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Navigating the Evolution of Stablecoins: Challenges, Regulation, and the Impact of PYUSD

Stability in the cryptocurrency realm took center stage in 2022 as the stablecoin sector’s capitalization faced a notable contraction following the Terra collapse in May, the overall market cap dropped from around 189 billion USD to approximately 144 billion USD by December. The industry faced additional challenges with the FTX bankruptcy and Binance’s withdrawal pause, triggering deviations in Tether’s USDT and Binance’s BUSD from their pegs.

Turbulence persisted into early 2023. Paxos encountered regulatory orders to halt BUSD minting, and the downfall of Silicon Valley Bank (SVB) froze part of USDC‘s cash reserves, impacting Maker’s DAI. USDT faced liquidity pool pressures, raising trader concerns, and TUSD struggled due to its custodial partner’s collapse. Moreover, the rapid expansion of Tether heightened stability concerns and the potential repercussions of eroding investor trust.

These episodes underscored the risks tied to centralized stablecoins relatively unregulated entities within the crypto landscape. In response, calls for stablecoin regulation gained momentum, with US committee members drafting a bill allowing banks to issue stablecoins under Federal Reserve oversight. The potential for a stablecoin run spurred critical regulatory discussions.

Stablecoin Market Dynamics in 2023

The year 2023 has brought significant turmoil to the stablecoin market, marked by deviations between USDC and USDT and increased regulatory scrutiny. Amidst these challenges, the launch of PYUSD by PayPal introduces new dynamics that reshape the landscape, offering both obstacles and opportunities.

The stablecoin market has experienced an 8.53 percent contraction year-to-date. Currently, the stablecoin market’s total capitalization is around 125.075 billion USD according to DefiLlama. Factors such as changing regulatory landscapes, discontinued offerings, and disruptions to relevant banking networks have contributed to this decline. During this period, many investors have redeemed stablecoins as they converted them back to fiat currency, causing withdrawals from the stablecoin system.

Global Stablecoin Market Trend, January 2023 – August 2023 – Havyn Research

The two main stablecoin issuers, Tether (USDT) and Circle (USDC) remain significant, with a combined circulating supply of around USD 110 billion as of August 2023, constituting around 88% of the stablecoin sector.

Stablecoin Market Shares of Individual Stablecoins as of August 3, 2023 – DefiLlama

Despite the challenges, stablecoins remain a vital bridge between traditional finance and cryptocurrencies, accounting for almost 10.3 percent of the global crypto market capitalization. They are seen as essential for the broader recovery of crypto prices.

USDC and USDT Deviation Amidst Regulatory Changes

One notable deviation in market capitalization is evident between USDC and USDT stablecoins. The circulation of USDC has experienced a significant decline, with its supply reducing by over 50% from its peak a year ago. Its market capitalization has decreased by almost 40% from 44.5 billion USD at the beginning of 2023 to around 27 billion USD, currently.

This decrease can be attributed to the collapse of SVB and the increased regulatory scrutiny in the United States, leading to reduced demand for stablecoins from issuers within that jurisdiction.

However, the decline of SVB bank didn’t impact USDC as much as Binance’s decision to remove it from the pairing and exclusively use USDT and BUSD. Binance’s dominant position in trading, with 56% market dominance, made dropping USDC significant.

In contrast, USDT’s usage in the stablecoin market remained strong, despite perceptions of USDC being less risky. USDT has maintained its position as the world’s largest stablecoin and has experienced growth in the Asian markets. Factors such as Binance’s influence on liquidity and trading volume, as well as USDT’s continued growth on certain blockchain networks, contributed to its dominance in Asian markets.

Offshore stablecoins like USDT have attracted activity, driven in part by the emergence of cryptocurrency hubs in regions like Dubai, Singapore, and Hong Kong. Tether has reported a 5.7% increase in assets to $86.5 billion in the second quarter of 2023 and a 30% increase in operational profit compared to the previous quarter.

Moreover, the regulatory crackdown on BUSD led to the issuer, Paxos, ceasing the minting of new tokens. Investors have been redeeming BUSD rapidly, reducing its share from over 16% in November 2022 to just 2.82% currently. In addition, the chaos surrounding USDC) which briefly lost its $1 peg, contributed to USDT’s dominance.

According to data from CoinMarketCap, USDT currently holds a whopping 67.05% market dominance, far ahead of others in its category. Data shows that USDT added 17.95% to its market dominance of 49.1% at the beginning of 2023. Its market capitalization has increased by 26.7% from 66.2 billion USD at the beginning of this year to 83.9 billion USD, currently. On the other hand, the stablecoin market share of USDC has decreased by 11.47% from 33.04% to 21.57% over the same period.

USDC (Blue) vs. USDT (Red) Market Capitalization between January 1, 2023 and August 3, 2023 – CoinMarketCap

Regulatory Hurdles Surrounding USDC

Regulatory issues further complicated stablecoin legislation, with disagreements over regulatory structures and Federal Reserve oversight. One of USDC’s main challenges is its constant effort to comply with regulators, which is crucial for its recognition as a reliable USD stable coin.

In a Bloomberg report on April 26, Circle and its CEO Jeremy Allaire attributed USDC’s decline to the United States banking crisis and regulatory crackdown. The CEO expressed concerns about the hostile U.S. crypto regulatory environment, suggesting that the uncertain regulations are deterring investors from investing in the nascent asset class.

The U.S. House Financial Services committee advanced the Clarity for Payment Stablecoins Act on July 27, a bill seeking to establish a federal regulatory framework for stablecoins. However, bipartisan support has not been achieved, and the bill faces opposition from the White House. The bill aims to give the Federal Reserve the authority to set requirements for issuing stablecoins while preserving state regulators’ oversight. The fate of the bill remains uncertain as it progresses through Congress.

Market Skepticism Surrounding Tether

On the other hand, market skepticism surrounded Tether and its reserves, with concerns about transparency and backing. Investors are also alarmed by the fact that tether’s ascendance is occurring at the same time as the total stablecoin market is contracting. USDT is currently audited irregularly, which raises questions about its transparency. On the other hand, USDC is audited once a month by a Top 5, TIER1 accounting firm to attest that it is 100% backed.

Bobby Zagotta, the CEO of Bitstamp USA, pointed out that Tether’s lack of transparency has currently given it an advantage over Circle’s more transparent stablecoin, USDC. However, in the long run, most investors would prefer greater openness.

Recent developments concerning Tether have raised concerns among observers as a majority of newly generated Tether tokens were released on the Tron network, which is under SEC scrutiny. The creator of Tron, Justin Sun, and Tron Foundation Limited were sued by the SEC in March for selling unregistered crypto tokens and manipulating the trading volume of TRX, Tron’s native token, in violation of securities laws.

Tether has over 40 billion of its tokens, roughly 49% of its total supply, on the Tron blockchain. Some analysts and investors believe this strong tie to Tron could pose risks for Tether. Tron’s blockchain is popular for payments and savings, particularly in high-inflation nations with a demand for US dollars. However, some investors are hesitant to rely solely on a significant stablecoin that operates outside of the United States.

According to David Wells, CEO of cryptocurrency trading site Enclave Markets, financial systems should not have a single point of failure. Whether it’s liquidity concentration on one trading platform or stablecoin concentration from a single issuer, it poses potential risks to the industry’s critical infrastructure.

PYUSD: A Catalyst for Stablecoin Competition and Regulatory Evolution

PayPal’s launch of PayPal USD in the stablecoin domain prompted a mix of excitement and skepticism among crypto enthusiasts. Issued by Paxos Trust, the PYUSD token has introduced regulatory oversight, distinguishing it from other stablecoins. With 431 million global users, PayPal’s move could have an impact comparable to BlackRock’s Bitcoin ETF bid, signifying a significant step toward crypto’s mass adoption. This development arrives in a context of increased stablecoin options, where competition fosters better products.

While some experts suggest PYUSD could challenge USDC, dominant stablecoins like Tether and USDC remain unfazed. Paolo Ardoini, the Chief Technology Officer of Tether, suggests that PayPal’s move into the stablecoin market may not have a significant immediate impact on Tether, but it could still emerge as a competitor, particularly in the U.S. market. Tether has yet to fully enter the U.S. market, and PYUSD’s regulated status might make it an attractive alternative for those seeking a regulated stablecoin option within the United States.

The entry of PayPal’s regulated stablecoin echoes the importance of regulatory measures in the industry. Paxos Trust’s role as a regulated trust company by the NYDFS adds a layer of protection for PYUSD holders worldwide. This level of regulation sets PYUSD apart from its counterparts like Tether and USDC, which operate with varying degrees of regulatory scrutiny.

However, skeptics on Crypto Twitter expressed reservations. Some commentators, like crypto analyst Adam Cochran, expressed disappointment, considering PYUSD’s confined use within PayPal’s ecosystem. Hodder Law Firm’s Sasha Hodder raised concerns about censorship and reversibility, likening PYUSD to a central bank digital currency.

Despite the divergent opinions, the launch of PYUSD signifies a broader trend towards regulated stablecoins with lasting implications for the digital asset landscape.

Future Outlook

Stablecoins are increasingly used by businesses and dealers for fund transfers as US officials tighten controls on crypto firms’ interactions with financial institutions. In the coming future, stablecoin issuers and investors will navigate a complex regulatory landscape. The trustworthiness of stablecoins is vital to uphold cryptocurrency market confidence. With ongoing regulatory efforts and technological advancements, the trajectory of the stablecoin market will take shape. As the crypto market matures, stablecoins will maintain their importance bridging traditional finance and digital assets.

Tether leads the stablecoin market with over $83 billion in market value, but transparency and stability concerns highlight potential downsides for investors. While USDC is facing regulatory challenges in the US, Circle expands in the UAE, focusing on growing USDC’s presence in the MENA region according to Miriam Kiwan, Vice President, MEA at Circle. Moreover, Circle recently launched “Programmable Wallets” in an attempt to boost USDC adoption across various financial applications.

While Tether and USDC remain established players in the stablecoin market, the launch of PYUSD signifies a pivotal moment for the industry. The regulatory aspect of PYUSD and its association with PayPal’s vast user base have the potential to influence the competitive landscape and adoption of stablecoins, especially in the U.S. market.

Salma Naueihed

Salma has dedicated the last 10 years of her career to academic research since she got her MBA degree in Finance and Economics from Notre Dame University - Louaize. With a strong background in research and data analysis, she has made valuable contributions to research at Olayan School of Business at AUB. She also works as a freelance researcher, providing expert research services on various business topics. Her expertise spans across research fields, including economics, finance, financial and managerial accounting, corporate governance, and corporate social responsibility. She also has keen interest in emerging trends in cryptocurrency and blockchain technology. She has a proven track record of providing high-quality research support, managing research projects, and contributing to publications.

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