Stablecoins: Everything You Need to Know

The bulls are charging ahead. The cryptocurrency market gained significant momentum around the US Presidential election on November 5 and has been surging ever since. Bitcoin is currently trading just above $97K, nearing the $100K psychological milestone with less than a 3% gap. Over the past week, Bitcoin's value has risen by over 8%, while the broader crypto market capitalization has grown by approximately 6.15%. In the last seven trading days, net inflows into US spot Bitcoin ETFs have surpassed $2.75 billion. Market sentiment is soaring, as reflected by the Fear and Greed Index reaching 90 this week — its highest level in a year.

At times like this when sentiments are high and volatility is soaring, stablecoins are invaluable. Their value, typically pegged to fiat currencies, allows traders and investors to hedge against sudden price swings without exiting to traditional fiat. This stability enables seamless trading, offering a safe harbor to lock in gains or minimize losses. They even help maintain liquidity in decentralized finance (DeFi) markets as the overall level of leverage gradually rises in tandem with soaring prices.?

By combining the stability of traditional currencies with the accessibility and borderless nature of blockchain networks, stablecoins represent a union between the old and the new. In this edition of the Crypto Market Monitor, we explore the origins of stablecoins, the advantages they offer over traditional fiat and the current state of the stablecoin market.?

Current Financial System Challenges

For corporations and individuals alike, the inefficiencies of the current financial system have many consequences. Slow and expensive cross-border payments are one of these. In some instances, sending money internationally can take several days and incur hefty interbank fees and FX charges. According to the World Bank, the global average fee on a remittance payment is 6.4%. Also, in many countries with high inflation, unstable local currencies, and limited access to financial systems, any cash savings accumulated can quickly be lost to fees and charges.

Cryptocurrencies have been suggested as a solution to the problems listed above. Anyone with internet access can send, receive and pay with cryptocurrencies where accepted, and the borderless nature of blockchain networks make most cross-border transactions fast and efficient. Still, despite these properties, some cryptocurrencies have experienced slower adoption when it comes to remittance payments and everyday use, primarily due to their price volatility. Stablecoins are one way to potentially change that.??

Stablecoin Advantage

With stablecoins, end users have a stable value bearer (something that holds value over a period, to be used freely as a medium of exchange such as fiat) while also keeping the accessibility and borderless nature of cryptocurrencies. This allows for fast and cheap cross-border transactions in a stable asset and access to savings in the most trusted currencies in the world.?

Stablecoins have had a meteoric rise in use over the last five years. They provide a solution to a common problem in the financial space - a stable value bearer and a more familiar currency to trade with - while retaining the portability of crypto.

Stablecoins have been around since 2014, but they gained notoriety in 2020. From the start of 2020 to the peak in May 2022, stablecoin issuance rose from $5 billion to over $180 billion, a staggering 3,500% increase. Since then, stablecoin issuance has followed market cycles, contracting throughout the bear market and rising as the markets have become bullish again.

Figure 1:?Aggregate Stablecoin Marketcap (Top 5) and Bitcoin Marketcap

Stablecoin on-chain transaction volumes are on par with those of the world's largest payment networks.

In 2020, stablecoin on-chain transaction volume surpassed PayPal's payment volume, before also surpassing the ten times larger volume of the Visa network the following year. Stablecoin volume has since been on par with Visa in 2022 and 2023 but is set to surpass the Visa payment network in 2024 convincingly. Still, stablecoins (processing USD$20 trillion annually) are some way from passing the payment volume of the Fedwire (processing USD$1K trillion annually), the system for instant money transfers between U.S. banks.

Figure 2: Stablecoin payment volumes compared to other networks.

The different types of stablecoins

For a blockchain token to be a stablecoin, it must have a pegging mechanism that keeps its value aligned with a fiat currency's value. The pegging mechanism is divided into three components: Trust, mint/redeem mechanism, and backing. Trust relates to whether the stablecoin is issued by a centralized counterparty or in a decentralized ecosystem, is governed by smart contracts. The mint/redeem mechanism covers the collateralization ratio that is maintained for minting and redemption of coins. Backing illustrates which types of assets underpin stablecoins.

Figure 3: The components making a stablecoin

Currently, Centralized asset-backed stablecoins (USDC, USDT and FDUSD) dominate the stablecoin landscape making up 94% of the stablecoin market cap. Decentralized crypto-over-collateralized stablecoins (DAI and USDS) make up 3%, while the emerging carry trade-backed stablecoins (USDe) almost make up for the rest 3%.

Figure 4: Components and MarketShare of Top Stablecoins

At time of publication, there are over $168 billion worth of centralized asset-backed stablecoins issued. Two issuers account for 98% of this issuance. These two issuers are Tether and Circle, with the USDT and USDC stablecoins, respectively. Tether's USDT is the largest, making up for over 76% of the centralized asset-backed stablecoin supply, while USDC's corresponding number is 22%. First Digital USD (FDUSD) is in a clear third with 2% of the remaining supply.?

With stablecoins becoming hugely popular, the prominent stablecoin issuers have become profit machines, especially after interest rates increased. In 2023, Tether reported net profits of $6.2 billion, of which about $4 billion represented the net operating profits on U.S. treasuries and alike. The remaining $2 billion in profits came from return on investments in bitcoin and gold, which Tether has partially bought from earlier profits.

Yield-bearing stablecoins are an emerging token class (USDY and USDe)?? and the natural next step given the current stablecoin issuers' outsized profits. A stablecoin that also pays an interest rate would be a strict improvement on the current non-yield-paying stablecoins. Hence, crypto users may switch to yield-bearing stablecoins in the future.

Future of Stablecoins

Stablecoins have established themselves as essential components of crypto trading infrastructure, bridging traditional and digital currencies. While this role has driven historical demand and will remain significant, the potential expansion beyond trading presents intriguing possibilities. These assets offer compelling benefits globally and see increasing adoption, though precise usage metrics remain unclear. Barring regulatory obstacles, stablecoin adoption in everyday transactions will likely continue growing, potentially representing the next major phase of crypto integration.

To get our research updates directly in your inbox, #subscribe to our newsletter at ??

https://info.aminagroup.com/subscriptions

Disclaimer

This document is provided by AMINA Bank AG (“AMINA”) and is intended for educational and informational purposes. AMINA’s weekly Crypto Market Monitor is not intended for distribution in any jurisdiction where such distribution would be prohibited. Furthermore, it is not aimed at any person or entity residing in such jurisdiction. It does not constitute an offer or a recommendation to subscribe, purchase, sell or hold any security or financial instrument. The document contains the opinions of AMINA as at the date of issue, which do not take into account an individual’s circumstances and objectives. AMINA does not make any representation that any investment or strategy is suitable or appropriate to individual circumstances or that any investment or strategy constitutes personalized investment advice. Some investment products and services may be subject to legal and regulatory restrictions or may not be available worldwide on an unrestricted basis. The information and analysis contained in this Crypto Market Monitor are based on sources considered as reliable. AMINA makes its best efforts to ensure the timeliness, accuracy, and comprehensiveness of the information contained in this document. Nevertheless, all information indicated herein may change without prior notice.