What Are Stablecoins?
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Stablecoins are a type of cryptocurrency that actually has an intrinsic value. That’s because they’re pegged to the U.S. dollar – generally. You give the issuer a dollar, and you get a stablecoin. But, what’s the point of that? If a stablecoin is backed by the dollar, why not just use dollars? It’s because stablecoins make it easier to transact on the blockchain. And it turns out to be a pretty lucrative business, similar to an insurance company. Today’s video will teach you all about stablecoins, their purpose, and what to watch out for.
Most of what’s come out of the crypto world has largely been crapto. When anyone can create a token and pump the living hell out of it on social media, what did you expect to happen? However, lately, the wind has been changing direction. The dust has settled and what’s emerging is of interest. ARK Invest recently described stablecoins as one of the most transformative and high-growth sectors in the digital asset space.
Today, we’re going to understand the mechanics of a stablecoin, look at the most popular stablecoins out there, think through the business model. We’re going to fully understand the stablecoin investment thesis through the lens of an MBA. And that’s not necessarily a good thing. Here’s what they don’t tell you about business school. You start looking for a job the moment your program starts. A school is only as good as its network. And perhaps the best thing about an MBA is that it’s a legitimate excuse for a career pivot. As you progress through your program you realize that someone has always done something, well, everything really, better than you will ever be able to do it. So you quickly learn to leverage the hard work of others in exchange for a few quick platitudes. Or as we call it, standing on the shoulders of giants.
So with that said, I’d like to acknowledge the crack research team over at ARK Invest for the great work they did on their Big Ideas 2025 report.
These folks here did all the heavy lifting and we’re going to amplify their efforts and share their knowledge with the masses. And that’s about all the recognition we’re going to give them before shamelessly posting their findings as our own.
One of the fastest-growing segments in digital assets
So ARK has described stablecoins as one of the fastest-growing segments in digital assets and they talk here about that being the case despite the 70 plus% decline in market capitalization.
Just pointing to the volatility in this segment and in crypto as a whole. The decline of that volatility is what will- should- accompany institutional participation. They talk here about the number of transactions on stablecoins hitting 110 million monthly. So that’s less than 1% of those processed by Visa and Mastercard each. But the stablecoin value per transaction is much higher than that of Visa and Mastercard. Now I really like this slide because it talks about the four stablecoin issuers that dominate and here’s the key sentence: the revenue generated in digital assets.
Great. Maybe now we can start to find some intrinsic value. They talk about how Tether reported over $5 billion in profits during the first half of 2024. They describe it as one of the most capital-efficient businesses in history.
What’s a stablecoin?
Now I know you’re asking, Joe, what’s a stablecoin already? So 98% of stablecoin market cap today represents coins that are pegged to the US dollar. So you give the issuer, let’s say, that’s Tether or Circle, you give that issuer a dollar and they give you a crypto coin. Now the intrinsic value of that coin is $1 because it’s backed by a dollar, supposed to be backed by a dollar.
It’s never more than that because the provider only owes you a single dollar. Now it might be less than that, if the provider doesn’t have a dollar to give you back. So you wouldn’t buy these coins as an investment because they’re simply just used for transactions in the crypto world. However, you might invest in the platform provider. And here’s why.
So if you look at Tether, everyone has given them $150 billion. That’s the market cap of their coin. If they just loaned that $150 billion to the US government, they’d realize $7.5 billion a year in interest. So that’s a very profitable franchise. It’s why ARK described them as one of the most profitable businesses in history, when you look at efficiency.
Circle (CRCL) IPO
So what’s of interest is that the second largest provider of stablecoins, Circle, just went public and we wrote this piece on how Circle’s IPO may be ushering in a golden era for stablecoins. And I think this chart pretty much says it all. Taken from their S1-filing document. Here you can see reserve income. So that’s the money, the $60 billion they’ve been given. They’re simply generating revenue income off that $60 billion and that makes up 99% of their revenues. But the problem here is when you start to look at gross margin, it’s not only declining but it’s dreadfully low for this sort of efficient business.
When we look at Tether and see how efficient they are, why can’t Circle be as efficient? This 39% gross margin- that’s absolutely pathetic. And the reason for that is because they’re giving a lot of money to Coinbase. Now you can read the article and understand all about that relationship. But for those of you holding Coinbase stock, you can go into their financials and see the stablecoin revenues that they’re receiving, the cost of goods sold from Circle reflected in Coinbase financials.
So when we look at the top stablecoins out there, the first thing you’ll notice is that the top two, so Tether and USDC, that’s from Circle, these represent 85% of stablecoin market cap. So when you’re talking about this space, most of that conversation is around two coins.
Now third on the list, Ethena. This isn’t actually a dollar-backed stablecoin. We’ll touch on that in a second. Now Tether is 61% of all stablecoin market cap. And rumor has it they’re actually going to be audited someday. You’d think that’s a pretty important task here. This recent article from Payment says, stablecoin issuer Tether says audit of reserves is top priority.
Certainly hope it is. Is this a stablecoin or a stable con? Well, we’ve written about that. Three or four years ago, we wrote about how this represents a massive systemic risk to the entire cryptocurrency industry. So we’ll see what happens there. Hopefully, everything pans out. Now CNBC also mimics ARK’s bullish talking points about stablecoins. You see here, they say, they should hit $2 trillion in the next 3 years. So they’re a lot more optimistic than ARK is. I think ARK puts it around $1.4 trillion by 2030.
Stablecoin business model
So if you would have $2 trillion in stablecoins, that’s a hundred billion run rate if you’re getting 5%. Now that’s going to be highly sensitive to interest rate fluctuations.
Now whenever you look at any sort of crypto assets, very important, you ask yourself, where is this money coming from? Always ask that question. And in this case, it’s coming from the yield off US treasuries. Here you can see this great chart from ARK showing the top foreign holders of US treasury securities and down there in that list you see Tether and Circle listed alongside foreign holders.
So as of the end of last year, they ranked as the 20th largest holder of US treasury. So they’re certainly quite sizable at the moment. So let’s think this whole US dollar-backed stablecoin business model through a bit. So there’s no barriers to entry for offering a stablecoin.
So you’ll see new VC-backed firms dabbling here, you’ll see notable firms like PayPal which is offering a stablecoin. So if Tether can be the leader, well, anyone really can. And Coinbase and Circle, the CEO of Coinbase said, they’re looking to displace Tether. Of course, they would be, right? It pays to have the dominant stablecoin.
And perhaps the easiest way to do that is simply passed through most of that reserve income so people are incented to hold these stablecoins. Now we see PayPal doing this, among others, especially smaller coins. You see this piece here from CNBC out, PayPal’s introduced 3.7% yield on stablecoin balances to boost payments activity.
Of course. And ARK points to this in one of the slides on their deck, talks about how stablecoins operating outside the US began to pass a significant portion of their interest income onto users.
These small yield-bearing stablecoins are the fastest-growing category in the stablecoin market. So you’ll want to pay attention to that. So this becomes a race to the bottom. And they say that Circle and Tether will avoid, as long as possible, having to do that. But, eventually, they’ll probably break. So everybody’s going to be taking a less and less of a cut to try to capture market share. And then you start to think about, well, what are other revenue streams that you could think up if you were the dominant stablecoin out there.
Other use cases for stablecoins
And to answer that question, you’d probably want to look at use cases and, I think, revenue streams are going to evolve based on changing use cases. ARK here in this slide points to how peer-to-peer transactions and storage account for 60% of USDC’s usage whilst some other use cases like bridges, decentralized exchanges, and money markets account for a much smaller fraction.
But they expect those other use cases to retake market share from P2P. So that will be interesting to see how this goes. But there’s also other types of coins that will start to pop up.
You have crypto-backed coins. I don’t know why you wouldn’t just buy the underlying there. You have algorithmic coins, stablecoins. These are problematic. I think, example of a problem, is when US collapsed. So those are to be avoided. They sound like a mess. You have commodity-backed stablecoin. So, again, just buy the underlying. What’s the point of holding this stablecoin and having systemic risk from that provider? Now one of the new stablecoins that’s popped up is this one from Ethena Labs.
It’s amassed $6 billion in just a single year. And they say that despite criticism of its novel design. Oh boy. So you look at this chart and try to understand it. It’s really just a delta-neutral asset. But my eyebrows certainly raised when I saw here, it says, can offer yields as high as 20 to 30%. What did I say earlier? Always ask yourself where that money is coming from? They go on to say, the yield could turn negative in a bear market. I bet a lot of other things could happen to this asset in a bear market.
A warning on stablecoins
So you want to be very careful about these new-fangled assets that are popping up. When you look at the crypto scam revenue out there by subclass, there’s so many crypto scams these days that they need to classify them, right? Kind of like a GICS for crypto scams. And high-yield investment trading.
So that’s where most of the scams originate from. And it doesn’t necessarily even mean they’re malicious. There’s no such thing as a free lunch, right? So everybody wants to believe there is. Be careful out there. And when you look at the different applications for blockchain as a whole, ARK had noted in their great report that the prediction markets have become the breakout consumer application in 2024.
Not everything is good, right? Look, if you’re some big BSD whale out there, and you want to hedge some tail risk, this stuff is, maybe, applicable for that. But this is basically gambling. And they talk about how sports is the most important category. Tell me exactly how your prediction market sports bets are helping complement your portfolio.
Conclusion
So just some parting thoughts here. Stablecoins have established a great deal of traction which is attracting the attention of institutions everywhere. Now this reserve income business model is really a race to the bottom. And I think platforms that offer stablecoins, you have Circle and Coinbase are the best way for retail investors to get exposure here. Well, really, the only way, right? The only pure play way.
Avoid snazzy investment vehicles that promise yield from nothing. There’s no such thing as a free lunch. Always ask yourself, where is this yield coming from? Now we continue to find Coinbase an attractive firm to invest in from a pick-and-shovel perspective when considering the cryptocurrency thesis. Now we wouldn’t be investing in Circle because of their funky relationship with Coinbase. But tell us, will you be investing in Circle? And if so, why?
Now I’m going to leave you with this deck we did on when crypto becomes crapto. It’s really eye-opening. I think that before you even dabble- start dabbling in this space, you ought to watch this and heed the warnings. Thanks so much for taking the time to watch this today.
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