The renewed interest in stablecoins

Recently, there has been renewed interest in stablecoins, signaled by the involvement of “traditional” financial institutions.

Bank of America and Standard Chartered are considering launching their own stablecoin, joining JPMorgan, which launched its stablecoin, JPM Coin — now Kinexys Digital Payments — to facilitate transactions with their institutional clients on their blockchain platform, Kinexys (formerly Onyx).

Mastercard plans to bring stablecoins to the mainstream, joining Bleap Finance, a crypto startup. The aim is to enable stablecoins to be spent directly onchain — without conversions or intermediaries — seamlessly integrating blockchain assets with Mastercard’s global payment rails.

In early April, Visa joined the Global Dollar Network (USDG) stablecoin consortium. The company will become the first traditional finance play to join the consortium.

In late March, NYSE parent Intercontinental Exchange (ICE) announced that it is investigating applications for using USDC USDCOIN stablecoin and US Yield Coin within its derivatives exchanges, clearinghouses, data services and other markets.

Why the renewed interest in stablecoins?

The stablecoin landscape

There are over 200 stablecoins, mostly pegged to the US dollar. Two well-established stablecoins, Tether’s USDt USDTUSD, the oldest, launched in 2014, and USDC, launched in 2018, hold 65% and 28% of the stablecoins market cap, respectively — both are centralized fiat collateralized.

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In third place is a relatively new one, USDe, which launched in February 2024, with about 2% of the stablecoin market cap and has an unconventional mechanism based on derivatives in the crypto market. Although it runs on a DeFi protocol on Ethereum, it incorporates centralized features since centralized exchanges hold the derivatives positions.

There are three primary mechanisms of stablecoins:

Centralized, fiat-collateralized: A centralized company maintains reserves of the assets in a bank or trust (e.g., for currency) or a vault (e.g., for gold) and issues tokens (i.e., stablecoins) that represent a claim on the underlying asset.

Decentralized, cryptocurrency-collateralized: A stablecoin is backed by other decentralized crypto assets. One example can be found in the MakerDAO stablecoin Dai DAIUSD, which is pegged to the US dollar and encapsulates the features of decentralization. While a central organization controls centralized stablecoins, no one entity controls the issuance of DAI.

Decentralized, uncollateralized: This mechanism ensures the stability of the coin’s value by controlling its supply through an algorithm executed by a smart contract. In some ways, this is no different from central banks, which also don’t rely on reserve assets to keep the value of their currency stable. The difference is that central banks, like the Federal Reserve, set a monetary policy publicly based on well-understood parameters, and its status as the issuer of legal tender provides the credibility of that policy.

Depegging, risk and fraudsters

Stablecoins are supposed to be stable. They were created to overcome the inherent volatility of cryptocurrencies. To maintain their stability, stablecoins should (1) be pegged to a stable asset and (2) follow a mechanism that sustains the peg.

If stablecoins are pegged to gold or electricity, they will reflect the volatility of these assets and thus may not be the best choice if you are seeking a no-risk (or close to no-risk) asset.

USDe maintains a peg to the USD through delta hedging. It uses short and long positions in futures, which generates a 27% yield annually — significantly higher than the 12% annual yield of other stablecoins pegged to the USD. Derivative positions are considered risky — the higher the risk, the higher the return. Therefore, it encapsulates an inherited risk due to its reliance on derivatives, which runs counter to the purpose of stablecoins.

Stablecoins have been around for more than a decade. During this time, there were no major depegging fiascos other than the case of Terra. The collapse of Terra was not the result of a reserve problem or mechanism but rather the act of fraudsters and manipulators.

TerraUSD (UST) had a built-in arbitrage mechanism between UST and the Terra blockchain native coin, LUNA. To create UST, you needed to burn LUNA.

To entice traders to burn LUNA and create UST, the creators of the Terra blockchain offered a 19.5% yield on staking, which is crypto terminology for earning 19.5% interest on a deposit, through what they called the Anchor protocol.

Such a high interest rate is simply not sustainable. Someone has to borrow at such a Trump administration executive order 14067, "Strengthening American Leadership in Digital Financial Technology