Stablecoins: 3 controversial predictions

Nik Milanović, founder of This Week in Fintech and Stablecon, pens today's guest column for the FR.

A year ago, nobody knew what stablecoins were. Today, everyone is pro-stablecoin.

Stablecoins are the hottest topic of the year in technology and payments. The U.S. government is passing multiple bills focused on codifying stablecoins’ role as a financial rail. USDC issuer Circle went public and saw its market cap rocket from $10 billion to $60 billion almost overnight. And every big bank – from JP Morgan to Citi to Bank of America — is now working on their own stablecoin project.

But what are we missing? 

We recently concluded the first Stablecon in New York City. The conference brought together the largest global group of builders focused on stablecoins and payments innovation, with 1,000+ attendees and 100+ speakers. Many of them had been working in this space for years, before it blew up. What’s true today may not be true tomorrow. Based on insights from their talks, the stablecoin space is primed for shakeups and surprises.

Parsing through the hype, there are a few fascinating early-stage developments, overlooked today, which promise to turn the current narrative on its head. I came out of the conference with three controversial predictions for stablecoins:

1. Foreign governments will launch or co-opt stablecoins to hold onto their own market-share against the U.S. dollar.

Today, the vast majority of stablecoins are U.S. dollar-denominated. They have become an easy, digitally-native payment method for people around the world to transact in dollars. This is partially why the U.S. government sees them as an interesting policy tool: they can help the US extend dollar hegemony against growing currencies like the Renminbi, while also providing an undersaturated market to sell treasuries.

But foreign central banks are not likely to want their economies to dollarize, as it will limit their ability to influence economic growth through monetary policy. Already, we are seeing many issuers develop foreign (privately-issued) stablecoins. At Stablecon, we heard about the market for non-USD stables from Circle, issuing EURC, cNGN, issuing a Naira stablecoin, Transfero, issuing a Real stablecoin, and IDRX, issuing a Rupiah stablecoin. The market is there for the taking, as local governments and merchants push to manage payments in their domestic currency, and around half of the world’s central banks are exploring the launch of government digital currencies (called CBDCs). 

2. Algorithmic stablecoins will make a comeback.

If you’ve worked in crypto for 3+ years, you remember the story of stablecoin-focused blockchain Terra and its paired treasury token, Luna. Terra was an undercollateralized algorithmic stablecoin, whose valuation was mechanically supported by an arbitrage mechanism tied to the depth of its Luna treasury reserves.

All it took was a large bet against Luna to break Terra’s 1:1 dollar peg — a break which Terra didn’t have the funds to repair — which led to a death spiral in the token value.

Crypto operators swore off algorithmic stablecoins after the Terra/Luna debacle, but was the true original sin of Terra that it was algorithmic? Or that it was intentionally undercollateralized, mirroring fractional reserve banking but without depth of assets or a government backstop?

Decentralized stablecoin platform M0 is betting that algorithmic stablecoins will make a comeback, as long as the reserves defend the value of the peg (it is 102% overcollateralized). The token has hit a $300 million supply as of writing and offers features exciting to DeFi builders — custom access, risk, and compliance rules; control over how yield is distributed; and native swapability through composable on-chain operations — without the risk of a ‘walled garden’ or a central intermediary like a bank or centralized exchange (CEX) controlling issuance.

But the U.S. government, which wants to replicate its KYC/AML regime from TradFi to stablecoins, is not likely to share M0’s enthusiasm for building truly decentralized digital dollars. I expect this to be the biggest battle in the next couple of years of stablecoins: permissionless, composable dollar tokens vs. centrally issued stablecoins with a ‘backdoor’ for banks and government.

3. Yield isn’t going anywhere.

One of the more surprising features of the U.S. GENIUS Act was its prohibition of yield-bearing stablecoins. Similar to a high-yield savings account (HYSA), yield refers to issuers passing along part of their net interest margin to holders as an incentive. It’s a key feature for stablecoin issuers like Global Dollar Network, which competes on yield to attract holders away from yieldless tokens.

You can see why banks and issuers would want to lobby against yield: they can effectively issue deposits without having to share economics to do so — just as fintechs did during the high-APY war in 2017. But competition in payments drives innovation, and if rewards credit cards and HYSAs are any indication, issuers and banks will find ways to compensate depositors for holding their token instead of a competitor’s. If not yield, it will be yield by any other name.