Stablecoin Hegemony Struggle

The battle for stablecoins, like the battle for home video, is won or lost not by technology or established status, but by applications

Original text: The Race to Dominate Stablecoins (HBR)

Author: Christian Catalini , Jane Wu

Compiled by: LlamaC

Cover: Photo by Vimal S on Unsplash

“Recommendation: Stablecoins have the potential to reshape the global financial system and put the banking and financial industries under new digital competition. The battle for stablecoins, like the war in the field of home videos, is not determined by technological superiority or existing status, but by application. Although regulators can make it more difficult for innovators to compete, they cannot stop their progress forever. In the end, the most likely outcome is that multiple stablecoins will fade into the background, bringing lower-cost and faster payment services to the world.”

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Stablecoins, as a novel form of interoperable and programmable money, have the potential to reshape the global financial system. In doing so, they could enable software to begin to eat banking and financial services — areas that have been relatively untouched by the internet. They could displace traditional payment and credit card networks like SWIFT, Visa, and Mastercard, accelerate the unbundling of financial institutions, and expand access to the U.S. dollar in heavily restricted countries, including those restricted by sanctions.

They also promise to change the balance of power in these industries. The companies that control the stablecoin market will have a significant impact on the future of money.

Given these high stakes, we are witnessing increasing competition among stablecoin issuers, established digital wallet providers, and traditional banks, all vying to establish the dominance of their platforms. This article delves into the strategies of incumbents and challengers, the role that regulators will play, and ultimately predicts how the market will evolve. The results are significant not only for financial institutions, but also for any company and digital platform that relies on large-scale financial flows.

Towards a Monetary Operating System?

Platform wars, where competitors with a vision of the future compete fiercely for market dominance, are the most tumultuous and turbulent chapter in the business world, vividly demonstrating both the good and bad sides of business strategy.

Some devolved into trench warfare, like the endless skirmishes and (sometimes controversial) growth strategies that Uber deployed against Lyft in its city-to-city rivalry, or Didi’s use of its home-field advantage to poach drivers, gather counterintelligence, and outwit Uber with the help of regulators.

Others begin quietly as technical discussions within standards-setting organizations—like the HD-DVD vs. Blu-ray battle—and become intense only when competitors drive prices to rock bottom, tilting the market in their favor. Because these markets are winner-take-all, CEOs will do whatever it takes to get ahead.

Often, the actual technology matters less than people give it credit for. While experts constantly debate the technical merits of each solution, in the end, it’s execution that wins out. A classic, but dated example is the VHS vs. Betamax competition in the 80s, where JVC beat Sony despite having fewer resources and a lower-quality product. JVC understood that having more content—what we would call “applications” today—was far more important than perfect video.

The same is true in the blockchain world: more than a decade into the Bitcoin experiment, countless teams have raised billions to try to replace Bitcoin’s limited design. Yet Bitcoin remains, with network effects and institutional adoption surpassing other options. While engineers obsess over metrics like transactions per second, energy consumption, or dimensions of scalability and decentralization, the world moves on.

Platform wars always end the same way: one dominant design emerges, everyone switches, and the conflict ends. The loser only gets a chance to win back when a new technological paradigm emerges: think of the Mac vs. PC battle, where Apple only managed to turn the tables on the iPhone, or Meta's aggressive deployment of AR/VR, only because it was currently limited to iOS and Android on mobile.

In the blockchain infrastructure space, Bitcoin and Ethereum have become the dominant designs, and more activity will converge on them (although some people tend to ignore this fact).

However, while the blockchain war may be over, the battle for stablecoin dominance has just begun. The former is crucial for developers, while the latter will determine our daily use. The reason is simple: stablecoins are the bridge between cryptocurrencies and traditional finance. Without stablecoins, crypto applications have to deal with volatility, which makes financial contracts costly.

The past and future of money

Regulators seem to recognize the relevance of stablecoins and the stakes they hold. Without stablecoins, blockchains lack competitiveness. However, in their current form, stablecoins pose a challenge to banks, are used to circumvent capital and anti-money laundering regulations, and could trigger or accelerate banking crises.

The run on Silicon Valley Bank was just a small preview: with about 8% of Circle’s USDC reserves at risk, it quickly decoupled and pulled $3 billion from the troubled bank. While such risks can be easily avoided with proper reserve design, they are real.

Back in 2019, when Facebook announced Libra—a project designed by one of the authors—central bankers probably knew that the currency would never become a new unit of account. The euro took years to establish, enforced from the top down by all the governments involved. Even so, Libra posed a credible threat to the status quo, drawing sharp criticism from financial establishments, legislative proposals to ban it, and regulatory roadblocks. By 2022, the project faded.

But the coalition behind blocking Libra only bought time for existing institutions, and the situation heated up again.

Incumbent financial institutions are threatened by stablecoins, which could become the new operating system for money, doing to the existing system what the internet did to Barnes & Noble. As a result, they are determined to adopt an “embrace, expand, and destroy” strategy. Financial giants like JPMorgan have developed their own proprietary blockchains and launched the programmable dollar on them. Although Microsoft used a similar strategy against Netscape in the 90s, which ultimately did not work well, the financial services sector is different. Regulation gives these institutions the opportunity to use their distribution networks and lobbying power to slow down the process of change while building mechanisms to fight back. This is what caused the Libra project to fail, and other projects may soon suffer the same fate.

The last serious attempt to reform the financial system did not use blockchain technology. It was Elon Musk’s original version of X.com, before it merged with Peter Thiel’s PayPal. Musk was ahead of his time and wanted to build a universal financial services app. Thiel was more pragmatic and focused on ensuring backward compatibility with card networks and banks. This solidified PayPal’s growth in the short term, but ultimately killed its chances of truly changing the system. Twenty years later, the card networks have become comfortable oligopolies, and the banking industry remains untouched by the internet.

Change or status quo?

Stablecoins offer a second chance to reform the financial system. But whether they can achieve this goal depends on the dynamics of competition in the stablecoin space—and whether regulators tend to support or inhibit innovation. By tightly limiting design choices, regulators could limit viable business models and allow only banks to enter the market. If this happens, the competition-enhancing element of the technology will once again be lost. While this may satisfy incumbent institutions, the cost to consumers and businesses will be high.

Regardless of the level of uncertainty surrounding regulatory intervention in the stablecoin race, the key question is whether we will end up with one or two global leaders or a multitude of commoditized issuers. The technology can support either outcome, so where we end up will depend on how well each player executes their strategy.

The first entrants are crypto-native teams Tether and Circle. Tether launched the first stablecoin for trading a decade ago and dominates the market with $114 billion in USDT in circulation. USDT is issued offshore, and although its reserves have also been questioned, its core challenge is whether it can transform into a compliant entity. Although Tether has repeatedly stated that it responds to law enforcement requests in a timely manner, reports from the United Nations and JPMorgan Chase question its compliance and point out that more efforts are needed. Tether's competitive advantage comes from its scale, integration with market makers, and strong product-market fit in segments where it is impossible to hold dollars. The last point is also Tether's biggest hidden danger.

Circle, with $33 billion in USDC, is Tether's strongest competitor. Although Circle operates under the same U.S. state money transmission licensing system as PayPal, the federal government has made it clear that the management of stablecoins should be a federal matter because the risks involved in managing stablecoin reserves are closer to banking than just operating a digital wallet. Therefore, for Circle, which has been seeking an IPO for many years, a major suspense is whether it can successfully transform into a federal charter, especially considering that it does not implement KYC rules for USDC holders. The uncertainty of future regulation may put Circle in a leading position or face the complexity of transforming into a bank. Banking supervision will also significantly limit Circle's revenue sources, as the Federal Reserve rightly hopes that issuers will remain stable and boring.

For Tether and Circle, we believe the strategy is simple: adapt to stricter compliance and consumer protection standards without losing profitability in the stablecoin ecosystem. This is a delicate balancing act, as stricter regulation will inevitably limit the ways issuers can create and capture value.

In the crypto-native space, Paxos, founded in 2012 to expand blockchain infrastructure, stands out for its unique strategy. Rather than scaling its own stablecoin, Paxos is betting on a world with many stablecoins. By positioning itself as a stablecoin infrastructure provider, Paxos has helped other institutions issue branded stablecoins with remarkable results. When PayPal decided to get involved in the crypto space, it chose to work with Paxos. Although PayPal's PYUSD circulation is only $350 million, market capitalization is not an appropriate metric if the focus is on payments rather than crypto trading and decentralized finance (DeFi). For stablecoins that want to compete with credit card companies, total payment volume (TPV) would be a better measure, and with its existing merchant business, PayPal is expected to quickly surpass USDC in this regard.

If Paxos can replicate this model with other large consumer brands that don’t want to become financially regulated businesses, the market could be flooded with stablecoins. Just as consumers choose branded rewards credit cards from airlines, hotel chains, or retailers, stablecoins could fade into loyalty points. Starbucks already holds over $1 billion in customer funds in its app, and it’s not hard to imagine Walmart or Amazon joining the fray. Target’s wildly successful RedCard program could be replicated by anyone with a loyal customer base by issuing stablecoins, shifting revenue away from credit card companies.

Because stablecoins exist on an open network, they will all be interoperable. Moreover, if regulation makes their security uniform, a key differentiating dimension will disappear. Consumers and businesses will hold digital and programmable dollars and perceive them as analogous to today’s commercial bank deposits. This is a doomsday scenario for Tether and Circle, as they will struggle to differentiate themselves among a multitude of competitors with distribution advantages.

Behind the scenes, banks are already pushing for a world with multiple stablecoins. This is the status quo they are familiar with, where dollars at different banks are treated as interchangeable in the eyes of consumers, even though this interchangeability is granted by the central bank’s clearing mechanism. This approach preserves the role of banks to some extent, unlike the rise of large stablecoin companies. By pushing network effects back to the dollar rather than a single stablecoin, banks are able to resist the emergence of competitors that are more powerful than the card networks. Moreover, this does not prevent JPMorgan Chase from dominating the institutional use case, or prevent US banks from doing the same in the retail market, thus maintaining the original hierarchy.

While Visa and Mastercard could retain more of a competitive advantage by issuing their own stablecoins, this is fraught with antitrust risks and would damage their relationships with banks. Therefore, a multi-stablecoin world is also one that the card networks will embrace: it doesn’t change their role, and they can add stablecoins just like they add new currencies. A slightly riskier strategy would be for the card companies to work with banks to design a stablecoin that distributes reserves among them — but this might be overly ambitious, similar to Liba.

This makes big tech companies an unpredictable variable. In fact, they have all learned from the lessons of Libra that it is not wise to enter the financial services field too high-profile. This move faces strong political opposition, and it is better to cooperate with banks rather than fight against them. In addition, their core businesses cannot operate under the federal banking legal and regulatory framework. Finally, because they control the distribution channels, they can use their network effects to capture value regardless of the stablecoin used, which is unstoppable. Although new banks such as Revolut or Nubank may have greater ambitions than tech giants, they will also face business scope challenges as they further intrude into traditional banking areas.

So, are pure stablecoin issuers like Tether and Circle the only ones driving a winner-take-all situation? After all, with the current market highly concentrated, network effects seem crucial. Stablecoin liquidity has played an important role in ensuring low-cost conversions between fiat and cryptocurrencies to date, and this importance will only grow as mainstream adoption increases.

But the reality is that existing status does not automatically translate into non-cryptocurrency use cases, and as banks are allowed in, traditional distribution channels will become increasingly important. So while Tether and Circle have dominated the crypto era, the leap from this niche, unregulated market to serving hundreds of millions of consumers and businesses is a fundamentally different battle.

Still, leading cryptocurrency exchanges like Coinbase and Binance could also enter the market as pure issuers and scale up, with the user base, technical talent, and regulatory experience to compete. Both companies have built payment and financial application networks (Base and BSC, respectively), and as they grow, they will have to become more like traditional banks and have a deep understanding of the relevant technology—perhaps more proficient than Circle or Tether.

Recruiting disruptors

The battle for stablecoins, like the competition in home video, is not determined by superior technology or incumbent status, but by use cases. While regulators can make it difficult for innovators to compete, they can’t stop the process forever. Ultimately, the most likely outcome is that multiple stablecoins fade into the background, providing lower-cost, faster payment services around the world. This would be a win for consumers and businesses, though it might not be for existing stablecoin issuers, which could be acquired by banks.

When this happens, it won’t end the battle for control of our digital wallets. The same companies will still be vying to dominate “the way payments are made.” Credit card companies will fight to keep payments flowing using Visa or Mastercard, which may not be a problem for banks. So it will be the leading digital banks and cryptocurrency exchanges that try the truly innovative moves that may be the real game changers.

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