However, it should be noted that even though stablecoins are a byproduct of the crypto ecosystem, at the current state, they inherently clash with the main ethos of crypto, decentralization. As known, the biggest stablecoins in terms of market cap are fiat-backed stablecoins such as $USDC and $USDT or RWA-backed ones such as $DAI and $FRAX.

Several projects aim to challenge this dynamic such as $LUSD, $crvUSD, or $mkUSD, however, as I discussed in a previous article called ‘’Crypto-backed stablecoins are broken’’, current crypto-backed stablecoin models are inherently limited and can’t scale. This problem has been pointed out several times, and some protocols like $DAI and $FRAX pivoted from their decentralized versions to become RWA-backed so that they become scalable and profitable while giving up on decentralization.

Even though there has been no significant change in the market that challenges my view until now, some developments encouraged me to write a follow-up as I think that the current crypto-backed stablecoin ecosystem is in an identity crisis.

What is the identity crisis of crypto-backed stablecoins?

For the last year, the RWA narrative has been becoming stronger in the stablecoin enthusiast circles as we saw how the leading crypto-backed stablecoins like $DAI and $FRAX adopted centralization over decentralization. This trend has coupled with the bleeding of the market cap of the crypto-backed stablecoins as the RWA yields are more attractive than the crypto-native yields.

As a result, the crisis is growing which forces crypto-backed stablecoins to find a new path, or let’s call it identity to both be scalable and decentralized.

• Most of the crypto-backed stablecoins are forking Liquity or adding new elements - $crvUSD and $mkUSD

• Liquity is developing a new model - Liquity v2

• New yield sources are explored - $eUSD

• Financial engineering - $fETH

These are bad times for decentralized crypto-backed stablecoins. However, we should note that bad times create strong people.

Failure of the CDP model: The ‘Growth’ of Prisma Finance and $LUSD redemptions

Prisma Finance is a newly emerging Liquity fork that utilizes LSTs as collateral assets. The only major difference of the protocol is that minting $mkUSD will be incentivized on Curve and Convex Finance so that users can receive trading fees, $CRV, $CVX, and $PRISMA on top of their $ETH staking rewards.

Since it was supported by the major players in the stablecoin ecosystem like Curve and Convex, its launch was viral, however, the results were not satisfactory.

After the launch of the governance token, $PRISMA, the protocol has reached a $170m $mkUSD supply and is currently hovering around $160m, however, most of this supply comes from Justin Sun, who is farming the governance token and dumping it to the holders, so, we are just seeing an example of liquidity farming where a whale gets all the benefits until he/she leaves.

As a CDP model stablecoin, $mkUSD shares all the inherent limitations of the CDP model, and as a result, I believe that the further demand for the protocol will be lower. Until now, I believe that the ‘growth’ of Prisma Finance has proven my thesis regarding CDP models.

On the other hand, one of the most OG stablecoin projects in the ecosystem, Liquity, has been losing its market share lately, decreasing from $300m to around $200m, due to the increasing redemption of $LUSD which also affects Trove owners.

Liquity has a built-in $LUSD redemptions mechanism that allows anyone to swap 1 $LUSD for $1 of $ETH using the protocol, which is a process that uses (lowest c-ratio) users' Troves. However, things are getting worse as even if you have a %285 collateralization, you’re not immune to the Trove redemption risk.

The launch of DAI Saving Rates is becoming a major blow to Liquity as people are creating a CDP position on Liquity with a low one-time fee that is around 0.5-1%, and then selling it for $DAI to have a 5% yield for $sDAI. This situation has been increasing the $LUSD redemptions and it is clear that the side effects of these redemptions are becoming unbearable for the users.

Given the fact that Liquity is currently building Liquity v2, which will be a separate stablecoin, we can assume that the team also thinks that the CDP model’s scalability issues will be a major limitation to the growth of the protocol.

Improvements to the CDP Model: Success of crvUSD

Curve team always leads the innovation in the ecosystem, and this trend continues with their stablecoin, $crvUSD.

$crvUSD is a CDP stablecoin project that requires over-collateralization with low liquidation risks. What makes $crvUSD unique is its liquidation mechanism called LLAMMA. With this method, LLAMA employs distinct price ranges to gradually sell off segments of the collateral, instead of immediately selling everything at a designated liquidation value. Consequently, as the collateral's price decreases, portions of it are auctioned off in exchange for $crvUSD.

Since the launch of $crvUSD, there has been a steady growth in the supply powered by the $CRV rewards, and it is possible that soon $crvUSD will be the biggest CDP model stablecoin. As LLAMMA is way more efficient than the current liquidation methods, traders who are looking to leverage collateralized debt positions prefer $crvUSD over competitors.

It is possible that during the bull market, the demand for CDPs will increase as traders will want to increase their exposure to $ETH, on the other hand, as the demand for CDP will decrease during the bear market, the market cap of $crvUSD will decrease as well. So, we can assume that $crvUSD is very dependent on the market cycles, which should not be seen from a stablecoin, just consider $USDT.

I believe that as every CDP model faces, the scalability and capital efficiency issues of CDP models will hinder $crvUSD’s success in terms of stablecoin functionality. As a result, I don’t think that $crvUSD can challenge the current state of the stablecoin market but dominate the CDP category against LUSD and mkUSD.

New Models Emerging: f(x) Protocol

Considering that CDP models are broken and the growth of this category is limited, there are surely people who are trying to develop new models to develop a scalable and decentralized stablecoin.

As I recently discovered, the f(x) Protocol developed by Alaaddin DAO is tailoring a unique solution that can provide a scalable and decentralized stablecoin that is immune to the TradFi and macroeconomic conditions and depends on the $ETH economy.

f(x) Protocol decomposes ETH into two products to build a decentralized stablecoin that aims to offer capital efficiency without liquidation risk while eliminating the risk associated with exposure to RWAs.

The protocol splits ETH into two products:

1. fETH: a decentralized floating stablecoin

2. xETH: a zero-cost leveraged long ETH position that absorbs the volatility of ETH price movements to stabilize fETH

These tokens are generated by dividing ETH collateral into two parts: a lower-volatility element termed $ETH with a beta (β) value less than 1, and a higher-volatility counterpart known as leveraged $xETH with a beta (β) value greater than 1. By enforcing the constraint βf = 0.1, $fETH token captures a portion of the cryptocurrency market's growth while curbing volatility sufficiently to maintain stablecoin-like attributes.

However, there are discussions among the community about creating a separate stablecoin that is pegged to USD as it can be an efficient way to attract capital.

Even though the current market cap of the protocol is around $8m and $fETH’s market cap is around $4m, I am sure that this model has the potential to replace CDP models for several reasons:

• Capital efficiency: Unlike the traditional CDP model where over collateral is locked, the model releases the liquidity of the excess collateral into the market as a byproduct $xETH. In the case of CDPs, as over-collateralization is required, 1.5 $ETH can generate a corresponding amount of stablecoins equivalent to 1 ETH. In the f(x) model, 1.3 $ETH can create $fETH valued at 1 ETH and xETH valued at 0.3 $ETH. This approach has significantly improved capital efficiency.

• Scalability: Compared to CDP models, the protocol depends on the demand for the stablecoin, not on the demand for CDP.

• ETH-powered: As an Ethereum native stablecoin, while the protocol is empowered by the general Ethereum ecosystem, it is also empowering the Ethereum and its LST ecosystem.

• Unlocking ETH LST liquidity: The protocol allows $ETH LSTs such as $stETH to be effectively utilized for further financial activity which was not possible before.

• No exposure to the macroeconomy: $fETH is a decentralized stablecoin that has no exposure to TradFi and is an Ethereum native stablecoin that is anchored by the $ETH economy.

• Yield-bearing: $fETH is a yield-bearing stablecoin that can generate native LST yield for the depositors in the Rebalance Pool.

• Peg stability: Even if the protocol fails, $fETH will be pegged to $ETH so that users won’t lose their investments

• No borrowing cost: Compared to CDP models, users do not borrow stablecoin, so there is no borrowing cost.

• No liquidation risk of the collateral: As the users do not open a collateralized debt position for $fETH, there is no liquidation risk for the collateral.

However, there is a major concern for the future of the protocol:

‘’Will there be enough demand for $xETH that allow the scalability of $fETH, especially during the bear market?’’

Until now, we haven’t seen any problem regarding the demand for $xETH against $fETH, however, time will give the best answer considering that the market cap of the protocol is still very small

The Future

Crypto-backed stablecoins are in an identity crisis. They are not able to serve thousands of people, but a small minority because of the inherent problems of CDP models. As a result, the market cap of major crypto-backed stablecoins is stagnant or bleeding gradually.

To survive, some protocols like $DAI and $FRAX completely abandoned the possibility of decentralization and went all in for the RWAs. Their promise of decentralization and censorship resistance is totally marketing buzz.

However, even though these protocols have breathing room for a short time, it is not clear what will happen when the US treasury bill rates go down.

On the other hand, current crypto-backed stablecoins need to develop new models and find new yield sources. Several problems need to be tackled:

1. scalability

2. capital efficiency

3. lack of yield sources

Surely there are more problems but I believe that if crypto-backed stablecoins can’t solve these problems while staying decentralized, we can assume that we won’t see any major decentralized crypto-backed stablecoin in the next bull cycle.

So, we should think about whether is there any chance of being both scalable and decentralized. Until now, we can easily say that the answer is ‘’NO’’. However, as the f(x) Protocol shows, there is a chance that LSTfi and financial engineering can help us to develop new solutions to tackle this problem. Moreover, UXD Protocol proved that new yield sources can be found in the on-chain ecosystem.

Decentralized crypto-backed stablecoins can still survive, however, they need to develop new solutions to this identity crisis.

In the course of this article, I will start by providing a definition of non-USD stablecoins. Subsequently, I will analyze the current state of non-USD stablecoins and explore potential use cases. Finally, I will delve into the reasons underpinning the dominance of USD stablecoins and draw comparisons with their non-USD counterparts.

What is Non-USD Stablecoins?

Non-USD stablecoins are basically stablecoins that are not backed by USD. These can be any asset, but mostly, Gold-backed stablecoins or other currency-backed stablecoins such as Euro or Yen consist of this category.

The current state of Non-USD Stablecoins

As of writing, the market cap of several stablecoins are as follows:

1. USD Stablecoins - $121,420,369,009

2. Gold-backed Stablecoins - $1,012,764,172

3. Euro Stablecoins - $446,939,485

4. TL Stablecoins - $22,226,740

5. JPY Stablecoins - $14,100,270

6. CNY Stablecoins - 2,842,649

As can be seen, compared to USD stablecoins, other types of stablecoins have not gained significant traction until now. The USD stablecoins capture more than 99% of the market, and there is no sign of a trend change. The reason for the lack of growth of non-USD stablecoins can be attributed to several factors, including a lack of liquidity across exchanges, a lack of regulatory clarity, cold start problems, and a lack of use cases.

However, it should be noted that every type of stablecoin should be analyzed separately since each of them has its unique characteristics.

When looking at gold-backed stablecoins, we can observe that their market capitalization is higher than that of other currency-backed stablecoins. This can be attributed to the widespread use of gold as a store of value across the world, which may explain its faster adoption compared to other currency-backed stablecoins.

Moreover, it is also crucial to note that Euro stablecoins have a market share of almost half a billion, which cannot be disregarded. The emergence of new players in the Euro stablecoin space, such as Tether and Circle, has possibly had a positive impact. The rise of FX trading in DeFi can also serve as a catalyst for the growth of Euro stablecoins.

On the other hand, it is clear that stablecoins from emerging markets like TL (Turkish Lira), JPY (Japanese Yen), and CNY (Chinese Yuan) have not gained significant traction and do not capture a meaningful market share.

The Reasons Behind the Dominance of USD Stablecoins

Before claiming that non-USD stablecoins will grow and challenge the supremacy of USD stablecoins, it is necessary to look at the reasons for the USD dominance in the stablecoin market.

1. a) DeFi Ecosystem

   1. Limited Non-USD Stablecoin Use Cases: Non-USD stablecoins, while gaining traction, often lack the versatility and broad acceptance of USD-backed stablecoins, limiting their utility in decentralized finance (DeFi) applications.

   2. Liquidity Challenges: Non-USD stablecoins often suffer from liquidity constraints, making them less attractive for DeFi participants seeking ample liquidity for their transactions and investments.

   b) Global Trends

   1. Hyperinflation and Devaluation: Economic instability and hyperinflation in emerging markets drive heightened demand for the USD, which is perceived as a safe haven and store of value during times of currency devaluation.

   2. Dollarization: A growing trend of dollarization is evident in emerging markets, driven by the aforementioned factors. Local populations and businesses increasingly prefer holding and transacting in USD due to its stability.

   c) Macroeconomics

   1. Historical Legacy: The sustained dominance of the United States Dollar (USD) is deeply rooted in its historical role as a reliable and stable currency, particularly after World War II. This legacy has established trust among nations and institutions, reinforcing its prominence.

   2. Global Reserve Currency: The USD's status as the world's primary reserve currency is a cornerstone of its supremacy. Central banks across the globe hold significant USD reserves, enhancing their credibility and liquidity.

   3. Medium of Exchange: The widespread use of the USD as a medium of exchange for international transactions simplifies cross-border trade and investment, reducing transaction costs and uncertainty.

   4. Global Trade: Despite efforts to diversify currency options, USD remains the dominant currency for global trade. Many commodities, including oil, are priced and traded in USD, solidifying its position.

   5. Remittances: The USD's preference for remittances stems from its accessibility and recognition, facilitating the flow of funds across borders with relative ease.

   6. Real-World Assets: A multitude of tangible assets such as real estate, commodities, and financial instruments are priced and transacted in USD, further entrenching its role in global finance.

   7. Financial Dependency: The international financial system heavily relies on the USD for various financial products, including debt instruments, derivatives, and foreign exchange markets.

In conclusion, the continued dominance of USD and USD stablecoins is underpinned by a combination of historical trust, its status as a global reserve currency, and its extensive use in international trade and finance. Additionally, challenges faced by non-USD stablecoins and the global trends of economic instability further cement the USD's enduring relevance in the financial landscape. As such, it is reasonable to expect that this dominance will persist for the foreseeable future due to the robust and long-lasting factors supporting it.

The Lack of Demand for Non-USD Stablecoins

As stated, there are several important reasons that create demand for USD stablecoins. However, compared to USD stablecoins, we do not see such a demand for non-USD stablecoins. There are two main reasons for that: access to local currencies and lack of use cases of non-USD stablecoins.

A key reason why USD stablecoins are in high demand compared to non-USD stablecoins is that they make it easy for people in emerging markets or other countries to use and exchange US dollars.

However, it is important to point out the distinct nature of non-USD stablecoins. Consider, for instance, an individual in Japan or Turkey. These individuals, by virtue of their geographical location, have direct access to their native currencies, the Japanese Yen and Turkish Lira, respectively. Consequently, the necessity for a stablecoin denominated in their local currency is markedly diminished. These stablecoins, in their native countries, often lack a distinct utility beyond that of credit cards. This observation also applies when considering USD stablecoins within the US. However, it is essential to recognize that the primary demand for USD stablecoins predominantly comes from emerging markets. Conversely, the demand for non-USD stablecoins is considerably less pronounced, given the absence of analogous economic dynamics and associated use cases.

The disparity in demand between USD stablecoins and non-USD stablecoins can be attributed to the breadth of their respective use cases. The US dollar enjoys a crucial role across various domains, encompassing global trade, financial markets, remittance channels, and its widespread acceptance as a global medium of exchange and a reserve currency.

The preeminence of the US dollar in international trade, as well as its central role in the world's financial infrastructure, renders USD stablecoins indispensable for facilitating cross-border transactions and investments. Additionally, the global recognition of the US dollar as a reliable medium of exchange and a store of value elevates the demand for USD stablecoins on a global scale.

Conversely, non-USD stablecoins, primarily limited to localized usage, do not garner the same level of demand on the global stage due to their inability to replicate the expansive reach and versatility of the US dollar. Consequently, the demand for non-USD stablecoins remains constrained, in stark contrast to the widespread appeal and necessity of USD stablecoins in facilitating a broad spectrum of international financial activities.

Future Prospects

It is clear that the market cap of non-USD stablecoins will grow, especially this can apply for Euro stablecoins or Gold-backed stablecoins. Moreover, I believe that other commodities such as wheat, gold, oil, and cattle can be tokenized and stablecoins that are pegged to these commodities can be issued.

However, I don’t believe that most of the non-USD stablecoins such as Japanese Yen stablecoins or Turkish Lira stablecoins will have a huge impact on the market as there is no global demand for them.

When assessing the potential of non-USD stablecoins, it is imperative to recognize that stablecoins are designed to offer global accessibility and reach. However, the critical factor in their success depends on the presence of substantial global demand from investors who want to access those stablecoins. Without a strong demand, even the most advanced stablecoin technology may struggle to secure a customer base.

In this article, I will elaborate on this topic, starting with a comprehensive definition of treasury bills, followed by an exploration of the features surrounding treasury bill-backed stablecoins. Furthermore, I aim to develop a comprehensive overview of the prospects and constraints associated with this stablecoin category. My analysis will extend to the potential applications and target user demographics.

What is the Treasury Bill?

A US Treasury Bill, or T-Bill, is like a short-term IOU issued by the US government to raise money for its needs and pay off its debts. These T-Bills are safe to invest in because the US government always pays them back, so there's no real risk of losing your money.

People often use T-Bills when they want to invest their money for a short time or when they're not sure where to put it yet. Think of it as a safe parking spot for your cash until you figure out where to invest it for the long term.

T-Bills are also important because they help set the interest rates for short-term loans in the economy, and experts keep a close eye on them to understand how the economy is doing.

Introduction to Treasury Bill-Backed Stablecoins

At this point, we can analyze two main projects under the category of Treasury bill-backed stablecoins, namely, Ondo Finance’s $USDY and Mountain USD’s $USDM.

Treasury bill-backed stablecoins can be defined as tokenized notes that operate as a yield-bearing asset as it is also stated by Ondo Finance. By holding the stablecoin, you can get exposed to the yield. In the case of treasury bill-backed stablecoins, the yield comes from the treasury bills.

Treasury Bill-backed stablecoins are an interesting area as they combine some of the hottest trends such as RWA tokenization and stablecoins into one product. They allow users to reach sustainable yields from the US treasury bills, which was not easy to access for international investors.

However, this innovation comes with its drawbacks.

As these stablecoins are backed by T-Bills, both $USDY and $USDM are permissioned stablecoins, and can’t be offered, sold, or otherwise made available in the US or to US persons. Moreover, centralized actors act as custodians for the reserves of these stablecoins.

Opportunities and Limitations

In order to comprehend the potential of treasury bill-backed stablecoins, it is important to highlight several key points:

1. Treasury bill-backed stablecoins are not available to U.S. citizens.

2. Treasury bill-backed stablecoins represent yield-bearing assets.

3. Treasury bill-backed stablecoins are essentially tokenized notes.

I believe that treasury bill-backed stablecoins present a multitude of opportunities for international investors. They provide a secure and cost-effective avenue for accessing both the U.S. dollar and treasury bill yields. Consequently, it will be attractive for the following groups such as accredited investors hailing from emerging markets and businesses operating in developing countries.

As a result, treasury bill-backed stablecoins offer these opportunities:

1. quality reserves

2. exporting US dollars

3. exposure to treasury bills

4. yield-bearing asset

In the future, I envision that treasury-bill-backed stablecoins will be used to get exposed to T-Bill yields, risk diversification, reaching the US dollar, and protection from hyperinflation and devaluation of local currencies in emerging markets by businesses. I need to stress that the user base will be mainly composed of businesses and accredited investors, not retail.

As a yield-bearing asset, treasury bill-backed stablecoins have great potential as the liquidity is deep, reserves are high-quality, and the product is capital efficient compared to the existing yield-bearing stablecoins. Moreover, considering that the interest rates in the US will be high for a certain period of time, this will be a great opportunity to get familiar with investors and increase the supply of these stablecoins.

However, it is crucial to acknowledge that treasury bill-backed stablecoins may not scale as anticipated. This is because, as yield-bearing assets, the expectation is for holders to retain treasury bill-backed stablecoins rather than spend them. This inherent characteristic may limit adoption among retail users.

As a result, treasury bill-backed stablecoins have limitations in these areas:

1. Censorable

2. Permissioned

3. Custody risks

4. Centralization

5. Limited use cases on DeFi

In the future, I envision that treasury-bill-backed stablecoins may not have a strong presence on DeFi since if a user spends the money, it does not act as a yield-bearing asset, meaning that it will lose its inherent value while also carrying the centralization risks. Moreover, since treasury-bill-backed stablecoins can’t be held or traded by US citizens, this will limit the DeFi activity.

It should be noted that even though we call this category treasury bill-backed stablecoins, they are not inherently stablecoins but tokenized notes, they won’t act as a medium of exchange, as a result, their comparative advantage against $USDT and $USDC is limited.

Future Prospects

I believe that treasury-bill-backed stablecoins can open many opportunities for people across emerging markets while they don’t have any utility for US citizens at this point. Moreover, how to utilize treasury-bill-backed stablecoins in DeFi is debatable, considering that protocols can’t differentiate who to sell or not due to the regulatory limitations upon US citizens, so they can’t offer treasury-bill-backed stablecoins to their users.

I am bullish on the future of treasury-bill-backed stablecoins, however, we should emphasize that currently, these products are going to have a challenging time finding PMF. Moreover, we need to discuss more about the comparative advantages of treasury bill-backed stablecoins and the user base of this category. My opinion is that most of the crypto-backed stablecoin users won't adopt treasury bill-backed stablecoins due to the centralized party risks, the comparative advantages of treasury bill-backed stablecoins against fiat-backed alternatives are limited, with only the quality yield opportunity is seen as a superior value.

I believe that many developers within the stablecoin ecosystem do not place enough emphasis on the pivotal role the network effect plays. Consequently, alternatives to well-established stablecoins like $USDT and $USDC struggle to gain a meaningful market share. To highlight the underlying reasons for this state of affairs, I wrote several articles, and in this particular piece, we will delve into the importance of the network effect within the stablecoin ecosystem.

We aim to discover why, in the decentralized finance ecosystem, we have yet to cultivate a decentralized and censorship-resistant alternative to challenge the dominance of $USDT and $USDC.

This article will begin by explaining the concept of the network effect, subsequently delving into the specific parameters that constitute the network effect in the realm of stablecoins. Furthermore, we will review $BUSD as an example of a successful alternative that managed to challenge the supremacy of $USDT and $USDC until it fell under the regulatory scrutiny of the SEC, which ultimately led to Paxos discontinuing the issuance of $BUSD and Binance gradually reducing its utilization and support for $BUSD.

Discovering Network Effect in Stablecoin Landscape

The network effect is a concept that drives the growth and value of a product or service in a virtuous cycle. When a project exhibits network effects, each new user or participant contributes to the overall utility and desirability of the network. This creates a positive feedback loop where more users attract even more users, resulting in exponential growth.

As the network expands, it becomes increasingly valuable to each user. This heightened utility can manifest in various ways, such as a larger user base to connect with, deepening liquidity, and more trading pairs.

One of the significant benefits of network effects is the competitive advantage it confers upon the project. As the network grows, it becomes challenging for new entrants to compete effectively because users are already invested in the existing network.

With this definition, I believe that we can easily understand the reason why $USDT and $USDC continue to dominate the stablecoin landscape while new alternatives have difficulty in getting traction. Thanks to the fact that $USDT and $USDC are the first movers, most of the protocols adopted $USDT and $USDC in their platforms. As a result, most investors/traders use $USDT and $USDC, which in turn resulted in more protocols adopting $USDT and $USDC. This also resulted in investors and traders prefer $USDT and $USDC. This is a basic example of the network effect.

As the network effect helps $USDT and $USDC to be more recognizable, trustable, and preferable in the eyes of investors/traders, it becomes harder for the new stablecoin projects to get traction.

However, even though it is getting harder to have a network effect in the stablecoin space, I believe that following the paths of $USDT and $USDC can be a good way for new stablecoin projects to have a network effect.

Based on this discussion about the network effect, we can conceptualize 4 main concept that helps to develop a network effect for a stablecoin.

1. Deep Liquidity: Liquidity is king. A stablecoin needs to possess deep liquidity across pairs, platforms, and chains to provide a superior trading experience for both traders and investors. This also contributes to a stronger peg. Without such deep liquidity, the development of new use cases and opportunities for this stablecoin becomes challenging. Deep liquidity has a cascading effect, attracting more users and creating a positive feedback loop. Therefore, it is essential to note that to achieve deep liquidity, the issuance of the stablecoin should be capital-efficient. This implies that decentralized stablecoins using a CDP model, which demands over-collateralization and carries liquidation risks, cannot scale sufficiently to create deep liquidity due to the inherent limitations of the CDP model.

2. CEX Integration: CEXs are the first place where the masses interact with the crypto ecosystem. There are millions of people who use CEXs but haven’t engaged with the DeFi ecosystem. Thus, being listed on the major CEXs is a prerequisite to achieving network effect. I believe that for a stablecoin project to have a network effect, it is crucial to have deep liquidity across centralized exchanges. Currently, only $USDT and $USDC achieve that while $BUSD was able to achieve this until Binance stopped its support. As an example, when Binance stopped support for $USDC to boost $BUSD’s growth, the $USDC supply decreased by almost $10 billion within a couple of months.

3. DeFi Integration: Integration with the major DeFi platforms is also crucial. Without such integration, a stablecoin faces several other issues. Its utility within the DeFi ecosystem is limited, reducing demand among DeFi users who prefer easily accessible and usable stablecoins. Liquidity may remain fragmented across different platforms, diminishing efficiency. Price stability can be compromised due to a lack of arbitrage opportunities and market depth. The stablecoin's use cases become limited, making it less versatile for DeFi participants. Adoption may stall, as DeFi platforms often act as gateways for new users entering the DeFi space. A non-integrated stablecoin may also face a competitive disadvantage, missing out on opportunities to attract users and liquidity. Additionally, its exclusion from DeFi collaborations may hinder its ability to innovate and adapt to changing market demands.

4. Cross-chain compatibility: Stablecoins with substantial market presence invariably exist across multiple blockchain networks. Consequently, it's reasonable to assert that if a stablecoin confines itself to a single native blockchain, it would struggle to cultivate network effects. Moreover, in the event of a competitor's expansion into this same native blockchain, said competitor is almost certain to challenge the established players. This is due to the competitor's existing presence on other blockchains, providing them with a robust network effect to leverage on the new blockchain.

Established projects like Uniswap serve as an excellent case in point. Uniswap has undeniably demonstrated its success on the Ethereum blockchain. When Uniswap extends its reach into other blockchain networks, it swiftly ascends to the top position, displacing native decentralized exchanges (DEXs) and eliminating competition within that specific blockchain.

Certainly, when assessing the primary objectives of a stablecoin project, the paramount goals invariably revolve around augmenting both the stablecoin's supply and its transaction volume. In this context, the concept of a network effect emerges as a pivotal factor. It essentially initiates a self-reinforcing cycle where users are naturally drawn to trade and hold this specific stablecoin. Consequently, this surge in user demand compels exchanges and platforms to integrate and support the stablecoin in question. This organic process then precipitates the exponential growth of the stablecoin, without necessitating any contrived or artificial strategies from its issuer.

In essence, the network effect acts as a powerful catalyst, creating a virtuous cycle that propels the stablecoin's adoption, liquidity, and overall prominence in the cryptocurrency ecosystem.

Case Study: $BUSD

BUSD is a fiat-backed stablecoin that is regulated by the New York State Department of Financial Services (NYDFS). All reserves are held 100% in cash and cash equivalents; hence customer funds are always available for 1:1 redemption.

Behind $BUSD’s short but well-known success story, Binance played a huge role as it offers several benefits for $BUSD users on its platform such as:

1. Zero Maker fees for all BUSD trading pairs on Binance

2. Zero transaction fees on BUSD stablecoin pairs on Binance

3. Deep liquidity for BUSD trading pairs with newly-listed tokens on Binance

4. High APY for $BUSD holders

5. Farm new tokens via Binance Launchpad using BUSD

6. Purchase NFTs on Binance NFT Marketplace

7. Access Margin Trading and Binance Futures

Thanks to these benefits, using $BUSD was very profitable as the minimal fees associated with using $BUSD make it an attractive choice for traders and investors, also $BUSD has been widely used in several CeFi and DeFi thanks to the foundational network effect that Binance and Binance Smart Chain provided.

It is clear that $BUSD has taken advantage of Binance’s backing, as a result, it created a network effect in which $BUSD was available on almost all of the platforms, exchanges, pairs, and chains and had deep liquidity, so it challenged the supremacy of $USDT and $USDC.

$BUSD’s rise from $3.482 billion to $23.337 billion on November 13th, 2022, where it reached ATH is great proof that $BUSD achieved a network effect that no one has realized other than $USDT and $USDC. During that period, while the total market share of $USDT and $USDC has been stagnant at around 75-80% the market share of $BUSD rose from 5.56% to 15.07%.

The catalyst for BUSD’s success can be summarized as:

1. CEX Integration: With Binance backing, $BUSD was able to exist in every major CEX as the network effect that Binance provided caused other CEXs to follow suit and launch $BUSD as a pair on their exchanges. This resulted in traders and investors prefer $BUSD because it is supported by major players in the ecosystem and it offers so many use cases. Moreover, since Binance offers low or zero fees in $BUSD pairs on its platform, traders were incentivized to use $BUSD since it was more profitable for them. Considering that Binance is the biggest CEX and most of the transactions on crypto happen on Binance, it created a great volume of transactions and supply increase for $BUSD.

2. DeFi Integration and cross-chain compatibility: Thanks to Binance backing $BUSD was one of the main stablecoins that has been used in BNB Chain and it also led to the popularity of $BUSD in Ethereum. For example, at some point, $BUSD’s market share on Ethereum was over 20%. As a result of this strong presence in both chains, $BUSD was able to achieve a network effect.

3. Deep Liquidity: As a result of CEX and DeFi integration, $BUSD achieved deep liquidity across platforms, pairs, and chains which resulted in more recognition and familiarity for the traders/investors. It initiated a self-reinforcing cycle to boost the network effect of $BUSD and make $it a strong alternative to $USDT and $USDC.

Conclusion

In conclusion, this article's framework highlights how the network effect plays a crucial role in the stablecoin world. Currently, centralized stablecoins dominate the decentralized finance scene. To make decentralized stablecoins bigger, we need to figure out how to scale them up. This framework breaks down the four key parts of the network effect to help us understand how a stablecoin can become popular in this fast-changing space.

Working together, we can refine and expand on this framework to make decentralized stablecoins better. By sharing ideas and finding new solutions, we can move closer to a financial future that's more open and available to everyone.

Let's keep pushing the boundaries of stablecoins, bringing traditional finance and the decentralized world together to empower people around the globe.

In this article, I will offer a comprehensive overview of yield-bearing stablecoins, emphasizing the primary categories within this landscape: LSD-backed stablecoins, Treasury Bill-backed stablecoins, and yield-generating stablecoins. Following this, I will conduct a user analysis, with a focus on identifying the types of users who may or may not find yield-bearing stablecoins appealing.

I will present a SWOT analysis for yield-bearing stablecoins, shedding light on potential risk areas and opportunities for improvement within this space. Finally, I will share my thoughts regarding whether yield-bearing stablecoins are a product-market fit or not.

Overview of the Yield-Bearing Stablecoins Landscape

Yield-bearing stablecoins are a class of stablecoins that offer a return on investment to their holders simply by holding the asset.

The emergence of several stablecoins focused on delivering predictable and sustainable yields has generated significant optimism within the crypto ecosystem. Many view these yield-bearing stablecoins as nearly risk-free investments, poised to carve out a substantial niche in the stablecoin market. Notable figures such as Nic Carter are particularly bullish, projecting that within the next few years, yield-bearing stablecoins could capture 20-30% of the stablecoin market share.

However, there are also skeptics, myself included, who question the long-term viability and potential of these yield-bearing stablecoins.

I believe that this quote from iamnico.eth in his article called ‘’Yield-Bearing Stablecoins: Dope or Nope?’’ points out the inherent problems with yield-bearing stablecoin very clearly.

‘’Here’s the catch with APR-bearing stablecoins: Their inherent growth-focused monetary policy, while intriguing, risks creating a currency that’s de facto deflationary if money velocity diminishes. Economic slowdowns often follow such trends.

🤔 Simplified: If your money might be worth more tomorrow, why spend today? And if everyone thinks this way, is the economy truly thriving?’’

Let’s analyze these protocols individually so that we can have a better understanding of the yield-bearing stablecoin landscape. To do so, we will separately analyze LSD-backed, Treasury Bill-backed, and yield-generating stablecoins.

a) LSD-backed stablecoins

LSD-backed stablecoins are CDP model stablecoins that require over-collateralization by liquid staking tokens with liquidation risk. They allow holders to earn yields intrinsically while preserving the key attributes of crypto-backed stablecoins.

The main features of the treasury-bill backed stablecoins can be summarized as:

1. Utilizing LSD-Derivatives

2. Dependent on $ETH staking rewards

3. Requires over-collateralization and has liquidation risks

4. Unlocking the locked $ETH liquidity

LSD-backed stablecoins have been a popular category lately as investors saw potential in increasing their $ETH exposure with LSD-backed stablecoins. It is possible that with the increasing amount of $ETH being staked, LSD-backed stablecoins’ market share can also increase.

The first wave of LSD-backed stablecoins such as $GRAI, $R, and $eUSD proved that there is a demand to utilize LSD-Derivatives with stablecoins, however, the existing flaws of these stablecoins will be a hardship in the future. On the other hand, new LSD-backed stablecoins such as $mkUSD and $crvUSD made some improvements to the existing models which can be an exciting development. It should be noted that Ethena Labs’ $eUSD is completely a new model in the space that can inspire other builders to develop similar models.

I believe that LSD-backed stablecoins can be used as an effective leverage primitive for $ETH investors, however, due to a lack of capital efficiency caused by the over-collateralization requirement and liquidation risks, it can’t achieve stablecoin functionality. Moreover, LSD-backed stablecoins inherently do not work as money since their primary utility is to provide a yield to their holders, thus, they can’t serve as a medium of exchange.

b) Treasury Bill-backed stablecoins

Treasury Bill-backed stablecoins are the last innovation in the ecosystem. With the rise of interest rates in the US, some realized that this could be an excellent opportunity to provide risk-free interest for investors. Ondo Finance’s $USDY and Mountain Protocol’s $USDM are the two main examples in this space.

The main features of the treasury bill-backed stablecoins can be summarized as:

1. Permissioned/KYC requirement

2. The yield is dependent on US interest rates

3. The yield source is not volatile like in DeFi

While $USDM is a rebasable token, $USDY is a non-rebase token. As a result, the integration of $USDM into DeFi protocols will be challenging, and $USDY will surely face problems in terms of user experience.

I believe that when it comes to peg stability and the risk-free rate, stablecoins backed by treasury bills offer the best solution. However, their growth is dependent on U.S. interest rates, which are beyond their control. Therefore, external factors will play a key role in the future of this category.

Moreover, it should be noted that treasury bill-backed stablecoins do not offer a strong value proposition to the crypto community since these stablecoins are permissioned, meaning that not everyone can mint or use them and a 5% interest rate isn’t so competitive among the other protocols. It is possible that these protocols will target users from developing countries, however, lack of liquidity and in the case of lower yield in the future, they won’t be competitive against $USDC and $USDT. Furthermore, treasury bill-backed stablecoins inherently do not work as money since their primary utility is to provide a yield to their holders, thus, they can’t serve as a medium of exchange.

c) Yield-generating stablecoins

Yield-generating stablecoins provide their holders an automatic DeFi yield by utilizing the collateral in several protocols. To mint these stablecoins, users are required to put collateral in $USDC or other stablecoins. Sperax and Overnight can be given as examples in this category.

Many see yield-generating stablecoins as stablecoins, but I disagree with this take. These stablecoins do not function as stablecoins but as LP tokens. This means that yield-generating stablecoins do not act as money but act as an LP token which users earn yield by just holding. Even though this criticism can be directed at every yield-bearing stablecoin, it is clear that yield-generating stablecoins like $USDs and $USD+ do not even try to add another utility than being an LP token.

The main features of the yield-generating stablecoins can be summarized as:

1. not a medium of exchange

2. counter-party risks

3. $USDC wrappers

4. DeFi yield

Many believe that yield-generating stablecoins can be an exciting initiative however, I don’t think they are stablecoins but $USDC staking providers. Thus, they don’t possess a unique value proposition in the ecosystem. As a result, I don’t see a bright future for this category as the product can easily copied or adopted by the existing projects with lower risks.

The Market of the Yield-Bearing Stablecoins: A User Analysis

To determine whether a protocol is a product-market fit, we need to look at the potential customers/users and how they would view/use the protocol.

For stablecoins, I believe that there are 3 main categories that we can analyze:

a) Institutions

Treasury bill-backed stablecoins can be a great way to have exposure to DeFi for the new institutions that are exploring the space. As these platforms require KYC/AML conditions and permissioned, institutions won’t have difficulty in terms of regulations and security while also utilizing the benefits of treasury bill-backed stablecoins.

These stablecoins can be very effective for institutions in developing countries whose access to the US dollar is limited.

Moreover, LSD-backed stablecoins can be a great tool for institutions that are familiar with the Ethereum and DeFi ecosystem as these stablecoins can help institutions increase their exposure to $ETH or in general to the Ethereum ecosystem.

b) Whales/LPs

I believe that Whales/LPs is the most exciting user category for yield-bearing stablecoins as these users have enough knowledge, experience, and capital to utilize yield-bearing stablecoins for high yield by developing leveraged trading strategies.

Most of the yield-bearing stablecoins can be utilized in several ways such as:

1. collateralized debt positions

2. yield-bearing

3. internet bond

4. leveraged yield-farming

Thanks to these utilities, whales/LPs can effectively develop trading/farming strategies and benefit from yield-bearing stablecoins.

LSD-backed stablecoins and yield-generating stablecoins can be great tools to utilize/diversify or increase exposure to certain assets for whales/LPs. I believe that even though the number of users may not be high, TVL can reach respectable levels for these stablecoins.

c) Retail users

Yield-bearing assets do not meet the requirements of stablecoin functionality. To explain briefly, with the concept of stablecoin functionality, I claim that a stablecoin must have specific features to be used as money in the digital space:

1. Medium of Exchange

2. Store of Value

3. Capital Efficiency

4. Fiat On-Ramp/Off-Ramp

5. Censorship Resistance

I believe that if a stablecoin can’t meet these requirements, it can’t scale, so it won’t be a bigger player in the stablecoin market.

In the case of yield-bearing stablecoins, I think that none of them achieves stablecoin functionality as they can’t be treated as a medium of exchange and are not capital efficient. These problems limit the ability of yield-bearing stablecoins to be used in transactions or buying/selling crypto assets. As retail traders use stablecoins mostly for these reasons, it is very hard for yield-bearing stablecoins to be adopted by this category of users. Also, the lack of liquidity and lack of use cases are the main obstacles that retail traders face while using yield-bearing stablecoins.

Moreover, considering that most retail users use stablecoins for transactions while the main utility of yield-bearing stablecoins is to hold the stablecoins to earn yield, there is a mismatch between the interest of the users and protocols. As a result, I believe any stablecoin that is not treated as a medium of exchange won’t be widely used by retail users.

SWOT Analysis of Yield-Bearing stablecoins

Strengths

• Dollarization: The U.S. dollar is a highly valued asset across the developing world, and yield-bearing stablecoins are expanding the reach of the U.S. dollar to these regions, where hyperinflation and devalution of national currency decreases purchasing power.

• Sharing the inherent yield: Circle and Tether do not share the inherent yield of USD that is deposited into their protocols. However, yield-bearing stablecoin protocols share this with the holders, thus, empowering the users.

• A new source of yield: While $ETH staking-based yield-bearing stablecoins introduce $ETH yield to institutions, treasury bill-backed stablecoins bring the U.S yields into DeFi, thus, both categories create new opportunities for investors.

• Store of value: Yield-bearing stablecoins can act as a store of value against inflation as they can provide a yield of around 5-8% in USD which is a great option for users.

Weaknesses

• Medium of exchange: Yield-bearing stablecoins are inherently limited to being used as a medium of exchange due to several reasons such as capital inefficiency, limited or permissioned use cases, and lack of liquidity. However, most importantly, since these stablecoins are generating yield by just holding no one wants to use them in transactions as they would lose the yield. As a result, there is limited reason to use yield-bearing stablecoins as money.

• Permissioned/Censorship: Treasury bill-backed stablecoins are permissioned and some people such as US citizens are not allowed to use them. As a result, there is a limitation on the adoption of these stablecoins. Moreover, there can be censorship risks since the protocols must follow the orders of regulatory agencies.

• Lack of use case/lack of liquidity: Due to several issues including scalability, liquidation risk, capital inefficiency, or permissioned use cases, there is a lack of liquidity and use cases for the yield-bearing stablecoins which limit the possibility of growth.

Opportunities

• Unique value proposition against fiat-backed stablecoins: As user empowerment increases across the ecosystem, there will be more criticism against fiat-backed stablecoins as they do not share the inherent yield of USD with the holders. This can be a good opportunity for yield-bearing stablecoins to differentiate themselves.

• Institutional adoption: Treasury bill-backed stablecoins can be a good starting point for institutions outside of the US, bringing new capital flow to DeFi.

Threats

• Competition: Most of the projects do not have a competitive advantage over others, so in a couple of years due to this competitive environment and lack of innovation/differentiation, some protocols may disappear.

• Profitability for protocol: The competitive nature of this space forces protocols to become more profitable for users, which in turn, decreases the profitability of these protocols. As a result, these projects may burn their capital and can’t live for a long period of time.

• Liquidity fragmentation: Due to the competitive environment, the ecosystem will possibly face a liquidity fragmentation problem which decreases the capital efficiency of these yield-bearing stablecoins.

• Yield sustainability: While some of the yield-bearing stablecoins depend on the treasury bill rate, others follow the $ETH staking rate. The problem with this method is that treasury bill rates will surely drop in the future and it is questionable the sustainability of the business as low rates may not be attractive for users. On the other hand, if the $ETH staking ratio increases, the yield rate will decrease accordingly, and this can be a future problem for these protocols as the lower yield may not be attractive.

Are Yield-Bearing Stablecoins PMF?

In the article, various types of yield-bearing stablecoins are discussed, each targeting a different market. Rather than analyzing them solely as a single category, it would be more beneficial to rank them based on their product-market fit and then evaluate the reasons behind this ranking.

Ranking the yield-bearing stablecoins based on PMF:

1. Treasury bill-backed stablecoins: With the rise of interest rates in the US coinciding with the rise of stablecoins builders realized that treasury bill-backed stablecoins can be a great tool for users. While it is clear that the average DeFi user won’t use treasury bill-backed stablecoin due to privacy, censorship, lack of use cases, and liquidity reasons, it is possible that institutional investors outside of the USD can be excited to use treasury bill-backed stablecoins. However, I should note that when the yield drops, there won’t be further utility for these stablecoins against the fiat-backed stablecoins. Thus, I believe that treasury bill-backed stablecoins can be great tools to access the US dollar across the world for institutions or accredited investors, the market may not be as big as many believe.

2. LSD-backed stablecoins: I am skeptical about the future prospects of LSD-backed stablecoins in reaching the potential many envision as the design of these protocols includes many flaws such as capital inefficiency, liquidation risk, easy to be copied, no real innovation that limits the ability of these stablecoins to grow/scale and to be treated as a medium of exchange. However, it is also clear that they are good financial primitives for leveraging $ETH, so even though there will be a place in the market for LSD-backed stablecoins, it won’t be as big as many envisioned. On the other hand, new protocols such as Ethena, a delta-neutral stablecoin that utilizes LSTs, can create a new model that eliminates these problems.

3. Yield-generating stablecoins: I don’t believe that yield-generating stablecoins offer a competitive value proposition that differentiates in the stablecoin market. I think that these products are only wrapped $USDC or LP tokens that let users earn interest on their stablecoins with several counter-party risks. Also, it is very easy for other stablecoins to copy the business model by just creating a liquid staking version of their stablecoins to challenge yield-generating stablecoins. As a result, I believe that yield-generating stablecoins are not a product-market fit.

The stablecoin market is still in its infancy and there are several upcoming projects that aim to challenge the current models. We’ll see together how the yield-bearing stablecoin landscape evolves in the near future. However, it should be noted that there is still time for us to find a product-market fit in this niche.

These LSDfi projects can be categorized into several distinct parts. However, in this article, my primary focus will be on LSD-backed stablecoins.

Throughout the article, I will provide a concise definition of LSD and LSDfi. Then, I will delve into the analysis of LSD-backed stablecoins by individually analyzing the projects. Then, I will explain my general overview of the LSD-backed stablecoin landscape by emphasizing both their advantages and limitations. Lastly, I will offer future insights into LSD-backed stablecoins’ evolving landscape by discussing the opportunities and setbacks that these projects can face.

What is LSD? What is LSDfi?

Liquid Staking Derivatives (LSDs) are financial tools that represent ownership of a staked token in a DeFi protocol. These instruments enable users to stake their tokens while retaining the freedom to use these LSDs in various applications. Some of the LSD protocols are Lido Finance and Rocket Pool. LSDs are providing so many benefits to the ecosystem as they unlock the previously locked capital while also providing security to the network.

LSDfi describes projects that utilize LSD protocols by building financial primitives upon these protocols such as Pendle Finance and Unsheth. By offering additional yield-generating opportunities, LSDfi protocols allow LSD holders to put their assets to work and maximize yield.

However, as a sub-category, there are also LSD-backed stablecoins such as Raft, Gravita, Ethena, Prisma, and Lybra which we will review now.

Review of LSD-Backed Stablecoins

LSD-backed stablecoins are CDP model stablecoins that require over-collateralization by liquid staking tokens with liquidation risk. They allow holders to earn yields intrinsically while preserving the key attributes of crypto-backed stablecoins.

As can be seen, LSD-backed stablecoins are not so different from established crypto-backed stablecoins like $LUSD, $FRAX, or $DAI. The main value proposition that LSD-backed stablecoins offer is the $ETH staking yield while enabling users to continue to have exposure to DeFi applications. However, there are also several innovative features that new projects offer.

To have a better understanding of this category, we need to have a look at the protocols individually.

• Prisma Finance ($mkUSD)

Prisma is an LSD-backed stablecoin that is Liquity fork but with significant improvements. Prisma enables users to mint $mkUSD that is collateralized by multiple LSTs such as $wstETH, $cbETH, $rETH, $sfrxETH, and $WBETH. $mkUSD will be incentivized on Curve and Convex Finance to create a capital-efficient flywheel where users can receive trading fees, $CRV, $CVX, and $PRISMA on top of $ETH staking rewards.

My thoughts on $mkUSD are as follows:

1. Competitive value proposition: Every LSD-backed stablecoin offers the $ETH yield to the users, however, on top of it, as the $mkUSD pools are deployed on Curve, users who deposit $mkUSD can earn trading fees, $CRV, $CVX, and $PRISMA rewards which will possibly make $mkUSD more competitive against competitors.

2. Not a medium of exchange: $mkUSD is a yield-bearing stablecoin and the protocol does not prioritize to be used as a medium of exchange. Most users hold $mkUSD for the APR that holding $mkUSD provides.

3. Yield-bearing assets: As $mkUSD can generate revenue for its holders, there will surely be a demand to just use it as a store of value. If users trust the peg stability, it can be a good way to have exposure to $ETH yield

4. Innovative tokenomics approach: vePrisma holders will be able to incentivize certain pools, thus, LST providers may be interested in incentivizing $mkUSD with their own LSTs. This can create a positive flywheel effect for the demand for $mkUSD. According to the document, voters can direct emissions towards minting with a certain collateral, to keep an active borrow with a certain collateral, and to any LP tokens staker. Considering that deep liquidity is key to maintaining the peg, this will be an important point that differentiates Prisma from competitors.

5. Multiple LST Collateral: There are several LSTs that can be used as collateral such as $wstETH, $cbETH, $rETH, $sfrxETH, and $WBETH with different market caps. Thanks to the unique tokenomics approach, these protocols can incentivize users to mint $mkUSD, thus, increasing the exposure to Prisma.

6. Lack of capital efficiency: The over-collateralization model means that $mkUSD is limited in terms of capital efficiency as users need to put more money than they get. Moreover, there is always a risk of liquidation considering that the collateral rate should always be above 120%.

7. Strong backers: Compared to the competitors, even though Prisma Finance is late to the game, the protocol is supported by several strong backers such as Curve Finance, FRAX, and Convex. This backing will surely help Prisma to become more competitive as can be seen from how it utilizes $CRV and $CVX rewards via its tokenomics model.

• Raft ($R)

Raft is a protocol that mints $R stablecoin that is backed by LSTs in an over-collateralized way with a liquidation risk. Users can earn sustainable yield via depositing into Savings Rate.

My thoughts on $R are as follows:

1. Lack of innovation: Raft is a fork of Liquity with small changes, so there is not much innovation on the product, thus, it may be easily overtaken after Liquity v2, which will utilize LSTs, is launched.

2. Not a medium of exchange: $R is a yield-bearing stablecoin and the protocol does not prioritize to be used as a medium of exchange. Most users hold $R for the APR that holding $R provides

3. Peg Stability: $R is currently worth around $0.98, and the team is trying to find solutions to restore the peg. The team proposed to implement an interest fee instead of a one-time fee to mint $R. By doing this, they aim to restore the peg by incentivizing buying pressure from the open market. The reason for the depeg can be attributed to the one-time fees to mint $R, lack of liquidity, and lack of use cases to create organic demand.

4. Limited value proposition against competitors: At this point, users do not need to pay an interest fee to borrow $R so they can leverage their $ETH positions. This is the main value proposition of $R. However, if the team decides to change this model there won’t be any value proposition for Raft.

5. Yield-bearing assets: As $R can generate revenue for its holders, there will surely be a demand just to use it as a store of value. If users trust the peg stability, it can be a good way to have exposure to $ETH yield.

6. Lack of capital efficiency: As $R is a CDP model stablecoin that requires over-collateralization with liquidation risk, it is not a capital-efficient model for retail users. This will limit the ability to grow as there is limited possibility to scale.

• Gravita ($GRAI)

Gravita is a fork of Liquity that accepts different LSD products as collateral. It enables users to borrow without an interest fee and it does not take a cut of the yield generated by the deposited LST. The redemption mechanism was not launched at the beginning of the launch but has been gradually released throughout the process. This may be the reason of $GRAI is around $0.98 from the beginning which surely creates a trust issue from the user's perspective.

My thoughts on $GRAI are as follows:

1. Lack of innovation: As stated, Gravita is a fork of Liquity, and there is not so much innovation on the product, thus, it may be easily overtaken after Liquity v2, which will utilize LSTs, is launched.

2. Limited value proposition against competitors: Users do not need to pay an interest fee to borrow $GRAU so they can leverage their $ETH positions. Also, allowing $bLUSD to be used as collateral without any risk of liquidation and not taking any fee from the staking yield is a value proposition that Gravita offers.

3. Not a medium of exchange: $GRAI is a yield-bearing stablecoin and the protocol does not prioritize to be used as a medium of exchange. Most users hold $GRAI for the APR that holding $GRAI provides

4. Peg Stability: Since the launch of $GRAI, the price has fluctuated around $0.98. This can be due to the fact that redemptions of $GRAI are not allowed during the launch, and then it is released gradually, which may create excess supply, thus, decreasing the price without any arbitrage opportunity. Moreover, low liquidity and lack of use cases to create organic demand may limit the demand growth for $GRAI which also worsens the situation.

5. Yield-bearing assets: As $GRAI can generate revenue for its holders, there will surely be a demand just to use it as a store of value. If users trust the peg stability, it can be a good way to have exposure to $ETH yield.

6. Multiple LST Collateral: There are several LSTs that can be used as collateral such as $WETH, $rETH, $wstETH, and $bLUSD. This can be an advantage as it provides several opportunities for users.

7. Lack of capital efficiency: The over-collateralization model means that $GRAI is limited in terms of capital efficiency as users need to put more money than they get. Moreover, there is always a risk of liquidation which will limit the growth..

• Lybra ($eUSD)

$eUSD is a stablecoin that is reserved by staked $ETHs as collateral. Owning $eUSD leads to a consistent earnings stream with an APY of around 8%. The protocol has also a governance token called $LBR with limited utility. With the introduction of Lybra v2, several new features were released which are expected to improve the drawbacks of the protocol.

My thoughts on $eUSD are as follows:

1. Lack of capital efficiency: The over-collateralization model means that $eUSD is limited in terms of capital efficiency as users need to put more money than they get. Moreover, there is always a risk of liquidation considering that the collateral rate should always be above 150%.

2. Limited value proposition against competitors: To have the potential to grow, newly emerging LSD-backed stablecoins need to possess unique value propositions. However, even though $eUSD has an early-mover advantage, it does not offer a competitive collateral requirement or any significant improvement against its competitors.

3. Not a medium of exchange: $eUSD is a yield-bearing stablecoin and the protocol does not prioritize to be used as a medium of exchange. Most users hold $eUSD for the high APR that holding $eUSD provides.

4. Peg Stability: $eUSD holders are eligible for staked $ETH rewards. Thus, instead of minting $eUSD, most users prefer to buy it on the market, which creates demand pressure. As a result of this, there is more demand for $eUSD than its supply which breaks its peg above $1.00. Unless the system changes, $eUSD will not find its peg. This can create a problem for the holders in the long term.

5. Yield-bearing assets: As $eUSD can generate revenue for its holders, there will surely be a demand just to use it as a store of value. If users trust the peg stability, it can be a good way to have exposure to $ETH yield.

6. Multiple LST Collateral: With the introduction of Lybra v2, new LST collaterals such as $rETH and $WBETH can be used. This will increase the possibilities for $eUSD minting, but we should not overestimate its impacts.

7. Bad tokenomics: $LBR is the governance token of the protocol, however, as almost all the yield from LSDs goes to $eUSD, not $LBR, the token almost has no utility. The bad tokenomics also perpetuates the positive premium of $eUSD, so it is always over the peg since users are incentivized to hold $eUSD as it is an interest-bearing stablecoin with significant $LBR emissions, the demand for holding $eUSD greatly exceeds the demand for minting $eUSD.

• Ethena ($USDe)

Ethena Labs is a new project that has not been released yet. The project differs from the competitors by offering a delta-neutral-backed model instead of a CDP model. With this model, the project will use LSDs as collateral and create a spot-long, 1x short position on the exchange, thus, preventing the volatility of the collateral. $USDe will be more efficient as it will offer a 1:1 collateralization ratio, and also other than the LSD yield, it will also offer funding fee yield which is the result of the delta-neutral model. However, users are not exposed to $ETH price volatility.

My thoughts on $USDe are as follows:

1. Innovation: Among all of the existing projects, Ethena is the only project that offers an innovative solution. I believe that the delta-neutral model can be successful in solving some of the main problems of LSD-backed stablecoins such as capital efficiency, lack of scalability, peg stability, and more.

2. Capital efficiency: Thanks to the delta neutral model, the protocol does not require over-collateralization to maintain the peg, thus, it can offer a 1:1 collateralization ratio. As a result of this, $USDe is the best among the competitors in terms of capital efficiency.

3. Peg stability: $USDe will use delta-neutral positions to maintain the peg stability. Considering that ‘’spot-long, 1x short position on the exchange’’ will always protect the value of the collateral in theory, we can feel safe about the peg mechanism. However, it is always important to see the results in practice.

4. Medium of exchange: As $USDe offers a 1:1 collateralization ratio, it can solve the scalability problem of existing crypto-backed stablecoin. As a result of it, $USDe can be used as a medium of exchange across platforms with deep liquidity.

5. Strong value proposition against competitors: $USDe has two main distinct advantages against its competitors that can differentiate the product in the market. First of all, it can offer a 1:1 collateralization ratio which will be more attractive to the user. Moreover, adding to the LST yield, $USDe will also offer the funding rate yield, which will be more competitive against the existing projects.

6. User adoption: As every innovative project faces the same problem, $USDe will also face some suspicion from the community as the delta-neutral method is not widely known and experienced, so it will take some time for Ethena to educate the users and experiment with the method.

7. No exposure to ETH volatility: As the deposited collateral is used to create a hedged position, the user won’t have any exposure to the price volatility of $ETH. Risk-averse users can see it as a benefit, however, $ETH maxis may see it as a drawback.

Thoughts on the general Landscape of LSD-Backed Stablecoins

Until now, I shared my thoughts on individual LSD-backed stablecoins so that we can have a better understanding of the dynamics of these stablecoins while analyzing their opportunities and limitations. I believe that this analysis can be helpful in understanding the competitive landscape of LSD-backed stablecoins and prove the trade-offs of every individual stablecoins.

Now, I will share my general overview of the LSD-backed stablecoin landscape so that we can predict how this category may evolve. To do so, I will implement a SWOT analysis:

Note: It should be highlighted that a general SWOT analysis for every LSD-backed stablecoin can’t provide a great overview as every one of them has different values/features. This especially applies to Ethena Labs, as their delta-neutral mechanism is completely different from CDP models. For example in the weakness section, capital efficiency, medium of exchange and limited use cases do not apply to $eUSD, Ethena’s stablecoin.

Strengths

1. Store of Value: LSD-backed stablecoins are great tools as a store of value as most of them have achieved price stability while offering the $ETH yield to the users. As a result, they can increase their market share in the near future as a low-risk yield opportunity and as a store of value. With people realizing that LSD-backed stablecoins empower users by sharing the inherent yield with them over fiat-backed stablecoins, the adoption rate will grow.

2. Yield opportunity: While having 5-8% APR on their stablecoins may not be attractive for retail traders, it is a great opportunity for the whales and leveraged traders considering that the high-yield opportunities in the DeFi ecosystem have been limited as the bear market continues.

3. Unlocking the liquidity: LSDs are a great way to unlock the staked $ETH liquidity, and on top of this, LSDfi, and in particular, LSD-backed stablecoins improve this situation further by creating new use-cases for LSDs which will surely further grow the opportunities for the ecosystem.

4. Increased $ETH Exposure: LSD-backed stablecoins are great tools to expand the Ethereum ecosystem as they improve the ways users can expose $ETH and also create new use-cases for it, so more organic demand.

Weaknesses

1. Growth depends on LSDfi adoption: LSDfi is a new category that needs to be explored further. As the first movers in this category, LSD-backed stablecoins will be highly dependent on the overall growth of the market which is partly independent of their impact.

2. Capital efficiency: As LSD-backed stablecoins also implement the CDP model, they require over-collateralization with liquidation risk. Thus, capital efficiency becomes a central challenge that users face.

3. Medium of exchange: LSD-backed stablecoins are inherently used for yield opportunities and as all of them are dependent on the CDP model, there is no possibility for LSD-backed stablecoins to be treated as a medium of exchange which will limit the scalability of these products.

4. Limited use-cases: Even though being a sustainable yield-bearing asset is a great value proposition, the liquidity fragmentation and lack of liquidity limit the use cases of LSD-backed stablecoins. Other than holding it, there are limited ways of utilizing these stablecoins.

Opportunities

1. ETH Staking Adoption: ETH staking is one of the areas in which we’ll see further growth with the continuing trust in the safeness of the Ethereum ecosystem and $ETH staking yield. With the $ETH staking rate possibly growing in the future, it can be predicted that LSD-backed stablecoins will benefit from it.

2. Store of value against inflation: There will always be a strong demand for yield-bearing assets due to inflation. As we can see from the attempts to build inflation-resistant stablecoins/flatcoins, there is a massive demand for them. Even though, in essence, LSD-backed stablecoins do not exist to beat inflation or act as a store of value against inflation, they proved that they can work as a great tool against inflation.

Threats

1. Lack of innovation: I believe that LSD-backed are mostly Liquity forks with little difference. As a result, they don’t add so much value proposition against Liquity except by allowing Liquid Staking Tokens (LST) to be used as collateral. I don’t see the reason why most of the investors would still use these protocols when Liquity allows LSTs to be allowed, which possibly will be realized with the launch of Liquity v2.

2. Yields may go lower: As there is always the possibility of $ETH staking yield going lower, the yield that LSD-backed stablecoins will be lower as well. This may disincentivize users to prefer these stablecoins. Considering that more $ETH will be staked in the future, this is an inevitable result that LSD-backed stablecoins will face.

3. Low demand and liquidity: Until now, most of the LSD-backed stablecoins are not able to maintain the peg around $1. Even though there are specific reasons for this situation, the common problem is that there is no strong demand and liquidity for these stablecoins.

4. Liquidity fragmentation due to the competition: At this point, there are several teams that are trying to build an LSD-backed stablecoin, and there is no clear-cut winner in this race. This means that liquidity fragments among the competitors which limit the ability to grow, thus preventing the product more effective or generating revenue. All of these may have a long-term impact on the success of the LSD-backed stablecoins.

5. The end of the bear market: Most of the investors choose LSD-backed stablecoins as a yield-bearing asset as there is no better solution/alternative during the bear market. However, when the bull market starts, the capital can flow into more profitable ventures as 5%-8% APR during the bull run may not be attractive. However, it should be noted that the end of the bear market will surely help these protocols grow as the general market cap will further grow.

Future Implications: Making LSD-backed stablecoins more efficient

It is clear that there is a growing interest in the LSD-backed stablecoins coinciding with the rise of LSDfi products. I believe that this trend will continue to grow. However, I think that most of the current models of LSD-backed stablecoins are not going to be a product-market fit or they won’t have a competitive edge over their competitors.

Some LSD-backed stablecoins such as $R, $GRAI, and $eUSD do not have definitive value propositions against existing projects like $crvUSD and $LUSD. It is possible that these protocols will be able to diminish the share of the aforementioned projects.

Prisma Finance is an interesting case as they’re developing unique tokenomics to improve the yield for the stablecoin holders and may create value for the governance token holders. Even though the stablecoin’s current CDP model is not unique and it does not add a new value proposition against the existing ones, the protocol may have a chance due to its tokenomics as it creates an organic demand for the user which deepens the liquidity so that maintaining the peg becomes easier.

Ethena Labs is a unique model that challenges the existing models. The protocol is more capital efficient and can create more revenue via funding fees due to the delta-neutral position that the protocol opens to maintain the collateral. This is crucial as this model creates an organic yield over to the existing LST yield and makes the protocol more competitive. However, it should be noted that in the CDP model, when the price of collateral goes up, the borrower gains profit. Still, in the case of Ethena, the user gives up the possible profit from the upside volatility of $ETH as the peg is maintained by the delta-neutral position. In general, I think that Ethena can solve some of the main problems of LSD-backed stablecoins such as capital efficiency, lack of scalability, peg stability, and more.

In general, the future of the LSD-backed stablecoins will depend on:

1. New models to improve capital efficiency

2. New sources of yield

3. ETH Staking adoption

4. LSDfi adoption

We’ll see what the future brings.

I believe that the inherent limitations of crypto-backed stablecoins are not discussed enough. As we will discuss in the article, the current projects have failed to attract users as the crypto-backed stablecoins are limited against fiat-backed stablecoins in several areas such as capital efficiency, liquidation risks, limited use cases, and liquidity.

Throughout the article, I’ll look at some stats on the current landscape of stablecoins and share some thoughts on that. Then, I will discuss stablecoin functionality as a concept that helps us to understand the reasons for the state of the stablecoin market. Lastly, I will focus on crypto-backed stablecoins individually, and address their problems.

Current Stablecoin Market Stats

Looking at the numbers from DeFiLlama:

• The total stablecoin market cap is around $125 billion with almost 87% of it held by $USDT and $USDC.

• Around 92% of the whole market is held by fiat-backed stablecoins with almost $116 billion.

• Only around $7 billion is held by crypto-backed stablecoins in which $DAI holds around $5 billion.

• The total market cap of algorithmic stablecoins is around 2 billion while $FRAX and $USDD capture 75% of the market share.

What does this data tell about the market conditions?

This data provides several insights about the market conditions:

1. $USDT and $USDC are projects that have achieved product-market fit and are in sync with market and user demands.

2. Despite the increasing number of projects in the crypto-backed stablecoin category, the dominant market share of $USDT and $USDC proves that there is no demand for alternatives right now.

3. Even though the increase in the DAI Savings Rate has helped DAI to gain market share for a while, $DAI has failed to maintain its market cap in terms of USD value for the last year while its dominance among crypto-backed stablecoin is unchallengeable.

4. With $DAI being the primary widely adopted crypto-backed stablecoin, its move towards RWA including US treasuries highlights the absence of a scalable stablecoin that is resistant to censorship and immune from counter-party risks.

5. Other crypto-backed stablecoins, excluding $DAI, have limited adoption, suggesting that their success and potential might be overestimated.

6. The viability of algorithmic stablecoins is uncertain, given that $FRAX is also attempting to distance itself from algorithmic mechanisms.

7. Notable changes in the stablecoin landscape are unlikely unless a major event undermines the credibility of $USDT and $USDC, or a groundbreaking project emerges.

Why do users prefer $USDT and $USDC?

Crypto started as a movement that was defined by the belief in freedom, decentralization, and skepticism toward centralized actors. However, the current landscape of the stablecoin market says otherwise. It is clear that with adoption in the ecosystem increases and more people coming to the space, the purity of the ecosystem also decreases, as most of the newcomers are not here for decentralization or censorship resistance.

The most centralized and may be the least transparent projects are the market leaders. The main reason for this situation can be explained with a new concept that I framed, called stablecoin functionality:

Stablecoin functionality is a new concept to understand some of the main topics in the stablecoin landscape:

1. The market dynamics between users and stablecoin projects

2. The reasons why some stablecoins are adopted while others not

3. The vision that stablecoin project developers should have

I claim that stablecoins should be treated as the digital versions of off-chain assets to which they are pegged. Thus, in our case, USD-backed stablecoins need to represent the functions of USD. These functions can be integrated into stablecoins as:

1. Medium of Exchange: A stablecoin should be seen by the users as a tool to exchange cryptocurrencies or make transactions with others, and it needs to be available in major protocols such as CEXs and established DeFi projects like Uniswap, Balancer, Curve, etc. and needs to have basic pairs.

2. Store of Value/Peg Stability: A stablecoin should have a historical performance of maintaining its peg, even a change of 1% can be seen as a failure from the perspective of the user.

3. Capital Efficiency: If a stablecoin requires over-collateralization or poses a liquidation risk, it is not capital efficient which will limit the adoption of users as most of the users understandably expect their holdings not to have these risks or limitations.

4. Fiat On-Ramp/Off-Ramp: If a stablecoin does not provide on-ramp/off-ramp solutions, it is becoming harder to use it as the long road of converting the crypto assets into cash dollars makes the process costly and tiring.

5. Censorship Resistance: A stablecoin should protect its users from the arbitrary actions of centralized actors by being a safe haven of privacy and self-custody while also not relying on centralized entities such as banks.

As it can be understood, $USDT and $USDC have most of these functions including medium of exchange, store of value, capital efficiency, and fiat on-ramp/off-ramp solutions, but both stablecoins are centralized and thus not censorship resistant. Even though $USDT and $USDC are not able to achieve full success within the framework of stablecoin functionality, they are the most successful ones in this framework, thus, they are product-market fits. Adding to these, the early-mover advantage of these projects coupled with brand awareness makes them highly adopted by users.

Thus, it is clear that to threaten to dominance of $USDT and $USDC, a stablecoin project needs to meet these 5 major requirements and then have brand awareness among the community.

However, we need to consider whether it is even possible or not to challenge $USDT and $USDC among the current models/technological developments within the crypto-backed stablecoins. Let’s dive into some of the existing stablecoin projects that may be considered challengers to $USDT and $USDC.

Review of crypto-backed stablecoins

In this section, I will focus on a couple of stablecoins that I think are worth analyzing as they comprehend all aspects of the crypto-backed stablecoins that are necessary to have a look at.

Before diving into each stablecoin, I would like to highlight that I believe that the limitation of the Collateralized Debt Position (CDP) model is a major problem that every crypto-backed stablecoin faces. CDP requires users to lock crypto assets in an over-collateralized loan with liquidation risk, thus, it is inherently limited in scale.

The lending-borrowing relationship between users and protocols is problematic as it does not suit stablecoin functionality in several ways:

1. Medium of exchange: As users are creating a lending position via minting, other than leveraged yield farming and leveraged trading, they won’t use this stablecoin for transactions. Therefore, crypto-backed stablecoins are not treated as a medium of exchange.

2. Capital efficiency: As CDP requires over-collateralization with liquidation risks, it is not capital efficient from a user perspective as there are more capital-efficient ways instead of minting a crypto-backed stablecoin.

As a result, we can say that crypto-backed stablecoins are not product-market fits, however, we need to analyze these stablecoins individually so that we can have a better understanding of the limitations and drawbacks while also highlighting the opportunities.

$DAI

$DAI is an over-collateralized CDP stablecoin that is issued by MakerDAO. It is one of the biggest crypto-backed stablecoins that attracts billions of dollars and saw good adoption in the DeFi ecosystem. However, with the launch of new crypto-backed stablecoins and the recent depeg of $DAI related to the depeg of $USDC, the stablecoin lost some of its market share to the competitors. However, with the introduction of the Enhanced DAI Savings Rate, the protocol achieved some traction again, even though the discussions on sustainability continue.

While it is one of the most profitable businesses in the ecosystem as the protocol utilizes its holdings in treasury bills, its future is also questionable as the protocol receives several criticisms such as ‘’$DAI is poor man’s $USDC’’ or dependency on centralized actors.

It is clear that the Maker DAO team decided to part ways with the ethos of decentralization and focus on monetization of the protocol, which in essence is not a bad thing in terms of business, however, it surely created some problems, for example, why should I use $DAI, why I can use $USDC?

As far as I am concerned, there are several challenges that $DAI will face:

1. Lack of innovation: $DAI is minted by a CDP position that is over-collateralized, thus, it does not possess any significant technological superiority against its competitors. The launch of the Enhanced DAI Savings Rate is also a good indicator that the project is having difficulties attracting users.

2. Dependency on centralized actors: $DAI is not a mostly decentralized stablecoin as it is reserved by mostly $USDC and RWA assets and revenue is generated via treasury bills which means that the custody of the assets is handled by a centralized actor.

3. No significant value proposition: The main value proposition of crypto-backed stablecoins is being decentralized and censorship-resistant. As a trade-off, these protocols implement CDP models and require over-collateralization with liquidation risk. However, while $DAI maintains these drawbacks, it does not offer any value proposition in terms of decentralization. Thus, it combines the worst parts of fiat-backed and crypto-backed stablecoins.

On the other hand, there are also opportunities that $DAI possesses:

1. High adoption: $DAI is one of the most well-known and adopted stablecoins in the ecosystem. This can be proven that there are around 500K $DAI holders*. Moreover, $DAI exists in most of the well-established DeFi protocols with strong liquidity. Considering that bootstrapping liquidity is the toughest part that every stablecoin project faces, $DAI is positioned in a very good place.

2. Medium of exchange: $DAI is perceived by many as a medium of exchange which can be proven by the fact that it is used by many to make transactions and buy/sell crypto assets while it has several pairs in different protocols with deep liquidity.

3. Store of Value: With the introduction of treasury bill revenue distributed to the DAI stakers via the Enhanced DAI Savings Rate, $DAI can be a safe and reliable source of yield and store of value, thus, increasing the adoption.

$FRAX

$FRAX started as an algorithmic stablecoin that is both backed by an algorithmic mechanism and a crypto reserve that is undercollateralized. However, the fall of $UST caused a loss of trust regarding algorithmic stablecoins made the FRAX team change this model. Thus, they decided to use $USDC as the reserve to reach 100% ratio collateralization. However, this model got criticism as $FRAX became a ‘’poor man’s $USDC’’.

However, this model will also change with the soon-release of FRAX v3. Even though not all the detail is public, it is rumored that the dependency on $USDC will be dropped and the FRAX ecosystem and its stablecoin $FRAX will be backed by US Treasury Bills.

As far as I am concerned, there are several challenges that $FRAX will face:

1. Dependency on centralized actors: One of the most frequent criticisms is that $FRAX depends on $USDC if $FRAX is reserved by $USDC, what is the reason to hold it? Even though they are changing the model, the dependency on centralized actors will still continue as they will work with other centralized actors for the FED Master Account.

2. The confusing and changing vision of the leadership team: It is debatable whether the criticism is valid or not but the FRAX leadership team looks like they’re focusing on too many developments in a short period of time and changing the roadmap very frequently which raises the question of what is the vision FRAX.

3. **Lack of $FRAX holders/users:** Considering that [$FRAX has around 8k holders](https://etherscan.io/token/0x853d955acef822db058eb8505911ed77f175b99e) according to Etherscan stats with a market cap of around $800 million**, the value proposition that $FRAX posses is not being a medium of exchange, thus, this limits $FRAX’s potential to challenge $USDT and $USDC. Frax is not widely used as a pair in the ecosystem. Apart from the products that are built on top of the Frax, it is only used on Curve. The reason for this is the incentives that Curve pays to $FRAX pools as a result of the position of Frax on Curve Wars. The sustainability of the Curve will be an important parameter for $FRAX as well.

On the other hand, there are also opportunities that $FRAX possesses:

1. Capital efficiency: At this point, users can deposit 1 $USDC and get 1 $FRAX which is capital efficient. It can be supposed that with migrating the new model, this capital efficiency will continue, thus, it is a competitive advantage that $FRAX possesses.

2. Established FRAX ecosystem to boost the use cases of $FRAX: Most of the stablecoins face the use cases problem, meaning that there is no place to utilize the underlying stablecoin. However, $FRAX can be used effectively via the general FRAX ecosystem including Fraxswap, Fraxlend, Fraxferry, and maybe in the future in the Fraxchain.

$LUSD

$LUSD is one of the most-forked stablecoin projects in the ecosystem as it offers a unique solution that provides censorship-resistant stablecoin. It is backed by $ETH, and users can borrow against their $ETH holdings with a minimum collateral ratio of only 110%.

Some of the features that make $LUSD competitive:

1. Immutable Smart Contracts

2. Governance Free

3. No interest charged

4. Collateral quality

Moreover, as we can see from the latest announcements from Liquity Protocol, with the launch of Liquity v2, they will develop a new model that will utilize delta-neutral methods to maintain the value of the collateral. This will be a new stablecoin that is separate from the existing project.

As far as I am concerned, there are several challenges that $LUSD will face:

1. Limited Scalability: Even though $LUSD is one of the most inspiring projects in the ecosystem, it is also one of the least scalable ones as it requires over-collateralization, possesses liquidation risks and only $ETH is accepted as collateral.

2. Lack of $LUSD holders/users: As a result of the lack of scalability of $LUSD, there are only 8k holders of the stablecoin with a market cap of around $300 million according to Etherscan***.

3. Lack of use cases: As $LUSD is not scalable enough, it is not possible to find enough liquidity across the major protocols, thus, preventing the adoption of $LUSD.

4. Capital Efficiency: Liquidity requires over-collateralization with liquidation risks, thus, it is not a good choice in terms of capital efficiency that limits the ability of $LUSD to be treated as a medium of exchange.

On the other hand, there are also opportunities that $LUSD possesses:

1. Censorship resistance: The most unique aspect of $LUSD is that it is the best project in terms of decentralization and censorship resistance. I do not think that there is competition in this field.

2. Strong brand: $LUSD’s long-term success in terms of decentralization and peg stability and the team’s success in achieving trust among the community makes the $LUSD brand a strong one, that can be utilized by the team.

3. Liquity v2: Liquity team is aware of the existing problems regarding the scalability of the protocol, and they aim to scale without breaking. Developing a delta-neutral model that uses a principal protection method to prevent the losses caused by the volatility can solve the scalability issue to some extent.

$eUSD

$eUSD is a stablecoin that is reserved by staked $ETHs as collateral. Owning $eUSD leads to a consistent earnings stream with an APY of around 8%. It is a CDP stablecoin that requires over-collateralization with liquidation risks.

As far as I am concerned, there are several challenges that $eUSD will face:

1. Lack of capital efficiency: The over-collateralization model means that $eUSD is limited in terms of capital efficiency as users need to put more money than they get with a liquidation risk.

2. Limited use cases: $eUSD does not have many use cases as the stablecoin does not have enough demand to create liquidity for several pools which limits the ability to scale.

3. Limited growth potential: To have the potential to grow, newly emerging stablecoins need to possess unique value propositions, however, even though leveraging LSD products can be seen as a good way to scale, it is limited as the market is very competitive.

4. Not a medium of exchange: $eUSD is a yield-bearing stablecoin and the protocol does not prioritize to be used as a medium of exchange. Even though this is also an important value proposition, it limits growth potential.

5. Peg Stability: eUSD holders are eligible for staked $ETH rewards. As a result of this, there is more demand for eUSD than its supply which breaks its peg above $1.00. Unless the system changes, eUSD will not find its peg.

On the other hand, there are also opportunities that $eUSD possesses:

1. Yield-bearing assets: As $eUSD can generate revenue for its holders, there will surely be a demand to just use it as a store of value. If users trust the peg stability, it can be a good way to have exposure to $ETH yield.

2. Exposure to LSD products: LSDfi is a growing market that surely has achieved product-market fit, Utilizing LSDs to mint a stablecoin is a lucrative business both for the protocol and the user.

$crvUSD

$crvUSD is a CDP stablecoin project that requires over-collateralization with liquidation risks. What makes $crvUSD unique is its liquidation mechanism called LLAMMA. With this method, LLAMA employs distinct price ranges to gradually sell off segments of the collateral, instead of immediately selling everything at a designated liquidation value. Consequently, as the collateral's price decreases, portions of it are auctioned off in exchange for $crvUSD.

Until now, the stablecoin has achieved a gradual increase in market cap without any major depeg. However, while it has around $100 million in liquidity, it only has around 600 holders**** which is concerning in terms of how scalable the product is.

As far as I am concerned, there are several challenges that $crvUSD will face:

1. Lack of capital efficiency: As $crvUSD is over-collateralized CDP position with liquidation risk, it can scale up to a certain as it does not differentiate itself from competitors in terms of capital efficiency.

2. Limited use cases: Due to the low liquidity and lack of scalability of $crvUSD, there are limited use cases of $crvUSD in which you can use the stablecoin. There are several staking pools of $crvUSD, however, considering the trade-offs, it is not very attractive.

3. Lack of holders: As stated, there are around 600 $crvUSD holders which is due to the lack of demand for CDP stablecoins. Thus, even though, it offers a unique liquidation mechanism that is superior to other CDP stablecoins, $crvUSD will have a problem attracting new holders.

On the other hand, there are also opportunities that $crvUSD posses:

1. Unique liquidation mechanism: $crvUSD’s soft liquidation mechanism is a great innovation that will surely be copied by the competitors as it prevents hard liquidation until a certain point which can increase the scalability of CDP stablecoins.

2. Curve backing: Curve is a well-established stable swap that has been in the ecosystem for years with deep liquidity that $crvUSD can utilize in the future and effectively increase its scalability.

Conclusion

It was a long read, and there is one simple thing that you should remember after closing the tab.

"The future of crypto-backed stablecoins will be determined by a simple question:

'Will users be able to buy stablecoins instead of lending?'

The current models do not provide a great solution in the crypto-backed stablecoin landscape that achieves stablecoin functionality. Thus, $USDT and $USDC can continue to dominate the space.

However, they also have some limitations, especially in terms of decentralization, censorship resistance, and self-custody.

I am sure that there can be new models that tackle these problems and achieve stablecoin functionality, however, I am also pretty sure that current models are broken and won’t succeed.

Notes

*This data is taken from Etherscan, and it may not include the stakers.

**This data is taken from Etherscan, and it may not include the stakers.

***This data is taken from Etherscan, and it may not include the stakers.

****This data is taken from Etherscan, and it may not include the stakers.

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.