Are stablecoins a new financial system or will they be replaced?

Author: DC Source: X, @DiogenesCasares Translation: Shan Ouba, Golden Finance

Stablecoins account for two-thirds of all on-chain transactions, whether for exchange, DeFi transactions, or simple transfers. At first, stablecoins rose to prominence with Tether - the first widely used stablecoin, born in the context of Bitfinex users seeking a solution to their limited bank accounts. Bitfinex created USDTether, which is pegged to the US dollar at a 1:1 ratio. Subsequently, USDT spread rapidly, and traders used it to arbitrage between different exchanges. Compared with bank wires that take days to process, USDT transactions can be completed in just minutes.

Although originally a product of the crypto industry, the application of stablecoins has long surpassed this scope. Today, they have become a powerful tool for everyday currency transfers and are widely used to earn income and real-world transactions. Stablecoins account for about 5% of the total crypto market, and if you include the companies that manage them and the blockchains that rely on them, such as Tron, stablecoin-related assets account for 8% of the total crypto market capitalization.

However, despite the rapid growth of stablecoins, there is still limited discussion about why they are so popular and why tens of millions of users around the world choose stablecoins as an alternative to the traditional financial system. In addition, there is even less research on the platforms and projects that are driving the expansion of stablecoins, as well as the user groups that use these applications. Therefore, this article will explore why stablecoins are popular, the main players in the industry, and the current core user groups, and analyze how stablecoins are becoming "the next evolution of money."

A Brief History of the US Dollar

When you think of "currency", what comes to mind? Cash? Dollars? Prices at the supermarket? Taxes? In all of these scenarios, currency is a conventional unit of value. Currency first appeared in the form of shells, salt, and later developed into copper coins, silver coins, gold coins, and eventually evolved into modern fiat money.

Modern fiat money (i.e., money issued by the government, not backed by commodities) has gone through multiple stages. In the United States, the first paper money was issued by private banks themselves, similar to the Hong Kong dollar system in Hong Kong today. However, because this model was problematic, governments eventually stepped in and passed laws mandating that the dollar be backed by gold.

• 1871: Western Union uses the telegraph to complete the first wire transfer, making the financial system more efficient by allowing funds to be transferred without the need for physical cash.

• 1913: The Federal Reserve System is established.

• 1971: Nixon ends the gold standard, and the dollar is no longer tied to gold, allowing it to float freely.

• 1950: The first credit card is created.

• 1973: The SWIFT payment network is established, enabling faster, more global dollar transactions.

• 1983: The first digital bank accounts appear at Stanford Federal Credit Union.

• 1999: PayPal is launched, allowing users to complete purely digital payments without a bank account.

• 2014: Tether issues the first dollar-backed stablecoin, laying the foundation for today's stablecoin ecosystem.

This history tells us a core fact: money, what it is and how we use it is always changing. Today, we can pay $20 with PayPal, Cash App, Zelle, or bank transfer, and using traditional bank transfers may even be considered "outdated." This trend is more pronounced in developing countries, but it is also becoming a reality in developed countries.

Many people have become accustomed to using stablecoins to pay wages, withdraw cash, and even replace bank deposits with stablecoins, and earn returns through protocols such as HyperliquidX’s HLP, AAVE, Morpho, and StreamDeFi.

In many countries, the existing financial system is burdensome for consumers. Capital controls, monopolistic banks, and high fees are the norm. In such an environment, stablecoins have become a tool for financial freedom, making cross-border transfers more convenient and gradually used to pay for goods and services directly. So why can stablecoins quickly replace the traditional financial system in just a few years?

Stablecoins vs Bank Transfers: A Tale of Two Cities

Essentially, stablecoins are digital tokens backed by fiat currencies such as the US dollar or the euro. For users in developed countries, the existing financial system is relatively efficient, such as:

• United States: PayPal and Zelle

• Europe: SEPA (Single Euro Payments Area)

• Asia: Alipay, WeChat Pay and other mature financial technology systems

Users in these regions do not need to worry about the safety of bank account funds, nor do they face the problem of hyperinflation. Although large bank transfers may take longer, the overall financial system is still smooth, and most companies prefer to let customers use the local banking system because it is considered safer and more convenient.

But in other regions, the situation is completely different:

• Argentina: Bank deposits have been confiscated by the government many times, and the local currency is one of the worst currencies in history.

• Nigeria: There are official and unofficial exchange rates, and it is extremely difficult to move money in and out of the country (similar to Argentina).

• Middle East: Bank account balances can be frozen at will by the government, making many people reluctant to deposit funds in banks.

In addition, traditional international money transfer services (such as SWIFT) are expensive and cumbersome, and many people do not have bank accounts at all. For example, Western Union's international remittance fees can be extremely high and use official government-set exchange rates, which can lead to significant hidden fees. Stablecoins allow people to hold funds outside of their local financial system because they are global in nature and transfers are made via blockchain rather than local bank servers. This reflects their history, as it was difficult for cryptocurrency exchanges to obtain bank accounts and process large deposits and withdrawals as well as transfers across exchanges. It is well known that there was arbitrage between global cryptocurrency prices and Japanese prices due to the overly bureaucratic Japanese banking system and its capital controls. Binance published its white paper in 2017 stating that it would only facilitate stablecoin-cryptocurrency trading pairs to ensure faster settlement. As a result, most trading volumes began to be processed in the form of stablecoin pairs. This position was further cemented in 2019 when Binance listed USDT perpetual derivative contracts, allowing users to trade on margin using USDT instead of BTC. Stablecoins in crypto have become widely accepted as underlying assets by others around the world - and now this acceptance is beginning to extend beyond pure crypto use cases.

Let's start by comparing stablecoins to fintech: mainly their speed, innovative design, and focus on solving global financial problems. Until now, fintech has largely been able to glorify or whitewash the current obscure and complex payment infrastructure for users.

Stablecoins represent the first major change to the global financial system in 50 years. Their speed, reliability, and verifiability make them ideal for storing value and sending remittances without paying high fees (although admittedly this comes at the cost of losing the traditional safeguards of the existing bureaucratic system). Stablecoins can be seen as competing with cash and payment processors such as Western Union, while being more durable and secure than cash. They cannot be washed away in floods, stolen in burglaries, and are easily exchanged for local currency. Fees (depending on the blockchain) are typically less than $2 and fixed, well below the floor for processors like Western Union, whose fees are variable but can range from 0.65% to as high as 4%+.

Once stablecoins are accepted and mature, they will inevitably be used to fill holes in the global financial system that traditional providers have yet to fill. With this stablecoin adoption, additional services and more complex products have also exploded. MountainUSDM brings RWA yields to numerous platforms in Argentina, and Ethena allows users to earn money through delta-neutral transactions without having to touch the traditional banking system or exchange custody.

Stablecoins are increasingly being used to earn yield and process local payments, rather than just processing payments or holding value/selling local currency. As this happens, stablecoins are becoming a core part of financial planning and even corporate balance sheets around the world. Many stablecoin users may not even know they are using cryptocurrencies in the background, which is a testament to the huge leaps companies have made in creating products around stablecoins over the past few years.

Companies Recruiting Stablecoin Users

The main projects associated with stablecoins are first and foremost their issuing companies. USDC is issued by @circle, USDT is issued by @Tether_to, DAI/USDS is issued by @SkyEcosystem, and PYUSD is a collaboration between @PayPal and @Paxos. There are many other stablecoins, but these are the ones that are primarily used for payments. Most of these companies hold bank accounts, receive traditional bank transfers and convert them into stablecoins to provide to users.

Stablecoin issuers hold these transferred funds and charge users a very small fee (usually 1-10 basis points). Users can then freely transfer these assets, while the issuer earns interest (or the equivalent of "floating income" for users more familiar with DeFi) on the funds held in the bank account. As many exchanges increase supervision of users who only use stablecoins for deposits and withdrawals, trading companies are increasingly handling large-scale stablecoin-dollar conversions. These trading companies often offer more competitive exchange rates than local exchanges, thereby increasing the circulation efficiency and competitive advantage of stablecoins. In this environment, all major trading companies are competing with each other to facilitate these fund flows. At the same time, stablecoin issuers make profits by earning interest on user funds instead of charging users high fees.

It is worth mentioning that @SkyEcosystem (formerly MakerDAO) has a different model. Sky uses a hybrid model, where its stablecoin USDS is backed by multiple collaterals and backed by other currency reserves. Users can deposit these collateral assets and lend USDS at a preset interest rate. Users can also deposit USDS into the Savings Rate module to earn a return equivalent to the "risk-free rate", or lend USDS on platforms such as @MorphoLabs, @aave, or simply hold it directly. This model provides both safe and stable income options, as well as higher risk but potentially higher return options.

Currently, most major stablecoin issuers do not directly face consumers, but interact with users through various companies, similar to MasterCard providing services through banks rather than directly to consumers. @LemonCash, @Bitso, @buenbit, @Belo and @Rippio These companies may not be well-known in the cryptocurrency community (CT), but the total number of KYC-certified users of these Argentine exchanges alone exceeds 20 million, which is equivalent to half the number of Coinbase users, and the population of Argentina is only 1/7 of that of the United States. Last year, Lemon Cash processed about $5 billion in total transactions, a large portion of which were conversions between stablecoins or the Argentine peso (ARS) and stablecoins. These platforms are the main entry point for most non-peer-to-peer (P2P) stablecoin transactions, and they also handle a large number of cryptocurrency transactions and stablecoin deposits. Although most of them (except Rippio) do not have their own order books, but instead use order routing systems to complete transactions.

This is similar to how Robinhood is not a real exchange, but routes transactions and provides pricing through market makers. I call these platforms “retail platforms” (because they focus on the experience and products for retail users rather than building their own trading infrastructure. Just like Robinhood will not allow professional market makers to use its app or API (in fact, if you make a lot of API requests on Robinhood, it will ban your account), the same is true for BuenBit and Lemon, because such professional users are not their target customer group.

Next, let’s look at which blockchains stablecoin transactions actually occur on, that is, where stablecoin transfers, transactions, and balances are recorded. Currently, this field is dominated by @justinsuntron’s @trondao, @binance’s Binance Smart Chain (BSC), @solana and @0xPolygon. These chains are mainly used for value transfer between users, rather than for participating in DeFi or earning yield.

While Ethereum still has an advantage in terms of TVL, its high transaction costs make it unsuitable as the preferred network for most stablecoin transfers. 92% of USDT transactions occur on Tron, and 96% of transactions on the Tron network are related to stablecoins. In contrast, stablecoin transactions on Ethereum, while still high, only account for 70% of its total transactions. In addition, several emerging public chains have emerged in the market, focusing on processing stablecoin transactions efficiently and at low cost, such as LaChain. This is an alliance composed of Ripio, Num Finance, SenseiNode, Cedalio, Buenbit and FoxBit, mainly targeting Latin American users and platforms. This shows that as the stablecoin market matures, its ecosystem has become more complex and sophisticated.

From remittances to daily payments

Since there will always be some friction (time or fees) in converting stablecoins to fiat, many companies and platforms have emerged to simplify this process. For example, Pomelo (https://www.pomelogroup.com/) provides cryptocurrency debit card payment services, allowing users to spend stablecoins at traditional merchants. @zcabrams' Bridge is a broader project that aims to simplify conversions between stablecoins, between different blockchains, and between local currencies, thereby reducing payment barriers for users and merchants. Stripe even acquired Bridge to make its own payment system more efficient. The existence of such systems shows that stablecoin payments still need a bridge mechanism, but as more merchants directly accept stablecoin payments, stablecoin-stablecoin transactions will also grow and eventually have an impact on the payment system dominated by traditional banks.

More and more companies and projects are trying to provide value-added services to stablecoin holders to encourage them to store funds on the chain instead of simply using them for transactions. For example, Lemon Cash allows users to deposit funds into @aave to earn returns. @MountainUSDM's USDM is also a yield-based stablecoin and has been integrated by multiple retail platforms and exchanges in Latin America. Many retail platforms and exchanges view stablecoin revenue as a potential long-term stable source of income, rather than relying on transaction fee income from trading volume. In a bull market, the income from transaction fees can be extremely considerable, but during a bear market, these incomes may drop significantly. Therefore, the stablecoin income business can not only increase user stickiness, but also provide a more stable income stream for the platform.

What's next for stablecoins?

The main use of stablecoins in the non-crypto space is international transfers and, increasingly, payments. However, as the infrastructure for stablecoins continues to improve and their popularity continues to grow, savings may also gradually move into the cryptocurrency space, especially in developing countries, where this trend has already begun to emerge.

A few weeks ago, @tarunchitra told me a story about a small shop in Georgia, USA, where the owner accepted customers' deposits of Georgian Lari, then converted them into USDT and earned interest, while recording the balance on a rudimentary physical ledger and taking a portion of the interest as a handling fee. In the same shop, users can also complete payments through Trust Wallet's QR code. It is worth noting that this happened in a country with a relatively sound banking system. In countries like Argentina, the Financial Times (FT) reports that citizens hold an estimated $200 billion in cash in U.S. dollars (but not in the banking system). If half of that money went into blockchain or cryptocurrencies, the size of decentralized finance (DeFi) would double, and the total market capitalization (MC) of stablecoins would grow by about 50%. And Argentina is just one of many countries, with large informal economies or low trust in the banking system in countries such as China, Indonesia, Nigeria, South Africa, and India, further highlighting the potential of stablecoins.

Possible new use cases in the future

As the use of stablecoins grows, more new use cases will continue to emerge. Currently, stablecoins are mainly used for fully collateralized credit, which is actually one of the rarest credit models in the world. However, with new tools launched by companies such as Coinbase, KYC information can be used to provide credit loans to users and may affect credit reports when repayments are not made on time.

At the same time, stablecoin issuers are increasingly allowing returns to be "passed on" to holders. For example, USDC currently offers an annual return of 4.7%, while Ethena's USDe, although its returns fluctuate greatly, usually exceeds 10%. In addition, the volume of cross-fiat transactions is increasing, that is, users first convert one currency into a USD stablecoin and then convert it into a third currency. Currently, such transactions usually require two conversion fees, and as the on-chain infrastructure improves, stablecoins may be directly converted into target fiat stablecoins in the future, thereby reducing fees and improving transaction efficiency.

As more and more funds flow into stablecoins, more and more financial products will be launched in the cryptocurrency and on-chain ecosystems, which will further promote the daily use of cryptocurrencies and gradually move them towards the mainstream.

Future Challenges

In the discussion of stablecoins, several important issues are often overlooked. First, almost all stablecoins today rely on bank accounts and the banking system. However, as we saw with the brief USDC decoupling in 2023 and the collapse of Silicon Valley Bank, the banking system is not always reliable.

In addition, the current level of use of stablecoins in money laundering is very high. If you agree that stablecoins are used to circumvent capital controls and escape the local monetary system, then you have actually tacitly accepted that this behavior is "money laundering" under the local legal framework. This has become an open secret with far-reaching consequences.

Currently, neither Circle nor Tether allows "re-issuance". In other words, if a user's stablecoin assets are frozen due to legal proceedings or are deemed to be stolen money, even if the user holds a court judgment document, the assets cannot be returned to the legal owner. This status quo is at least morally questionable and may even be difficult to maintain in the long run. Governments will increasingly exert regulatory pressure to make stablecoins more susceptible to seizure or detention. In this context, stablecoins may be replaced by central bank digital currencies (CBDCs), but I will discuss this topic in detail in subsequent articles.

However, regulatory pressure from governments will also create new opportunities for truly decentralized and privacy-preserving stablecoins to emerge, allowing them to operate in a fully decentralized environment and without government interference. I may write a more in-depth article in the future specifically exploring this "grey area" of stablecoins, as it is a wide-ranging and highly controversial topic.