Stablecoins: Finally bringing stability, trust, and innovation to Cryptocurrencies and Web3

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Second-Level Thinking

12 min readOct 17, 2023

Disclaimer: Opinions expressed are solely my own and do not express the views or opinions of my employer or any other institution. Any information shared on a publicly listed company or digital assets is for informational purposes only and is not a recommendation of an investment strategy or to buy or sell any security or digital asset.

Background

The article is not a primer on blockchain, cryptocurrencies, CDBCs, or the history of Bitcoin. To learn some of the basics on these topics, you can visit Crash Courses by Coindesk.

What is a Fiat Currency?

A term used for any government-issued currency, such as the U.S. dollar (USD) or the Canadian dollar (CAD).

What is a DEX?

Definition: A decentralized exchange (or DEX) is a peer-to-peer marketplace where transactions occur directly between crypto traders. DEXs fulfill one of crypto’s core possibilities: fostering financial transactions that aren’t officiated by banks, brokers, or any other intermediary. Many popular DEXs, like Uniswap and Sushiwap, run on the Ethereum blockchain. (Source and how do DEXs work?)

What is a Stablecoin?

A type of digital asset that maintains a stable value by tying it to another asset, such as gold or the U.S. dollar.

Before delving deeper into how stablecoins are gaining traction because of their liquidity benefits when converted into fiat currency, it’s useful to understand the types of money (M1, M2) and how they are supplied in the economy — Money Supply Definition: Types and How It Affects the Economy (Investopedia article and explainer video).

Payments Landscape in Canada 🇨🇦

In Canada, we are witnessing a growing trend where, over 5 years, online transfers have continued to be the fastest-growing payment type. So, could it be possible that in the near future, we will start keeping more deposits in a decentralized exchange (DEX) as stablecoins, rather than using traditional banks, to facilitate remittances and pay for goods?

This shift makes sense to me, as it will certainly be cheaper to store and spend our money through a DEX, as it will be a digital dollar that is native to the internet, available 24/7, and moves at internet speed.

Key highlights related to the growth of “online transfers” from Payments Canada’s annual Canadian Payment Methods and Trends 2023 report —

Canada reaches $11.7 trillion in total payment transactions in 2022 — up 7% in value from 2021.
1.06 billion e-transfers were sent in 2022, up 11% in volume from 2021.
Electronic funds transfer represented 59% of the total payment value in 2022.
Online transfer continued to be the fastest-growing payment type with year-over-year volume growth of 11% and value growth of 19% from 2021. Interac e-Transfer continued to dominate the online transfer payment segment with more than three in five Canadians (61%) using Interac e-Transfer to either send or receive a payment in a given month.
The image below: Payments Canada Oct 2023 report — Total Payment Transaction Volume and Value —

Source: — Total Payment Transaction Volume and Value

The rise of the stablecoins as a digital dollar —

Inspired by the words of Eswar Prasad, Senior Professor of Trade Policy at Cornell University and the author of the book “The Future of Money: How the Digital Revolution is Transforming Currencies and Finance”, for thousands of years, money has served as a means to transfer resources across time and space, facilitating commercial transactions and trade across geographically disparate locations. From the early use of precious metals, which were challenging to transport over long distances, to one of the first widespread introductions of paper money in 1260 by Kublai Khan, a grandson of the great conqueror Genghis Khan, the evolution of money has been marked by its adaptability. You can learn more about the history of paper money from the History of Information article and Invention of Money by the New Yorker.

To understand the trajectory of the future of money, author Eswar Prasad breaks down the basic functions of real money as follows —

As a unit of account: When we enter a store, goods are marked with prices denominated in fiat currencies such as USD or CAD.
As a medium of exchange: Money takes various forms, including cash, checks, debit, or credit cards, enabling financial transactions to purchase goods.
As a store of value: Money is used as a means to save and ensure it retains its value for future use.

Now, if we were to compare the use of cryptocurrencies to the functions of money outlined above, it becomes clear that Bitcoin and some other volatile cryptocurrencies that promised to replace traditional money have not lived up to their hype or promises.

These cryptocurrencies exhibit volatile value relative to the unit of account, do not function well as widely used mediums of exchange without a trusted party intermediating those transactions, and are often characterized by high costs, slow processing times, and cumbersome usage. So far, Bitcoin has evolved into a store of value, with people holding onto it as a speculative investment.

For those crypto traders and investors who believed that anonymity would contribute to the success and wider adoption of cryptocurrencies, they can now see how the government is capable of tracking some of the top hackers of stolen cryptocurrencies. Here are a few episodes from the Journal podcast (WSJ) by cybersecurity reporter Robert McMillan-

How North Korea’s Hacker Army Stole $3 Billion in Crypto — June 22, 2023
How Investigators Cracked a $3.4 Billion Crypto Heist — April 20, 2023

However, the foundational blockchain technology of this network has paved the way for the development of a wide range of innovative financial products and services. It has carved a path toward greater decentralization in finance (DeFi), promising numerous advantages.

DeFi refers to a group of specific apps known as decentralized applications or dapps, which provide access to various financial services. These decentralized apps operate using smart contracts, a special type of computer program that automatically executes a transaction whenever a predetermined input is received. This innovation has led to a wide range of DeFi applications, particularly excelling in removing middlemen from traditional financial services. Ethereum is currently the most popular blockchain for creating DeFi applications, but there are several other popular options, including Solana, Binance Smart Chain, and Polygon.

One such DeFi application innovation is Stablecoins. The most popular stablecoins are a type of cryptocurrency whose value is pegged 1-to-1 basis to a fiat currency such as the U.S. dollar (USD).

According to ARK Invest, Stablecoins have distinct advantages in bridging the gap between closed and open ecosystems. In a closed-loop system, transactions require both parties to have an account, which limits flexibility and access. Alternatively, stablecoins operate in open ecosystems and can transact across different networks and platforms, enabling interoperability and a broad-based user base. As a result, stablecoins foster more inclusive financial participation, eliminate barriers to entry, and facilitate seamless integration with various payment channels.

Growing Use Cases: Stablecoins —

Some of the most common use cases of Stablecoins are -

e-Commerce and mobile payments
Cross-border payments and remittances
Smart contract-enabled transactions as a programmable money
Corporate treasury services to foreign aid in conflict-stricken countries
Replacement for the already declining use of cash as a regulated digital dollar

Some of the notable stablecoins include:

USD Coin (USDC) by Circle (more on this below)
Tether (USDT)
Binance USD (BUSD)

Disruptive Innovator — Circle

Circle, founded in 2013 by Jeremy Allaire, is a global financial technology company that launched USD Coin (USDC) with a vision ‘to bring traditional money natively onto the internet in the form of digital currency, making it available on open, interoperable, and global networks.’ Circle refers to this concept as ‘moving money at internet speed.’

In one of his podcast discussions, Circle’s founder, Jeremy Allaire, describes Circle’s approach as ‘the new physics of money’. This entails money becoming internet-native, resulting in a frictionless, instant, global, and cost-free environment. Just as the internet reduced the marginal cost of sending data and making voice connections to zero, unleashing a surge in productivity, reducing the cost of storing and moving money to zero would similarly accelerate economic activity.

USD Coin (USDC): a leading regulated digital dollar —

I’m covering Circle here because the USDC economy is expanding rapidly and has become a significant force in facilitating economic activities on a global scale, spanning more than 190 countries. According to Circle, through 2022, USDC has powered more than $8.6 trillion in cumulative on-chain transactions. Circle has achieved this USDC market cap of over $25 billion (CoinGecko Oct 10, 2023) by complementing its innovation with the traditional financial system.

USD Coin (USDC) — source: Circle website, Oct 12, 2023

USDC is a fully-reserved stablecoin, which is a type of cryptocurrency (or digital asset). Unlike other cryptocurrencies that fluctuate in price, USDC is designed to maintain price equivalence to the US dollar. USDC is a stable store of value that benefits from the speed and security of blockchain technology. USDC is used every day as a digitally- native store of value, unit of measure, and payment innovation.

Here is an example of how Circle’s USDC is helping businesses with cost savings and faster settlements in cross-border payments and remittances, a recent LinkedIn post shared by Jeremy Allaire, CEO at Circle —

USDC is a trusted, widely accepted, and highly liquid digital dollar. Since the launch of USDC in 2018, Circle has managed the USD assets backing USDC (the ‘USDC reserve’) to ensure it is redeemable 1:1 for U.S. Dollars at any time. To date, more than $213 billion USDC has been redeemed since its inception through December 2022. You can view Circle’s Reserve composition at any time by visiting their Transparency page on the website.

Remember the 2022 collapse of the stablecoin terraUSD and its companion token, LUNA?

Circle has been a leader in setting the standards for a regulated digital dollar and ensuring the structural integrity of USDC. They achieve this through the following methods —

Maintaining approximately 80% of the USDC reserves in 3-month U.S. Treasuries, known for their price stability and liquidity. These reserves are held within the Circle Reserve Fund (ticker: USDXX), which is 100% owned by Circle, managed by BlackRock (the world’s largest asset manager), and custodied by The Bank of New York Mellon (the world’s largest custodian).
Allocating the remaining 20% of the USDC reserves in cash, diversified among eight U.S.-regulated banking partners.
Keeping the USDC reserves in segregated accounts, exclusively for the benefit of USDC holders, entirely separate from Circle’s operations.

Circle and USD Coin (USDC): Demonstrating resilience —

While Circle has put in place comprehensive controls and ensured the structural integrity of USDC, like any other company, external events can still impact the overall operations of a financial technology company. Assessing a company’s resiliency and effective management becomes apparent when observing how they navigate and overcome such challenges.

In March 2023, the failure of Silicon Valley Bank led to Circle’s USD Coin (USDC) losing its 1-to-1 peg to the U.S. dollar, dropping to as low as 87 cents. With $3.3 billion of its reserves at SVB, over $1 billion of USDC was swiftly redeemed for U.S. dollars, leading to the destabilization of USDC’s value. In response, Circle promptly collaborated with the U.S. government and financial regulators. Following a weekend of instability, on March 13, Circle announced (via press release) that the risk associated with the $3.3 billion USDC reserve had been resolved, restoring its value to the normal 1-to-1 peg with the U.S. dollar.

Circle and USD Coin (USDC): Encouraging innovation across the ecosystem —

As one of the leading stablecoins in the cryptocurrency market, USDC has secured a significant maturity. Circle’s robust technology and infrastructure have set a standard, encouraging other financial technology companies within the ecosystem to drive rapid innovation.

Visa

In September 2023, Visa expanded its stablecoin settlement capabilities with Circle’s USDC, through a Crypto.com pilot program, with merchant acquirers Worldpay and Nuvei (Canada) by leveraging the Solana blockchain. Crypto.com now uses USDC to fulfill its settlement obligations on the Visa card in Australia and intends to roll out this capability in other markets. Live pilots with issuers and acquirers demonstrated the movement of millions of USDC between partners over Solana and Ethereum blockchain networks to settle fiat-denominated payments authorized over VisaNet. By utilizing Circle’s USDC, Visa is bypassing slow currency conversion processes and avoiding international wire fees. Visa anticipates that USDC will significantly expedite processing and settlement times with the aforementioned merchant acquirers. (source: Visa press release: Visa expands stablecoin settlement capabilities to merchant acquirers).

PayPal

On August 7, 2023, with the help of Paxos Trust Company, PayPal announced PayPal USD (PYUSD) stablecoin backed 1-to-1 by U.S. dollar deposits, short-term U.S. treasuries, and similar cash equivalents, and fully redeemable 1-to-1 for U.S. dollars. As a major player in the payments and money movement space, PayPal USD (PYUSD) aims to bridge the gap between fiat currency and Web3 apps for consumers, merchants, and developers. The image below highlights key features available to PayPal (U.S.) customers who purchase PayPal USD —

Closing thoughts —

With the Canadian government currently lagging in enacting laws and regulations for Open Banking, Real-time Rails (RTR), and cryptocurrencies, the significance of stablecoins, as demonstrated by Circle’s USDC, underscores the pressing need for immediate action on critical financial infrastructure. Urgent and comprehensive measures are essential to ensure Canada remains competitive in the rapidly evolving global financial landscape. Stablecoins can be effectively introduced in Canada, benefiting from the expertise of experienced participants such as Circle and Paypal, and effectively addressing known frictions across areas including e-commerce and mobile payments, cross-border payments, and remittances, as well as government aid or benefits reimbursements, both domestically and internationally.

It’s important to note that Canadian entities like Nuvei, and Stablecorp (with QCAD) are actively participating in the economy as enablers, while technology companies like Wise, Wealthsimple, and Shopify, among many others, have the opportunity to leverage stablecoins to address the diverse financial needs of Canadian consumers and businesses.

Other Stablecoins —

MakerDAO, DAI — perhaps the most famous stablecoin issuer that uses this mechanism, accomplishes this through a service called “Vault” (formerly known as a Collateralized Debt Position), which locks up a user’s cryptocurrency collateral. Then, once the smart contract knows the collateral is secured, a user can use it to borrow freshly minted dai, the stablecoin. Source — https://www.coindesk.com/learn/what-is-a-stablecoin/
Tether tokens (USD₮) — launched in 2014, Tether is a blockchain-enabled platform designed to facilitate the use of fiat currencies in a digital manner. Tether tokens market cap is $83.4 billion (Tether transparency report, Oct 14, 2023). All Tether tokens are pegged at 1-to-1 with a matching fiat currency (e.g., 1 USD₮ = 1 USD) and are backed 100% by Tether’s reserves.

Relevant Books —

The Future of Money: How the Digital Revolution Is Transforming Currencies and Finance, by Eswar S. Prasad
Going Infinite: The Rise and Fall of a New Tycoon, by Michael Lewis (Oct 23)
The Psychology of Money, by Morgan Housel