Stablecoins – The Tether and Circle Conundrum: Will New Stablecoin Regulations Change the Current Market Structure?

Current Ecosystem

First, we should probably gather some basic information about the stablecoin market. The biggest players are:

1. USDT (Tether) - $120 billion

2. USDC (Circle ex-Centre Consortium) - $36 billion

3. SUSD (ex-DAI) - $5 billion

4. FDUSD (First Digital) - $3 billion

If we rank these based on average daily trading volume on centralized exchanges, the list would look like this (I’m not including numbers as they fluctuate, but the rankings remain consistent):

1. USDT

2. USDC

4. FDUSD

For the purpose of this report, let’s also rank the average daily transaction volume in DeFi:

1. USDC

2. USDT

3. SUSD

4. FDUSD

There are some notable differences between these stablecoins in terms of how they are set up. USDT, USDC, and FDUSD are controlled by central entities. Only SUSD can be labeled as a true decentralized stablecoin. Additionally, USDT and USDC have affiliated businesses and are linked to crypto exchanges.

Tether Holdings Limited (BVI) owns 100% of:

- iFinex Inc. (operates the Bitfinex exchange)

- Tether Limited Inc. (Hong Kong-based, issues USDT)

- Tether Operations Limited (BVI-based, manages USDT operations)

- Tether International Limited (BVI-based, manages international USDT operations)

USDC was co-founded and launched by:

- Circle

- Coinbase

As of August 2023, the Centre Consortium has been disbanded, and the governance of USDC now rests solely with Circle. However, a revenue share agreement still exists between Circle and Coinbase. The revenue share is based on:

1. How much USDC is held on Coinbase and Circle

2. How much USDC is held outside their platforms (which is the majority), where the revenue is split 50/50

Thus, out of the top five stablecoins, two are linked to crypto exchanges (USDT, USDC), two are regulated (USDC, FDUSD), and only one is decentralized (SUSD). USDT and USDC dominate the market in terms of combined market capitalization and trading volume on centralized (CEX) and decentralized exchanges (DEX). USDT leads trading volume on CEXs, while USDC has gained more traction in the DeFi space.

The Big Question

Will stablecoin regulation in Europe (MiCA) have a significant impact on the current market structure (ranking) of the top five stablecoins?

What Makes Them Different?

I don’t have a conclusive answer, but when I examine the various stablecoins and factor in my experience, there are certain elements that could either drive or hinder their future. Before delving into those points, let’s quickly revisit the functions and characteristics of money.

Functions of Money:

- Medium of exchange

- Store of value

- Unit of account

- Means of payment

Characteristics of Money:

- Durability

- Divisibility

- Portability

- Fungibility

- Acceptability

I’ve highlighted the characteristics and functions most relevant to the stablecoin discussion. I believe the medium of exchange and store of value, along with portability and acceptability, are crucial for stablecoin adoption. It’s clear that USDT is still the dominant "medium of exchange" on CEXs, whereas USDC has become the preferred choice for many payment and infrastructure providers. However, both USDT and USDC meet the portability and acceptability criteria, depending on the user base.

Let me provide two user scenarios to illustrate how I view this.

User in Unregulated/Emerging Markets:

USDT is much more accepted in countries across South America, Africa, and Asia, where there are more infrastructure rails for peer-to-peer transactions. These users typically don’t intend to off-ramp USDT into their local currency or fiat USD, as it serves them better to keep it in stablecoin form. Additionally, this group is generally less DeFi-savvy or doesn’t care about the opportunity cost of holding USDT without investing it. Some may understand the opportunity cost but have no local service provider to facilitate investments into low-risk, USD-denominated products like U.S. Treasuries.

User in Regulated/Developed Markets:

In more developed financial markets, users are accustomed to efficient on/off ramps for converting their stablecoins. They are used to KYC (Know Your Customer) processes, and the institutions they deal with screen transactions to ensure AML (Anti-Money Laundering) compliance. In such environments, stablecoin holders often convert to fiat more frequently and face high opportunity costs by not investing their stablecoins in low-risk yield products like U.S. Treasuries.

Conclusion

If USDT maintains its lead in market capitalization and CEX trading volume due to its early mover advantage, this may shift as regulatory pressure mounts (see Coinbase’s recent announcement about delisting unauthorized stablecoins in the EU by December: https://www.coindesk.com/policy/2024/10/04/coinbase-to-delist-unauthorized-stablecoins-in-eu-by-december/). However, regulatory changes might affect CEX trading volumes more than overall market capitalization. If USDT continues to push adoption in less-regulated emerging markets, it could offset any regulatory impact. A unique value proposition from USDT, as highlighted by Tether's CEO Paolo Ardoino, is its diversification of U.S. debt holders (see this article: https://cointelegraph.com/news/tether-usdt-best-friend-united-states-ceo).

In conclusion, unless the DeFi sector sees more institutional adoption (from users who require regulated stablecoins) and the crypto credit market (borrowing & lending) continues to evolve (following the implosion of Genesis, BlockFi, Celsius, and others), it will be difficult for USDC to catch up with USDT. On the other hand, USDT faces a tail risk of regulatory crackdowns, which could lead to further delisting from exchanges and restrictions from infrastructure and technology providers (wallet companies and payment rail services).