Original Author: Caesar
Original Translation: Deep Tide TechFlow
Due to the significant alignment between stablecoins and market demand, it remains a central topic of discussion within the ecosystem. As a result, developers and enthusiasts are actively exploring ways to create stablecoins that can have a lasting impact on the ecosystem. However, the progress of these efforts has been relatively limited so far.
I believe that the inherent limitations of cryptocurrency-backed stablecoins have not been sufficiently discussed. As we will discuss in this article, current projects have failed to attract users due to limitations compared to fiat-backed stablecoins, such as capital efficiency, settlement risk, limited use cases, and liquidity.
In this article, I will present some statistical data on the current stablecoin market and share some thoughts on it. Then, I will discuss stablecoin functionality as a concept, helping us understand the reasons for the stablecoin market's current state. Finally, I will focus on cryptocurrency-backed stablecoins and address their issues.
Current Stablecoin Market Statistics
The following data is from DeFiLlama:
The total market value of stablecoins is about $125 billion, with approximately 87% being USDT and USDC.
About 92% of the market share is held by fiat-backed stablecoins, totaling approximately $116 billion.
Only about $7 billion is held by cryptocurrency-backed stablecoins, with DAI holding approximately $5 billion.
The total market value of algorithmic stablecoins is about $2 billion, with FRAX and USDD accounting for 75% of the market share.
These data provide several insights into the market situation:
USDT and USDC are projects that have achieved market fit and remained aligned with market and user demands.
Despite the increasing number of projects in the category of stablecoins supported by cryptocurrencies, the dominant market share of USDT and USDC indicates that there is currently no demand for alternatives.
While the increase in savings rates for DAI helped it gain market share for a period of time, DAI has failed to maintain its market value calculated in US dollars over the past year, and its dominant position among cryptocurrencies supported stablecoins is undisputed.
As the most widely adopted cryptocurrency-supported stablecoins, DAI's shift towards actual assets, including US government bonds, highlights the lack of a scalable stablecoin that can resist censorship and be immune to counterparty risks.
Apart from DAI, the adoption rate of other cryptocurrency-supported stablecoins is limited, indicating that their success and potential may have been overestimated.
The feasibility of algorithmic stablecoins is uncertain, as FRAX also seeks to move away from algorithmic mechanisms.
Unless there are significant events that disrupt the credibility of USDT and USDC or breakthrough projects emerge, the stablecoin market landscape is unlikely to undergo significant changes.
Why do users prefer USDT and USDC?
Cryptocurrencies initially began as a movement defined by beliefs in freedom, decentralization, and skepticism towards centralized participants. However, the current state of the stablecoin market is contrary to this. It is evident that with the increasing adoption rate of the ecosystem and more people joining the field, the purity of the ecosystem is also decreasing, as most newcomers are not driven by decentralization or resistance to censorship.
The most centralized and perhaps the least transparent projects have become market leaders. This situation can be explained by a new concept I propose, called stablecoin functionality:
Stablecoin functionality is a new concept used to understand some key issues in the stablecoin space:
Market dynamics between users and stablecoin projects;
Why some stablecoins are adopted while others are not;
The vision that stablecoin project developers should possess.
I believe stablecoins should be viewed as digital versions of off-chain assets they are pegged to. Therefore, in our case, a stablecoin backed by the US dollar should represent the functions of the US dollar. These functions can be integrated into a stablecoin, including:
Medium of exchange: Stablecoins should be seen by users as a tool for exchanging cryptocurrencies or conducting transactions with others, and should be available on major protocols such as centralized exchanges and established DeFi projects like Uniswap, Balancer, Curve, etc., and need to have basic trading pairs.
Store of value/Anchored stability: Stablecoins should have a historical performance of maintaining their anchored stability, where even a 1% fluctuation can be considered a failure from the user's perspective.
Capital efficiency: If a stablecoin requires over-collateralization or has liquidation risks, it lacks capital efficiency, which restricts user adoption as most users understandably want their assets to be free from these risks or limitations.
Fiat currency exchange channels: If a stablecoin does not provide a solution for fiat currency exchange, it becomes more difficult to use as the lengthy process of converting crypto assets into cash USD can make the whole process expensive and cumbersome.
Censorship resistance: Stablecoins should protect their users from arbitrary actions by centralized participants by becoming a privacy-oriented and self-custodial safe haven that does not rely on centralized entities such as banks.
It can be understood that $USDT and $USDC have most of these functionalities, including medium of exchange, store of value, capital efficiency, and fiat currency exchange solutions, but these two stablecoins are centralized and therefore lack censorship resistance. Although USDT and USDC may not accomplish complete success within the stablecoin functional framework, they are the most successful within this framework, making them a product-market fit. Additionally, the early advantage and brand recognition of these projects have led to widespread user adoption.
Therefore, for a stablecoin project to threaten the dominant position of $USDT and $USDC, it needs to meet these 5 main requirements and have brand recognition within the community.
However, we need to consider if there are any existing stablecoin projects in the current model/technological development of crypto-backed stablecoins that can challenge $USDT and $USDC. Let's take a closer look at some existing stablecoin projects that could be considered challengers to $USDT and $USDC.
Crypto-backed stablecoins
In this section, I will focus on several stablecoin projects that I believe are worth analyzing as they cover various aspects of crypto-backed stablecoins that must be considered.
Before delving into each type of stablecoin, I want to emphasize that I believe a major issue faced by stablecoins backed by cryptographic assets is the limitations of the Collateralized Debt Position (CDP) model. CDP requires users to lock their cryptographic assets in an overcollateralized loan, which introduces liquidation risk and therefore, inherent scalability restrictions.
There are several issues with the borrowing and lending relationship between users and protocols that are not suitable for the functionality of stablecoins:
Medium of exchange: Since users create lending positions through minting, they do not use these stablecoins as a medium of exchange, except for leverage mining and trading. Therefore, stablecoins backed by cryptographic assets are not considered a medium of exchange.
Capital efficiency: From the users' perspective, the CDP model requiring overcollateralization and exposing to liquidation risk is not capital efficient, as there are more capital-efficient methods available.
Therefore, we can say that stablecoins backed by cryptographic assets do not meet the demands of the product market. However, we need to analyze these stablecoins separately to better understand their limitations, drawbacks, and also highlight opportunities.
$DAI
$DAI is a stablecoin issued by MakerDAO through the overcollateralized CDP model. It is one of the largest stablecoins backed by cryptographic assets, attracting billions of dollars in funding and gaining significant adoption in the DeFi ecosystem. However, with the introduction of new stablecoins backed by cryptographic assets and the decoupling of $DAI from $USDC, this stablecoin has lost some market share. Nevertheless, with the launch of Enhanced DAI Savings Rate, the protocol has regained some momentum, although discussions about its sustainability are ongoing.
Although being one of the most profitable businesses in the ecosystem, the protocol utilizes its treasury securities holdings, but it also faces challenges for its future, such as why should I use $DAI instead of $USDC?
Based on my knowledge, $DAI will face the following challenges:
Lack of innovation: $DAI is minted through an overcollateralized CDP position, so it doesn't have any significant technological advantages compared to competitors. The launch of Enhanced DAI Savings Rate also indicates difficulties in attracting users to the project.
Dependence on centralized participants: $DAI is not a fully decentralized stablecoin as its asset reserve consists mainly of $USDC and RWA, with income generated through treasury securities, meaning asset custody is handled by centralized participants.
No clear value proposition: The primary value proposition of stablecoins backed by cryptographic assets is decentralization and censorship resistance. As a trade-off, these protocols implement the CDP model, which requires overcollateralization and exposes to liquidation risk. However, despite retaining these drawbacks, $DAI doesn't provide any clear value proposition in terms of decentralization. Thus, it combines the worst elements of fiat-backed stablecoins and cryptographic asset-backed stablecoins.
On the other hand, $DAI also presents opportunities:
High Adoption Rate: $DAI is one of the most well-known and widely adopted stablecoins in the ecosystem. Additionally, $DAI is present in most mature DeFi protocols, providing strong liquidity. Considering that launching liquidity for each stablecoin project is the most challenging part, $DAI is in a very favorable position.
Medium of Exchange: Many consider $DAI as a medium of exchange, which is evidenced by its usage by many for trading and buying/selling crypto assets, as well as its deep liquidity across various protocols.
Store of Value: By distributing treasury coupon income to $DAI holders through Enhanced DAI Savings Rate, $DAI can become a secure and reliable source of income and store of value, increasing adoption.
$FRAX
$FRAX was initially an algorithmic stablecoin backed by algorithmic mechanisms and undercollateralized crypto reserves. However, the collapse of $UST led to a loss of trust in algorithmic stablecoins, prompting the FRAX team to change this model. As a result, they decided to use $USDC as reserves to achieve a 100% backing ratio. However, with $FRAX becoming the "poor man's $USDC," this model has faced criticism.
However, with the upcoming release of FRAX v3, this model is set to change. While not all details are public, there are rumors that they will abandon reliance on $USDC and that the FRAX ecosystem and its stablecoin $FRAX will be supported by US Treasury bonds.
$FRAX will face several challenges:
Dependency on Centralized Participants: One of the most common criticisms is that $FRAX relies on $USDC, so what reason is there to hold $FRAX if it is backed by $USDC? Despite their model changes, reliance on centralized participants will still continue as they collaborate with other centralized participants for FED principal account transactions.
Indecisive Leadership Team: There is controversy regarding whether this criticism is valid, but the FRAX leadership team has indeed been focused on excessive development within a short period and has frequently changed the roadmap.
Lack of $FRAX holders/users: According to Etherscan's statistical data, $FRAX has approximately 8,000 holders with a market value of around 800 million US dollars. The value proposition of $FRAX is not as an exchange medium, which limits its potential to challenge $USDT and $USDC. Frax is not widely used in the ecosystem, apart from products built on top of Frax, it is only used on Curve. The reason is the incentives paid by Curve to the $FRAX pool, which is due to the position of Frax in Curve Wars. The sustainability of Curve is also an important parameter for $FRAX.
On the other hand, $FRAX also has some opportunities:
Capital efficiency: Currently, users can deposit 1 $USDC and receive 1 $FRAX, which is a capital-efficient method. It can be assumed that this capital efficiency will continue to exist through the migration to the new model, thus giving $FRAX a competitive advantage.
Established FRAX ecosystem drives use cases of $FRAX: Most stablecoins face the problem of use cases, i.e., there is nowhere to make use of the underlying stablecoin. However, $FRAX can be effectively used through the general FRAX ecosystem, including Fraxswap, Fraxlend, Fraxferry, and perhaps in the future on Fraxchain.
$LUSD
$LUSD is one of the most forked stablecoin projects in the ecosystem, as it offers a unique solution for providing censorship-resistant stablecoins. It is backed by $ETH and users can borrow against their $ETH holdings with a minimum collateral ratio of 110%.
Some features that make $LUSD competitive:
Immutable smart contract;
No governance required;
No interest charged;
Collateral quality.
In addition, from the latest announcement of Liquity Protocol, it can be seen that with the launch of Liquity v2, they will develop a new stablecoin that maintains collateral value using a risk-free method. This will be a separate stablecoin from existing projects.
$LUSD will face several challenges:
Lack of Scalability: Although $LUSD is one of the most inspiring projects in the ecosystem, it is also one of the least scalable projects because it requires overcollateralization, has liquidation risks, and only accepts $ETH as collateral.
Lack of $LUSD Holders/Users: Due to the limited scalability of $LUSD, the stablecoin has only approximately 8,000 holders with a market cap of around $300 million, according to Etherscan data.
Lack of Use Cases: The limited scalability of $LUSD prevents sufficient liquidity within major protocols, hindering the adoption of $LUSD.
Inefficient Capital Efficiency: Liquidity requires overcollateralization and carries liquidation risks, making it not an optimal choice in terms of capital efficiency, limiting $LUSD's ability to function as a medium of exchange.
On the other hand, $LUSD also presents some opportunities:
Censorship Resistance: The most unique aspect of $LUSD is its decentralization and censorship resistance. I believe there is no competition in this field.
Strong Brand: $LUSD has achieved long-term success in decentralization and stability anchoring and has gained trust within the community, making $LUSD a powerful brand that the team can leverage.
Liquity v2: The Liquity team recognizes the scalability issues of the protocol, and their goal is to expand without disruption. Developing a risk-free model using primary safeguard methods to prevent losses caused by volatility can partially address the scalability problem.
$eUSD
$eUSD is a stablecoin collateralized by $ETH. Holding $eUSD offers a stable income stream with an annual yield of approximately 8%. It is a CDP stablecoin that requires overcollateralization and carries liquidation risks.
In my opinion, $eUSD will face several challenges:
Inefficient Capital Efficiency: The overcollateralization model means that $eUSD is limited in terms of capital efficiency since users need to invest more funds than they receive and bear liquidation risks.
Limited Use Cases: Due to insufficient stablecoin demand to provide liquidity to multiple pools, the use cases for $eUSD are limited, restricting its scalability.
Limited Growth Potential: Emerging stablecoins need to have growth potential and a unique value proposition. However, despite leveraging LSD products being seen as a good method for expansion, it is limited by intense market competition.
Not a Medium of Exchange: $eUSD is a yield-bearing stablecoin, and the protocol does not prioritize using it as a medium of exchange. While this is also an important value proposition, it limits its growth potential.
Anchor Stability: eUSD holders are eligible to receive $ETH rewards for staking. Due to this reason, the demand for eUSD exceeds supply, causing it to be anchored above $1.00. Unless there are changes to the system, eUSD will not be able to maintain its anchor.
On the other hand, $eUSD also has some opportunities:
Income-Generating Asset: Since $eUSD can generate income for holders, there will definitely be a demand to use it as a store of value. If users trust the anchor stability, it can be a good way to earn $ETH rewards.
Access to LSD Products: LSDfi is a growing market that has certainly achieved product-market fit, and using LSD to mint stablecoins is a profitable business for both the protocol and the users.
$crvUSD
$crvUSD is a CDP stablecoin project that requires over-collateralization and has liquidation risk. The unique feature of $crvUSD is its liquidation mechanism called LLAMMA. Through this method, LLAMMA gradually sells portions of collateral at different price ranges instead of immediately selling the entire collateral at a specified liquidation value. Therefore, as the price of collateral drops, some of the collateral will be auctioned off in exchange for $crvUSD.
So far, stablecoins have achieved gradual market cap growth without any significant decoupling. However, while it has around $100 million in liquidity, it only has around 600 holders, which is concerning in terms of product scalability.
As far as I know, $crvUSD will face several challenges:
Inefficient Capital Efficiency: Since $crvUSD is an over-collateralized CDP position with liquidation risk, it doesn't have a distinct advantage in terms of capital efficiency compared to competitors, limiting its scalability to some extent.
Limited Use Cases: Due to the lower liquidity and lack of scalability of $crvUSD, its use cases are limited. While there are several $crvUSD staking pools, considering the trade-offs, it is not very attractive.
Insufficient Holders: As mentioned earlier, $crvUSD only has around 600 holders, which is a result of inadequate demand for CDP stablecoins. Therefore, despite providing a unique liquidation mechanism that is better than other CDP stablecoins, $crvUSD will face challenges in attracting new holders.
On the other hand, $crvUSD also faces some opportunities:
Unique clearing mechanism: The soft clearing mechanism of $crvUSD is a great innovation that competitors will surely emulate because it can increase the scalability of CDP stablecoins to some extent and avoid hard liquidation.
Curve support: Curve is a mature stablecoin exchange platform that has been present in the ecosystem for years. It has deep liquidity, and $crvUSD can leverage this to effectively enhance its scalability.
Conclusion
Although this article is long, there is one simple thing you should remember.
The future of asset-backed stablecoins will be determined by one simple question:
"Can users buy stablecoins instead of just borrowing them?"
The current model does not provide a good solution for achieving stablecoin functionality. Therefore, $USDT and $USDC can continue to dominate this field.
However, they also have limitations, especially in terms of decentralization, censorship resistance, and self-custody. I believe there can be new models to address these issues and achieve stablecoin functionality, but I'm also very certain that the current model is flawed and difficult to succeed.
IOS
Android