Stable Coin is not the future king of cash flow? Understand 3 common misconceptions in one article and subvert your perception!

Image source: Stripe Inc.

Stripe Inc. is headquartered in South San Francisco, California, USA, on Tuesday, April 16, 2024.

Stripe recently acquired the stablecoin protocol startup company Bridge, causing a huge stir in the Cryptocurrency world. This marks the first time a major payment company has invested over a billion dollars to promote this technology. While this is not Stripe's first foray into the Cryptocurrency industry, the timing of this move appears particularly different. Currently, the market's enthusiasm for stablecoins is unprecedented, and Bridge's co-founder Zach Abrams has successfully shaped the company as the "Stripe of the Cryptocurrency world," thereby attracting the attention of the Collison brothers.

Many may not have noticed that, while Bridge is valued at $1.1 billion for Stripe, it may not have reached that valuation itself. This is not due to a lack of ability on the team's part—Zach and his team have assembled a group of top engineers—but because making profits in the stablecoin industry is extremely difficult. Whether it's issuance, structuring (i.e. converting between different stablecoins), or integrating with traditional banking systems, achieving long-term profitability is a major challenge.

So, why is this again? After all, Circle and Tether have made substantial profits against the background of Intrerest Rate rise in the past two years, and as the market's expectations for the listing of Circle continue to grow, the market seems to be ready for further growth and integration.

However, the reality is that the network effect of the Stable Coin market may not be as strong as expected, nor is it a situation where one 'winner takes all'. In fact, Stable Coin may only be a product that incurs losses, and without necessary supplementary assets, it may even become a loss-making project. Although industry insiders generally believe that Liquidity is the main reason why only a few Stable Coins can dominate, the reality is much more complex.

What are some common misconceptions about Stable Coins? Let's take a closer look.

Image source: Photographer Nathan Laine/Bloomberg© 2023 Bloomberg Finance LPTether Holdings Ltd. CEO Paolo Ardoino

1. Stablecoin needs a matching business model

When designing Libra, we realized that for a stablecoin to succeed, it must rely on a complementary business model. The Libra ecosystem is built around a nonprofit association that combines wallets, merchants, and digital platforms to support the issuance and payment network of the stablecoin.

Relying solely on Interest reserves to achieve profitability for Stable Coins is not sustainable. We realized this when we planned to issue Stable Coins supported by low interest rates (such as the Euro) or even negative interest rates (such as the Yen). Stable Coin issuance companies like Circle and Tether seem to have overlooked the fact that the current high interest rate environment is only a temporary abnormality, and a sustainable business model cannot be built on this potentially rapidly changing foundation.

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Of course, Stable Coin can not only profit from 'stock' but also from 'flow'. Circle recently increased the redemption fee, indicating that they are beginning to realize this. However, this practice violates a basic principle of the payment industry: in order to win the trust and loyalty of users, the inflow and outflow of funds should be seamless. Although withdrawal fees may be acceptable in the gaming industry, in mainstream payments, such fees would undermine the basic expectation of free flow of funds. Therefore, Money Laundering may become a potential source of income, but it is challenging to implement these fees in Block on-chain without strict control of the protocol. Even so, fees cannot be charged to transactions between users within the same wallet provider. These are all scenarios we have deeply studied in the Libra project, revealing the complexity and uncertainty of the non-profit association's business model.

So, how should stablecoin issuers choose? Unless they rely on temporary regulatory loopholes - which are unlikely to exist in the long term (as detailed in the next section) - they need to start competing with their customers.

Circle's recent series of initiatives, including the launch of programmable Wallet, Cross-Chain Interaction protocol, and Mint plan, clearly demonstrate the company's development direction. However, this is not good news for many closely related partners. In platform strategies, this situation is not uncommon: never let partners come between you and your customers. However, many exchanges and payment companies have made this mistake by incorporating Circle into their ecosystems. To survive, Circle must transform into a payment company, even if it means encroaching on allies' markets. This model is not new—think of Amazon with third-party sellers, travel platforms with hotel chains, or Facebook with news publishers. When platforms succeed, they often bring functions that originally relied on partners in-house and profit from the effective parts. Developers in the Apple and Google ecosystems are no strangers to this.

Stripe, on the other hand, does not face such a dilemma. As one of the most successful global payment companies, they have mastered how to build and profit from a streamlined software layer on top of global fund flows - a model that efficiently scales through network effects without relying on country-specific bank licenses. Stablecoin accelerates this process by bridging the gap between Stripe and domestic banks and payment networks, enabling networks previously constrained by traditional institutions (such as card companies) to overcome the last mile problem and provide greater value to merchants and consumers.

This is why PayPal has launched its own Stable Coin, and why other fintech giants like Revolut and Robinhood are following suit. Unlike before, they are starting to compete on open protocol, but can strengthen their core business by adjusting Stable Coin strategy. In this way, they will make Stable Coin extremely cheap and convenient for consumers and businesses.

Image source: 2023 Bloomberg Finance LP On Tuesday, September 26, 2023, the equivalent of 1,000 US dollars in Argentine pesos was organized in Buenos Aires, Argentina.

2. Dollarization is not a product

The cryptocurrency industry has been seriously underestimated the impact of regulation on its future. We experienced this when we released the first version of the Libra white paper, leading to two years of difficult regulatory dialogue to ensure the project meets the expectations of legislators and regulators.

Today, Stable Coin is also facing the same situation. Many believe that Stable Coin can seamlessly provide consumers and businesses with low-cost global US dollar account. After all, in times of crisis, people around the world hope to hold US dollars in a "too big to fail" US Financial Institution. Furthermore, some may think that the US government would support this trend as it helps solidify the US dollar's position as the global reserve coin.

However, the reality is much more complex. Even if the United States were to lose its financial and sanctioning infrastructure as the global standard, it would face huge losses - especially if the 'excessive privilege' of the US dollar were to be weakened as it had been with previous reserve currencies, the consequences would be even more severe - this does not mean that the US Treasury will always support the acceleration of dollarization. In fact, its International Affairs Office may see this as a major challenge to diplomacy and global financial stability.

Countries that value the independence of monetary policy, are concerned about capital flight during crises, and seek domestic banking stability will strongly oppose the widespread adoption of frictionless US Dollar Stablecoin accounts. They will use all means to prevent or restrict these accounts, just as they resist other forms of dollarization. Although a complete ban on encryption transactions may not be realistic, as demonstrated by the development of the internet, governments still have various ways to restrict access and suppress its mainstream application.

Does this mean that Stable Coins will face challenges in emerging economies with capital controls or concerns about capital outflows? Actually, not necessarily - the rise of domestic Stable Coins that comply with local banking and regulatory frameworks is a inevitable trend. Although the US dollar has always dominated the Stable Coin market, the situation may change rapidly. In Europe, with the implementation of the MiCA (Markets in Crypto-Assets) regulations, banks, fintech companies, and emerging enterprises are competing to issue Euro-denominated Stable Coins. This strategy helps maintain the stability of the local banking system and will become increasingly important in regions such as Latin America, Africa, and Asia.

Clear regulation also enables banks to compete on a level playing field, which has not yet been achieved in the United States. In addition to fully supporting Stable Coin issuance, banks can also issue deposit Tokens to increase profits through coin creation. This puts pure Stable Coin issuers without bank licenses, discount windows, or government deposit insurance at a significant competitive disadvantage.

Image source: Anthony ... [+] © 2016 Bloomberg Finance LP In Hong Kong, various payment service icons are displayed

3. There will not be a single stablecoin winner

Indeed, issuers can build network effects around their Stable Coin's global Liquidity and availability, but as Decentralizationexchange (DEX) protocol knows, Liquidity is easy to come by and easy to lose. Similarly, the scale effects of branding and marketing may help issuers gain market share, but this does not always translate into a truly sustainable competitive advantage.

The reality is that the most core feature of Stablecoin - anchoring to the US dollar or euro, etc. coin - is also its biggest weakness. Currently, these assets are considered to exist independently, but once the regulations unify the standards and make all Stablecoins equally safe, individuals and businesses will regard them as ordinary US dollars or euros. Although there is indeed a legal distinction - as demonstrated in the Silicon Valley bank run event - most people do not care whether their dollars are held in a US bank or JPMorgan Chase. This is the magic of the US dollar as a coin, all of which is driven by the Federal Reserve behind the scenes.

Stablecoins will undergo a similar process. Although there may be dozens of stablecoins in each major market, users will overlook this complexity. Once this happens, the economics of stablecoins will favor companies with complementary business models or companies that control the interface between stablecoins and their supporting assets (such as bank deposits, US treasuries, or currency market funds).

This is bad news for pure stablecoin issuers like Circle, as their banking system interfaces rely on companies such as BlackRock and BNY Mellon. These financial giants may become direct competitors. For example, BlackRock already operates the world's largest tokenization of US treasuries and repurchase funds (BUIDL).

There is a common misconception in the history of technological disruption that existing enterprises are often able to resist challenges. Even the classic case of disruptive innovation mentioned by Clayton Christensen, the rise of small disk drive manufacturers in the hard drive industry, is not completely accurate: Seagate not only survived the disruption, but is still the largest manufacturer in the world. In highly regulated industries such as Financial Service, newcomers face even greater challenges.

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Technology companies with banking licenses, such as Revolut, Monzo, and Nubank, have already gained a favorable position in the market, while other companies may accelerate their acquisition of licenses to gain similar advantages. However, many participants in the Stable Coin market may struggle to compete with traditional banks and face the risk of acquisition or failure. Banks and credit card companies will resist a market dominated by a few Stable Coin issuers, preferring instead to support a market structure composed of multiple interconnected and interchangeable issuers. In such a scenario, Liquidity and availability will be driven by existing consumer and merchant distribution channels, which is precisely the advantage possessed by new banks and payment companies like Stripe and Adyen.

Stable coins with full support such as USDC and USDT need to find high-frequency usage scenarios, such as cross-border capital flows, to maintain their market position, or attract a Decentralized Finance (DeFi) ecosystem that can introduce transparent fractionalization to support its narrow banking model. At the same time, bank-issued deposit tokens or tokenized funds will have a wider application due to their stronger economic foundation, especially at the consumer and institutional levels. Institutional users are particularly accustomed to managing diversified assets, such as currency market funds, and are very sensitive to the opportunity cost of their capital. In this industry, the competition for Stable Coin revenue sharing has already begun.

In each region, whether it is a bank or a Cryptocurrency company, they will strive to become the key portal to enter the local market. However, they need to seriously consider how Stable Coins can lower the threshold for foreign competitors to enter the market by connecting the local payment system with the blockchain network. After all, from a business perspective, the core change is that these systems will operate based on an open protocol.

Image source: Taken by Vernon... [+] Yuen/NurPhoto from Getty Imagesbank for international settlements General Manager Agustin Carstens

So what does all this mean?

For leading payment companies, financial technology firms, and emerging banks, the future looks bright. They can use Stable Coin to streamline operations and accelerate global expansion. This also creates new opportunities for domestic Stable Coin issuers to enhance their status and prepare for the global Interoperability of payment systems—Stable Coin is expected to succeed in this industry, while the 'financial network' vision of the bank for international settlements may be difficult to achieve.

Leading Cryptocurrency exchange will also use Stable Coin more actively to enter the consumer and merchant payment industry, becoming a strong competitor to major fintech and payment companies.

Although there are still questions about how Stable Coins can expand functions related to anti-money laundering and Compliance controls during the popularization process, there is no doubt that they provide opportunities for rapidly modernizing the Financial Service system and changing the industry leadership landscape.

[Disclaimer] The market is risky, and investment should be cautious. This article does not constitute investment advice. Users should consider whether any opinions, viewpoints, or conclusions in this article are suitable for their specific situation. The responsibility is on their own when investing.

This article is reproduced with permission from: 'Shenzhen Tide TechFlow'

Original author: Christian Catalini