The battle for stablecoin supremacy

Original author: Christian Catalini and Jane Wu

"Recommendation: Stablecoins have the potential to reshape the global financial system and put the banking and financial industries under new digital competition. The battle for stablecoins, like the war in the field of home videos, is not determined by technological superiority or existing status, but by application. Although regulators can make it more difficult for innovators to compete, they cannot stop their progress forever. In the end, the most likely outcome is that multiple stablecoins will fade into the background, bringing lower-cost and faster payment services to the world."

Stablecoins, as a novel form of interoperable and programmable currency, have the potential to reshape the global financial system. In this process, they may prompt software to begin to devour banking and financial services - areas that have been relatively untouched by the influence of the Internet. They could displace traditional payment and credit card networks like SWIFT, Visa, and Mastercard, accelerate the unbundling of financial institutions, and expand access to the U.S. dollar in heavily restricted countries, including those due to sanctions.

They also promise to shift the balance of power in these industries. The companies that control the stablecoin market will have a significant impact on the future of money.

Given these high stakes, we are witnessing increasing competition among stablecoin issuers, prominent digital wallet providers, and traditional banks to establish the dominance of their platforms. This article delves into the strategies of incumbents and challengers, the role that regulators will play, and ultimately predicts how the market will evolve. The consequences are significant not only for financial institutions, but also for any company and digital platform that relies on large-scale money flows.

Towards an Operating System for Money?

Platform wars, where future-vision competitors battle it out for market dominance, are some of the most tumultuous chapters in business, and they showcase both the good and bad sides of business strategy.

Some turn into trench warfare, like the endless skirmishes and (sometimes controversial) growth tactics Uber deployed against Lyft in its city-to-city battles. Or, as Didi used its home-field advantage to poach drivers, gather counterintelligence, and outwit Uber with the help of regulators.

Others begin quietly as technical discussions within standards-setting organizations—like the HD-DVD vs. Blu-ray battle—and only become intense when competitors drive prices to the bottom to tilt market choice in their favor. Because these markets are winner-take-all, CEOs will do whatever it takes to get ahead.

Often, the actual technology matters less than people give it credit for. While experts debate the technical merits of each solution, in the end, execution wins. A classic but dated example is the 80s VHS vs. Betamax competition, where JVC beat Sony despite fewer resources and a lower-quality product. JVC understood that having more content—what we call “apps” today—was more important than perfect video.

The same is true in the blockchain world: more than a decade into the Bitcoin experiment, countless teams have raised billions to try to replace Bitcoin’s limited design. Yet Bitcoin remains, with network effects and institutional adoption outstripping alternatives. While engineers obsess over metrics like transactions per second, energy consumption, or dimensions of scalability and decentralization, the world moves on.

Platform wars always end the same way: a dominant design emerges, everyone switches, and the conflict ends. The loser will only have a chance to regain his position when a completely new technological paradigm emerges: think of the Mac vs. PC battle, where Apple only managed to turn the tables on the iPhone, or Meta’s aggressive deployment of AR/VR, which is currently limited to iOS and Android on mobile.

In the field of blockchain infrastructure, Bitcoin and Ethereum have become the dominant designs, and more activities will converge on them (although some people tend to ignore this fact).

However, while the blockchain war may have ended, the battle for stablecoin dominance has just begun. The former is crucial for developers, while the latter will determine our daily use. The reason is simple: stablecoins are the bridge between cryptocurrencies and traditional finance. Without stablecoins, crypto applications have to deal with volatility, which makes financial contracts costly.

The Past and Future of Money

Regulators seem to have recognized the relevance of stablecoins and their stakes. Without stablecoins, blockchains are uncompetitive. However, in their current form, stablecoins pose a challenge to banks, are used to circumvent capital and anti-money laundering regulations, and can cause or accelerate banking crises.

The run on Silicon Valley Bank was just a small preview: with about 8% of Circle's USDC reserves at risk, it quickly decoupled and withdrew $3 billion from the troubled bank. Although such risks can be easily avoided with reasonable reserve design, they are real.

Back in 2019, when Facebook announced Libra - a project designed by one of the authors of this article - central bankers may have known that such a currency would never become a new unit of account. It took years for the euro to be established, and it was enforced from the top down by all the governments involved. Even so, Libra posed a credible threat to the status quo, and was sharply criticized by financial vested interests, proposed legislation to ban it, and blocked by regulators. By 2022, the project had faded.

But the coalition behind blocking Libra only bought time for incumbents, and the situation heated up again.
Existing financial institutions are threatened by stablecoins, which could become the new operating system for money, doing to the existing system what the Internet did to Barnes & Noble. So they are determined to adopt an "embrace, expand, and destroy" strategy. Financial giants like JPMorgan have developed their own proprietary blockchains and launched the programmable dollar on them. Although Microsoft used a similar strategy against Netscape in the 1990s, which ultimately did not work well, the financial services sector is different. Regulation gives these institutions the opportunity to use their distribution networks and lobbying power to slow down the process of change while building mechanisms to fight back. This is what killed the Libra project, and other projects may soon suffer the same fate.

The last serious attempt to reform the financial system did not use blockchain technology. It was Elon Musk's original version of X.com, before it merged with Peter Thiel's PayPal. Musk was ahead of his time, wanting to build a universal financial services app. Thiel was more pragmatic, focusing on ensuring backward compatibility with card networks and banks. This solidified PayPal’s growth in the short term, but ultimately killed its chance to truly change the system. Two decades later, the card networks have become a comfortable oligopoly, and the banking industry remains untouched by the internet.

Change or status quo?

Stablecoins offer a second chance to reform the financial system. But whether they can achieve this goal depends on the dynamics of competition in the stablecoin space—and whether regulators are inclined to support or stifle innovation. By strictly limiting design choices, regulators could limit viable business models and allow only banks to enter the market. If this happens, the competition-enhancing element of the technology will once again be lost. While this may satisfy incumbent institutions, the cost to consumers and businesses is high.

Whatever the level of uncertainty surrounding regulatory intervention in the stablecoin race, the key question is whether we will end up with one or two global leaders or a multitude of commoditized issuers. Technology can support either outcome, so where we land will depend on how well each player executes their strategy.

The first entrants are crypto-native teams Tether and Circle. Tether launched the first stablecoin for trading a decade ago and dominates the market with $114 billion in USDT in circulation. USDT is issued offshore, and while its reserves have also been questioned, its core challenge is whether it can transform into a compliant entity. Despite Tether's repeated statements that it responds to law enforcement requests in a timely manner, reports from the United Nations and JPMorgan Chase question its compliance and point out that more work is needed. Tether's competitive advantage comes from its scale, integration with market makers, and strong product-market fit in market segments that cannot hold dollars. The last point is also Tether's biggest concern.

With $33 billion in USDC, Circle is Tether’s most formidable competitor. While Circle operates under the same U.S. state money transmission licensing regime as PayPal, the federal government has made it clear that the management of stablecoins should be a federal matter, as the risks involved in managing stablecoin reserves are closer to banking than simply operating a digital wallet. Therefore, for Circle, which has been seeking an IPO for years, a major suspense is whether it can successfully transition to a federal charter, especially considering that it does not implement KYC rules for USDC holders. The uncertainty of future regulation could put Circle in a leading position or face the complexity of transitioning to a bank. Banking regulation would also significantly limit Circle’s revenue sources, as the Fed rightly wants issuers to be robust and boring.

For Tether and Circle, we think the strategy is simple: adapt to stricter compliance and consumer protection standards without losing the profitability of the stablecoin ecosystem. It’s a delicate balancing act, as tighter regulation will inevitably limit how issuers create and capture value.

In the crypto-native space, Paxos, founded in 2012 to expand blockchain infrastructure, stands out for its unique strategy. Rather than scaling its own stablecoin, Paxos is betting on a world with many stablecoins. By positioning itself as a stablecoin infrastructure provider, Paxos has helped other institutions issue branded stablecoins, with significant results. When PayPal decided to get involved in the crypto space, it chose to partner with Paxos. Although PayPal’s PYUSD circulation is only $350 million, market capitalization is not the right metric if the focus is on payments rather than crypto trading and decentralized finance (DeFi). For stablecoins that want to compete with credit card companies, total payment volume (TPV) would be a better measure, and with its existing merchant business, PayPal is expected to quickly surpass USDC in this regard.

If Paxos can replicate this model with other large consumer brands that don’t want to become financially regulated businesses, the market could be flooded with stablecoins. Just as consumers choose branded rewards credit cards from airlines, hotel chains, or retailers, stablecoins could fade into loyalty points. Starbucks already holds over $1 billion in customer funds in its app, and it’s not hard to imagine Walmart or Amazon joining the fray. Target’s wildly successful RedCard program could be replicated by anyone with a loyal customer base by issuing a stablecoin, shifting revenue away from credit card companies.

Since stablecoins exist on an open network, they will all be interoperable. Moreover, if regulation makes their security uniform, a key differentiating dimension will disappear. Consumers and businesses will hold digital, programmable dollars and perceive them as analogs to today’s commercial bank deposits. This is a doomsday scenario for Tether and Circle, as they will struggle to differentiate themselves among a sea of ​​competitors with distribution advantages.

Banks are already pushing behind the scenes for a multi-stablecoin world. This is the status quo they are familiar with, where dollars from different banks are seen as interchangeable in the eyes of consumers, even though this interchangeability is conferred by the clearing mechanism of the central bank. This approach preserves the role of banks to some extent, unlike the rise of large stablecoin companies. By pushing network effects back to the dollar rather than a single stablecoin, banks are able to resist the emergence of competitors that are stronger than the card networks. Moreover, this does not prevent JPMorgan from dominating the institutional use case, or prevent Bank of America from doing the same in the retail market, thus preserving the original hierarchy.

While Visa and Mastercard can retain more competitive advantages by issuing their own stablecoins, this is fraught with antitrust risks and will damage their relationships with banks. Therefore, a multi-stablecoin world is also one that the card networks will embrace: it does not change their role, and they can add stablecoins just like adding new currencies. A slightly riskier strategy is for the card companies to work with banks to design a stablecoin that distributes reserves among them - but this may be too ambitious, similar to Libra.

This makes big tech companies unpredictable. In fact, they have all learned from the lessons of Libra that it is not wise to enter the financial services sector too high-profile. There is strong political opposition to this move, and it is better to work with banks rather than against them. In addition, their core businesses cannot operate under the federal banking legal and regulatory framework. Finally, since they control the distribution channels, they can't be stopped from using their network effects to capture value regardless of the stablecoin used. Although neobanks such as Revolut or Nubank may have greater ambitions than the big techs, they will also face business scope challenges as they further intrude into traditional banking areas.

So, are only pure stablecoin issuers such as Tether and Circle driving the winner-take-all situation? After all, with the current market highly concentrated, network effects seem to be crucial. Stablecoin liquidity has played an important role in ensuring low-cost conversion between fiat and cryptocurrencies to date, and this importance will only increase as mainstream adoption increases.

But the reality is that incumbent status does not automatically translate into non-cryptocurrency use cases, and as banks are allowed in, traditional distribution channels will become increasingly important. So while Tether and Circle have dominated the crypto era, the leap from this niche, unregulated market to serving hundreds of millions of consumers and businesses is a fundamentally different game.

That said, leading cryptocurrency exchanges like Coinbase and Binance could also enter the market and scale as pure issuers, with the user base, technical talent, and regulatory experience to compete. Both companies have built networks for payments and financial applications (Base and BSC, respectively), and as they grow, they will have to become more like traditional banks and have a deep understanding of the relevant technology—perhaps more proficient than Circle or Tether.

Disruptors Wanted

The battle for stablecoins, like the competition in home video, will not be determined by superior technology or incumbent status, but by use cases. While regulators can make it difficult for innovators to compete, they can’t stop the process forever. Ultimately, the most likely outcome is that multiple stablecoins fade into the background, providing cheaper, faster payment services to the world. This would be a win for consumers and businesses, although it might not be the case for existing stablecoin issuers—they might be acquired by banks.

When this happens, it won’t end the battle for control of our digital wallets. The same companies will still be vying to own the “payment method.” Credit card companies will fight to retain payment flows using Visa or Mastercard, which may be fine with banks. So it will be the leading digital banks and cryptocurrency exchanges that try truly innovative moves, and they may be the ones that truly change the rules of the game.