The Emergence and Predictable Demise of the Stablecoin – And Its Rising Replacement

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In the dynamic and ever-shifting world of Web 3.0, stablecoins have been perceived as the go-to on-chain safe haven for investors seeking protection from notoriously volatile crypto assets.

Nonetheless, now several years into their plight as presumed on-chain fiat, stablecoins have failed to resolve or even improve upon their inherent defects, which have taken a heavy toll on the Web 3.0 space.

In addition to struggling to pick up traction in traditional use case scenarios, stablecoin meltdowns and insolvencies have bankrupted many users and compromised the trust of many more.

Without growth prospects nor improvements in the works, the stablecoin sector has at best arrived at a standstill.

Until recently, stablecoins have managed to stay afloat largely due a lack of on-chain alternatives.

In 2023, that has all changed with the emergence of deposit tokens, which have received attention from within and beyond Web 3.0 for their streamlined issuance models, robust security and compliant reserve management.

The Web 3.0 space may be on the precipice of a major shift away from stablecoins – one that will launch its decentralized ecosystems into the mainstream for good.

The conception and short-lived success of the stablecoin

The digital asset space’s first attempt at fungible, fiat currency units produced the stablecoin.

For its role as an accessible on-chain volatility hedge, the stablecoin enjoyed early success – particularly during the emergence of DeFi when stablecoin holders could enjoy hefty yields in exchange for staking their coins.

Nonetheless, despite amassing a hundred-billion dollar market capitalization within the digital asset space, the stablecoin sector entirely failed to make a landing in traditional use case scenarios, much to the chagrin and confusion of early DeFi users.

Today, in 2023, most Web 3.0 users are finally becoming privy to what banks, financial institutions and regulators have been trying to communicate for years – stablecoins are riddled with inherent security risks that are rooted in their fundamental operations.

Unlike issuers of fiat currency, stablecoin issuers are lean startups that depend on a loosely affiliated group of banks, accounting firms and legal representatives to issue currency units and manage their reserves.

As a result, stablecoins require highly intermediated deposit, redemption and audit processes, and are rarely able to produce adequate reporting or provide transparency into their reserves.

With the clarity of hindsight, it is no surprise that the last three years have seen rampant meltdowns, insolvencies, critical litigation and most recently, frequent depeggings.

Departure backed by data

According to the new AI-powered DAM (Digital Asset Monitor) developed by Moody’s Analytics, fiat-backed large-cap stablecoins have produced 609 depeggings in 2023 alone – approximately two per day.

Such is par for the course in a nascent Web 3.0 sector rife with systemic risk factors, superfluous intermediation and inadequate transparency.

Stablecoins don’t appear to be on the verge of improved stability any time soon.

Moody’s purports that its DAM is capable of predicting stablecoin depeggings up to 24 hours in advance – a feature that will likely only accelerate sell-offs and market volatility surrounding stablecoins.

Most poignantly, after years of warnings from traditional finance, Web 3.0 markets are finally beginning to display a growing dissatisfaction with stablecoins.

Per a report from CCData, the total market capitalization of the stablecoin sector slipped to $124 billion in July 2023, marking the 16th consecutive month of decline.

This downward trend was complimented by a broad decline in volume over the same period and punctuated by USDC’s 11% depegging following the insolvency of Silicon Valley Bank in March, alongside SEC lawsuits against Binance and Coinbase during the same period.

The Web 3.0 space is more prepared than ever for a departure from stablecoins – as soon as the proper alternative arrives on the scene – that is, ‘on-chain.’

The rise of deposit tokens

Deposit tokens are stable-valued assets issued directly to on-chain ecosystems by banks based on fiat currency deposits in their core banking systems.

Rather directly, deposit tokens represent tangible reserves held at regulated financial institutions that operate under strict reporting standards.

Unlike stablecoins, deposit tokens eliminate intermediaries and carry extremely low-counterparty risk.

Meanwhile, within the Web 3.0 space, deposit tokens address the same dilemmas and confer the same benefits as stablecoins.

Deposit tokens are minted, burned and exchanged on public blockchains, and maintain fixed values via pegs to real-world assets – most commonly fiat currencies.

Taking the baton from stablecoins

In addition to protecting Web 3.0 investors from volatility with a trusted medium of exchange, deposit tokens have the potential to act as a major catalyst that can drive Web 3.0 toward mass market adoption.

As direct representations of customer deposits, deposit tokens present an array of benefits in cross-border transactions, which are normally expensive and heavily intermediated.

Deposit tokens not only streamline processes related to capital transfers, but they also eliminate the unnecessary middlemen that occupy and obfuscate stablecoin issuance models.

Quite simply, deposit tokens connect two previously disparate financial universes by providing each with the other’s advantages – they bring robust, secure and trusted fiat units to on-chain ecosystems while delivering ultra-efficient cross-border transfers and settlement to legacy finance.

Already in 2023, JPMorgan and Citigroup have both taken initiative developing early iterations of deposit token infrastructure to begin providing superior services to their private clients.

As deposit tokens begin landing in Web 3.0, let us remember stablecoins not for their flaws and misgivings but for the instrumental role they played in getting Web 3.0 off the ground in the early stages of the digital financial revolution.

Deposit tokens are not arriving to relinquish stablecoins per se but merely to receive the baton and carry decentralized systems forward to their next mission in the global mass market.

In the meantime, stablecoins may occupy a retail niche in the same way that Wise and PayPal do today. Institutional use cases, on the other hand, are where deposit tokens will take the wheel.

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Bradley Allgood is the founder and CEO of Fluent Finance, a project focused on developing deposit token infrastructure that brings banks and financial institutions on-chain. Before founding Fluent, Bradley designed the Web 3.0 banking platform and its associated legal framework for the first SEZ (special economic zone) in the US.

 

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