to mature, it represents a significant shift in financial paradigms, offering new opportunities for investment and reshaping the future of crypto usage.
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