Author: YBB Capital Researcher Zeke

Introduction

According to CoinGecko data, the total market capitalization of stablecoins has surpassed the $200 billion mark. Compared to when we last mentioned this sector, the overall market cap has nearly doubled and broken historical highs. I once likened stablecoins to a critical component in the crypto world, serving as a stable store of value and acting as a key entry point in various on-chain activities. Today, stablecoins have moved into the real world, demonstrating financial efficiencies that surpass traditional banking systems in retail payments, B2B transactions, and international remittances. In emerging markets such as those in Asia, Africa, and Latin America, the application value of stablecoins is gradually becoming evident. The high financial inclusion they offer enables residents of third-world countries to effectively counteract the high inflation caused by unstable governments. Additionally, stablecoins allow participation in global financial activities and access to cutting-edge virtual services such as online education, entertainment, cloud computing, and AI products.

The next step for stablecoins is to challenge traditional payment systems in emerging markets. In the foreseeable future, the legalization and accelerated adoption of stablecoins will become inevitable, and the rapid development of AI will further boost the demand for stablecoins (for computing power purchases and subscription services). Compared to the past two years, the only constant is that Tether and Circle still maintain a dominant position in this sector, while more startup projects are now focusing on the upstream and downstream of stablecoins. However, today, we will focus on the issuers of stablecoins — who in this intensely competitive multi-billion-dollar space will capture the next slice of the pie?

1. Evolution of Trends

In the past, when we discussed the classification of stablecoins, we typically categorized them into three types:

• Fiat-Collateralized Stablecoins: These stablecoins are backed by fiat currencies (such as the US dollar or Euro) as reserves, usually issued on a 1:1 ratio. For example, every USDT or USDC corresponds to one US dollar held in the issuing party’s bank account. The main feature of fiat-collateralized stablecoins is their relative simplicity and directness, and in theory, they offer high price stability.
• Over-Collateralized Stablecoins: These stablecoins are created by over-collateralizing other volatile and liquid high-quality crypto assets (such as ETH or BTC). To mitigate potential price fluctuation risks, these stablecoins typically require a higher collateralization ratio, meaning the value of the collateral must significantly exceed the value of the minted stablecoins. Typical examples include Dai, Frax, and others.
• Algorithmic Stablecoins: These stablecoins are entirely regulated by algorithms that control their supply and circulation, aiming to keep the stablecoin’s price pegged to a reference currency (usually the US dollar). Typically, when the price rises, the algorithm issues more coins, and when the price falls, it buys back coins from the market. The most famous example is UST (the stablecoin of Luna).

In the years following the UST collapse, the development of stablecoins has primarily focused on micro-innovations within Ethereum’s LST ecosystem, with various risk-balancing mechanisms used to create some over-collateralized stablecoins. The term “algorithmic stablecoin” has not been mentioned much since. However, with the emergence of Ethena earlier this year, stablecoins have gradually embraced a new development direction: combining high-quality assets with low-risk wealth management strategies to attract a large user base with higher returns. This has created an opportunity to carve out a space in an otherwise relatively rigid stablecoin market. The three projects I will mention below all align with this new direction.

2. Ethena

Ethena is the fastest-growing fiat-collateralized stablecoin project since the collapse of Terra Luna. Its native stablecoin, USDe, has surpassed Dai, reaching a market size of $5.5 billion, ranking third. The project’s overall approach is based on Delta Hedging using Ethereum and Bitcoin as collateral. The stability of USDe is achieved through Ethena shorting Ethereum and Bitcoin on CEXs in an amount equivalent to the value of the collateral. This is a risk-hedging strategy designed to offset the impact of price fluctuations on the value of USDe. If both assets increase in price, the short position will incur a loss, but the value of the collateral will also rise, offsetting the loss; conversely, if the prices decrease, the short position will profit, but so will the collateral’s value. The entire process relies on OTC settlement service providers to facilitate it, meaning the protocol’s assets are custodied by multiple external entities.

The project’s revenue sources primarily include three points:

1. Ethereum Staking Rewards: Users’ staked LSTs generate staking rewards from Ethereum.
2. Hedge Trading Profits: Ethena Labs’ hedging trades may generate funding rates or basis spread profits.
3. Liquid Stables Fixed Rewards: USDC or other stablecoins deposited in exchanges such as Coinbase can earn deposit interest.

In essence, USDe is a packaged CEX-based low-risk quantitative hedging strategy wealth management product. By combining these three revenue sources, Ethena can offer annualized returns of up to several dozen percentage points when market conditions are favorable and liquidity is high (currently around 27%), which is even higher than the 20% APY offered by Anchor Protocol (Terra’s decentralized bank) in its heyday. While it is not a fixed annual yield, this is still an extraordinary return for a stablecoin project. So, does Ethena carry a similarly high risk as Luna did?

Theoretically, Ethena’s biggest risks come from CEXs and custodian failures, but such black swan events are impossible to predict. Another risk to consider is a bank run. A large-scale redemption of USDe would require sufficient counterparties. Given Ethena’s rapid growth, this situation is not impossible. If users quickly sell off USDe, it could lead to a decoupling of its price from the secondary market. In order to restore the price, the protocol would need to liquidate and sell the collateral to buy back USDe, potentially turning unrealized losses into actual losses and ultimately exacerbating the vicious cycle. [1] However, this scenario has a much lower probability than the collapse of a single-layer mechanism like UST, and the consequences would not be as severe — though the risk still exists.

Ethena also experienced a long period of low performance in the middle of the year. Despite a significant drop in returns and doubts about its design logic, it did not experience any systemic risks. As a key innovation in the current wave of stablecoins, Ethena has provided a design logic that integrates on-chain and CEX elements, bringing a large number of LST assets from the mainnet to exchanges. This creates scarce short liquidity in bull markets and provides exchanges with significant fees and new liquidity. This project represents a compromise but offers a highly interesting design idea, achieving high yields while maintaining relatively good security. Looking ahead, as order-book DEXs rise and more mature blockchain abstractions emerge, it remains to be seen if this model could be used to create a fully decentralized stablecoin.

3. Usual

Usual is a RWA stablecoin project created by Pierre PERSON, a former French legislator and advisor to President Macron. The project gained significant attention following its listing on Binance Launchpool, with its TVL quickly rising from tens of millions to around $700 million. The project’s native stablecoin, USD0, adopts a 1:1 reserve backing system. Unlike USDT and USDC, users do not exchange fiat for an equivalent virtual currency. Instead, they exchange fiat for equivalent U.S. Treasury bonds, which is the core selling point of the project — sharing the profits gained by Tether.

As shown in the diagram, on the left is the operating logic of traditional fiat-backed stablecoins. For example, in the case of Tether, users do not earn any interest when they mint USDT with fiat. To some extent, Tether’s fiat can be seen as “getting something for nothing.” The company purchases low-risk financial products (mainly U.S. Treasury bonds) with a large amount of fiat, and last year alone, the earnings amounted to $6.2 billion, which are then reinvested in higher-risk ventures to generate passive income.

On the right side is Usual’s operational logic, which is built around the core concept of Become An Owner, Not Just A User. The project’s design reallocates infrastructure ownership to the TVL providers, meaning that users’ fiat will be converted into ultra-short-term U.S. Treasury bonds (RWA). This process is implemented through USYC, which is managed by Hashnote, one of the leading on-chain institutional asset management firms, supported by DRW partners. The profits eventually flow into the protocol’s treasury, which is owned and governed by the protocol’s token holders.

The protocol’s native token, USUAL, will be distributed to holders of locked USD0 (which will be converted into USD0++), enabling profit sharing and early alignment. It’s important to note that the lock-up period for this token is four years, which coincides with the maturity period of certain U.S. mid-term government bonds (usually ranging from 2 to 10 years).

Usual’s advantage lies in maintaining capital efficiency while breaking the control that centralized entities like Tether and Circle have over stablecoins. It also redistributes the profits more equally. However, the long lock-up period and relatively lower yield compared to others like Ethena may make it hard to achieve large-scale growth in the short term. For retail investors, the appeal may be more concentrated in the value of Usual’s token. On the other hand, in the long run, USD0 has clear advantages. Firstly, it enables citizens of countries without U.S. bank accounts to more easily invest in U.S. Treasury bonds. Secondly, it offers stronger underlying asset support, allowing the project to scale much larger than Ethena. Thirdly, the decentralized governance model also means that the stablecoin will not be as easily frozen, making it a better option for non-trading users.

4. f(x)Protocol V2

f(x)Protocol is the core product of Aladdindao, which we previously discussed in detail in an article last year. Compared to the two star projects mentioned earlier, f(x)Protocol is relatively less well-known. Its complex design has brought about several drawbacks, such as vulnerability to attacks, low capital efficiency, high transaction costs, and complicated user access. However, I still consider it one of the most noteworthy stablecoin projects born during the 2023 bear market. Here, I will provide a brief overview of the project again (for more detailed information, you can refer to the whitepaper for f(x)Protocol V1).

In the V1 version, f(x)Protocol introduced the concept of a “floating stablecoin,” which involves breaking down the underlying asset stETH into fETH and xETH. fETH is a “floating stablecoin,” meaning its value does not remain fixed, but fluctuates slightly with the price movements of ETH. xETH, on the other hand, is a leveraged ETH long position that absorbs most of the ETH price fluctuations. This means xETH holders will bear more market risk and rewards, but they also help stabilize the value of fETH, making it more stable overall.

Earlier this year, based on this concept, a rebalancing pool was designed. Within this framework, there is only one highly liquid and USD-pegged stablecoin: fxUSD. All other stable derivative tokens in the leveraged pairs no longer have independent liquidity and must exist within the rebalancing pool or as part of the backing for fxUSD.

A Basket of LSDs: fxUSD is backed by multiple liquid staked derivatives (LSDs) like stETH and sfrxETH. Each LSD has its own stable/leveraged pair mechanism.

Minting and Redemption: When users want to mint fxUSD, they can either provide LSD or extract stablecoins from the corresponding rebalancing pool. In this process, LSD is used to mint the stable derivative of that LSD, which is then stored in the fxUSD reserves. Similarly, users can redeem fxUSD for LSD.

In simple terms, this project can be seen as an ultra-complex version of Ethena and early-stage hedged stablecoins. However, the balancing and hedging process is much more intricate on-chain. First, the volatility is split, then various balancing mechanisms and leverage margin requirements are introduced. The negative impact on user accessibility has surpassed the positive attraction.

In the V2 version, the design focus shifted to eliminating the complexities introduced by leverage and providing better support for fxUSD. In this version, xPOSITION was introduced. This component is essentially a high-leverage trading tool — a non-fungible leveraged long position product with a high beta value (i.e., it is highly sensitive to market price changes). This functionality allows users to engage in on-chain high-leverage trading without worrying about individual liquidations or paying funding fees, which brings clear benefits.

Fixed Leverage Ratio: xPOSITION offers a fixed leverage ratio, meaning users’ initial margin will not be subject to additional requirements due to market fluctuations, and unexpected liquidations due to leverage changes will not occur.

No Liquidation Risk: Traditional leveraged trading platforms may cause users’ positions to be forcibly liquidated due to sudden market fluctuations. However, the design of f(x)Protocol V2 avoids this risk.

No Funding Fees: Typically, leverage involves additional costs, such as interest paid when borrowing assets. However, xPOSITION eliminates the need for users to pay these fees, thereby lowering overall trading costs.

In the new stable pool, users can deposit USDC or fxUSD with one click, providing liquidity support for the protocol’s stability. Unlike the V1 version’s stable pool, the V2 stable pool serves as an anchor between USDC and fxUSD. Participants can perform price arbitrage within the fxUSD — USDC AMM pool, helping fxUSD maintain stability. The protocol’s revenue sources come from position opening, closing, liquidations, rebalancing, funding fees, and collateral earnings.

This project is one of the few non-over-collateralized and fully decentralized stablecoin projects. For stablecoins, it is still somewhat too complex and does not align with the minimalist design principle of stablecoins. Users must have some knowledge to feel comfortable starting. In extreme market conditions, when a run occurs, various protective framework designs could also potentially harm users’ interests. But the project’s ultimate goal does align with the vision of crypto enthusiasts for stablecoins: a truly decentralized stablecoin backed by top-tier crypto assets.

Conclusion

Stablecoins will always be a battleground, and they represent a highly challenging field in the crypto space. In last year’s article “On the Verge of Death, But Innovation in Stability Never Stopped,” we briefly introduced the history and evolution of stablecoins and expressed hope for more interesting decentralized, non-overcollateralized stablecoins. A year and a half later, apart from f(x)Protocol, we haven’t seen any startups pursuing this direction, but it’s fortunate that Ethena and Usual have provided some middle-ground solutions. At least, we now have some more ideal and Web3-friendly stablecoin options.

About YBB

YBB is a web3 fund dedicating itself to identify Web3-defining projects with a vision to create a better online habitat for all internet residents. Founded by a group of blockchain believers who have been actively participated in this industry since 2013, YBB is always willing to help early-stage projects to evolve from 0 to 1.We value innovation, self-driven passion, and user-oriented products while recognizing the potential of cryptos and blockchain applications.

Website | Twi: @YBBCapital

References:

1. Mario’s Insight on Web3: In-Depth Analysis of Ethena’s Success and Death Spiral Risks
2. @protocol_fx_667/fxusd-the-nuts-and-the-bolts-335408276073">fxUSD: The Nuts and the Bolts
3. What is Usual?

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