Crypto Current #73

This week, we explore the explosive growth in the stablecoin market, now exceeding $235 billion, with new institutional entrants like BlackRock and Fidelity reshaping the landscape. Meanwhile, the recent Hyperliquid incident highlights important market structure challenges in decentralized exchanges, raising critical questions about transparency trade-offs and underscoring the platform's growing pains.

Over the last week, the broader crypto market remained relatively stable as investors tired of macro concerns and sought the next catalyst. Of the top ten tokens by market cap, Dogecoin stood out with a +10% gain amid increased liquidity and growing speculation around a potential ETF. Conversely, Ripple experienced a -7% decline as some of the initial excitement surrounding its SEC case settlement began to fade.

What's happening in crypto?

Podcast: "Is this the investment opportunity of our lifetime?"

Richard Galvin, DACM's Co-Founder & CEO, sat down with Managing Partner Tim Whybourne, CFA of Emanuel Whybourne & Loehr to explore the evolution of digital assets and institutional crypto investing.

iTunes:
https://podcasts.apple.com/au/podcast/the-exchange/id1654418616
Spotify:
https://open.spotify.com/show/2vpsvildgmbYWbRDliBLJ0?si=bOrUWiOKQLGTK5kVIMRQwg&nd=1

Stablecoins: What Are They and Why Should I Care?

In a market where Bitcoin can swing 10% in a day, the stablecoin sector has quietly grown to a mammoth $235 billion (see below). For sophisticated investors and advisors exploring digital assets, understanding this foundational layer of the crypto ecosystem is no longer optional – it's essential.

Source: Defillama, Total Stablecoin Market Cap

What Exactly Are Stablecoins?

At their core, stablecoins are cryptocurrencies designed to maintain a stable value, typically pegged to a fiat currency like the US dollar. They emerged as a solution to crypto's volatility, creating a bridge between traditional finance and digital assets.

Stablecoins serve several critical functions:

A reliable unit of account in crypto markets
A safe haven during market turbulence
A more efficient mechanism for cross-border payments
A foundation for DeFi lending, trading, and yield generation

The market has evolved into five distinct categories, each with different risk-reward profiles:

1. Fiat-Collateralized Stablecoins: Backed by reserves of actual currency or cash equivalents. Tether (USDT) and USD Coin (USDC) dominate this category, together accounting for over 75% of the market. They prioritize stability and liquidity but offer no native yield to holders.

2. Crypto-Collateralized Stablecoins: Backed by other cryptocurrencies, typically over-collateralized to accommodate price volatility. DAI is the most prominent example, currently holding over $4.3 billion in market cap.

3. Algorithmic Stablecoins: Use algorithms and smart contracts to maintain their peg by automatically adjusting supply. After Terra/UST's spectacular $40 billion collapse in 2022, this category remains under intense scrutiny and has lost significant market share.

4. Tokenized Money Market Funds: The newest and fastest-growing category. These tokens represent ownership of short-term Treasuries and other cash equivalents while passing yields directly to holders. BlackRock's BUIDL is the poster child here, showing remarkable 250% weekly growth and now becoming significant holders of US treasuries.

5. Hybrid Yield Products an emerging catagory that bundle MMF-like stability with higher-risk exposures (lending, private credit, etc.) The reality is these often have opaque risk while marketing themselves as "stable."

Top 10 Stablecoins by Market Cap

Source: Defillama

The Stablecoin Landscape Today

The market has stratified into clear leaders. Tether remains dominant with $143 billion market cap, representing 64% market share. USDC follows at $51 billion (23%). There is space for new entrants as the recent growth shows:

BlackRock's BUIDL $2 b has shown staggering 250% weekly growth
Ethena USDtb +36% weekly and an astounding $1.4b in monthly flows

These growth figures point to a significant shift in the market – from pure stability to stability-plus-yield.

New Entrants Reshaping the Ecosystem

Several recent developments highlight the maturation and diversification of the stablecoin space:

Government-Backed Stablecoins: Wyoming has announced WYST, the first state-issued fiat-backed and fully-reserved stablecoin, built as a Layer-Zero OFT (Optimistic Fraud Proof) token. This marks a significant milestone in regulatory legitimacy.

Global Expansion: Circle's USDC has launched in Japan, becoming the first and only stablecoin officially available in this major market, in partnership with SBI.

Traditional Finance Giants Enter: Fidelity is in advanced testing of its own stablecoin according to Financial Times, signaling major institutional interest in the sector.

New Institutional-Grade Offerings: World Liberty Financial is launching USD1, fully backed by short-term US treasuries and cash equivalents, initially on Ethereum and Binance Smart Chain.

Why USD Dominance in Stablecoins?

It's no coincidence that virtually all major stablecoins are pegged to the US dollar. Several factors drive this:

The dollar's position as the world's reserve currency (and primary settlement currency)
Deeper regulatory clarity for USD-backed products compared to other currencies
Greater market demand and liquidity for USD-denominated assets
The dominance of US financial institutions in the digital asset space

While euro, yen, AUD and pound-pegged stablecoins exist, they've failed to gain significant traction and a lot of the reason is they've gone after retail, not the insto market.

How Many Stablecoins Will Survive?

The current proliferation of stablecoins likely isn't sustainable. Historical parallels suggest consolidation around a few key players:

Factors favoring consolidation:

Network effects and liquidity naturally concentrate in fewer assets
Institutional adoption typically favors scale and established track records
Regulatory compliance costs create barriers to entry

Factors favoring diversification:

Different risk profiles serve different user needs
Multi-chain ecosystems require chain-native solutions
Yield-generating vs. pure stability offerings attract different users

The market will likely expand to adopt new stablecoin categories that emerge and then consolidate down to one or two main players, similar to the Fiat collateralized model where 87% of market cap is currently held by the dominant two players.

Regulatory Clarity on the Horizon

The anticipated passage of US stablecoin legislation in the coming months will likely accelerate market development and adoption. This regulatory framework will provide much-needed clarity and legitimacy to the sector, potentially opening floodgates for institutional participation.

The biggest winners from this regulatory milestone will be:

1. Crypto's Brand and Perception: Clear regulations will enhance legitimacy and trust in the broader digital asset ecosystem, particularly among institutional investors who have remained on the sidelines due to regulatory uncertainty.

2. Established Players like Circle and Tether: Incumbency advantage cannot be overstated in this market. These companies have spent years building extensive integration networks across exchanges, wallets, and DeFi protocols. As regulation crystallizes, these existing relationships and technical integrations will become even more valuable.

New entrants will face significant challenges as they attempt to compete with established networks. While many new tokens will emerge seeking the institutional edge, those without existing integrations will struggle to gain traction regardless of their technical merits or backing.

Investment Implications for sophisticated investors

This evolving landscape presents both opportunities and risks:

Strategic considerations:

Zero-yield stablecoins increasingly look like a poor value proposition compared to yield-bearing alternatives
The risk spectrum within "stablecoins" has widened considerably, requiring deeper due diligence
Regulatory developments could rapidly change the competitive landscape

Key to remain focused on:

Analyzing counterparty risk across the expanding stablecoin ecosystem
Evaluating tokenized Treasury instruments for risk-adjusted yield opportunities
Monitoring the integration of traditional finance and crypto systems

Conclusion: A Paradigm Shift Underway

What's truly fascinating about the current stablecoin market isn't just its size – it's the reversal of expected adoption patterns. For years, the narrative was about traditional finance eventually tokenizing their products for crypto markets. Instead, we're seeing crypto actively incorporate traditional finance products.

These tokenized Treasury instruments represent the first major instance where crypto markets are integrating TradFi assets rather than the other way around. This flip in adoption dynamics signals a maturation that institutional players can no longer afford to ignore.

The stablecoin sector has evolved from simple digital dollars to a sophisticated market with diverse risk-reward profiles. Understanding these nuances has become essential for any investor exploring digital asset allocation.

Hyperliquid: Growing pains in evolution

Recent events involving Hyperliquid's derivatives platform have raised important questions about market structure risks in decentralized finance. For institutional investors considering DeFi exposure, this incident provides valuable insights into the current state of on-chain derivatives and why it is important to engage an accredited advisor or investor.

The Incident

Hyperliquid faced a significant market challenge when several coordinated trading activities targeted JellyJelly, a low-capitalization token listed on the platform:

A trader established an $8 million short position (approximately 40% of JellyJelly's total supply)
The same trader simultaneously bid up spot prices on external venues while removing margin from their Hyperliquid short
JellyJelly's price increased approximately 5x as other traders recognized and amplified the emerging short squeeze
Upon the trader's "liquidation," Hyperliquid's LP vault (HLP) assumed the position, facing unrealized losses exceeding $10 million
A second trader opened substantial long positions, further pressuring the price upward
Both Binance and OKX listed JellyJelly futures during this period, adding more complexity to the situation

The situation created significant risk to the HLP vault, which could have been depleted if JellyJelly's price continued rising while users simultaneously withdrew their funds. Ultimately, network validators held an emergency vote to delist the token and settle all trades at prices close to pre-incident levels.

Market Structure Implications

While the financial impact on users was minimized by the emergency intervention, the incident highlights several structural challenges in decentralized derivatives platforms:

Trust and Transparency Trade-offs: Hyperliquid's public on-chain position data creates transparency but also vulnerability to targeted attacks using that information.

Governance vs. Market Integrity: The emergency delisting raises questions about intervention thresholds and how decentralized a platform can truly be while maintaining market integrity.

Liquidity Pool Vulnerabilities: The architecture of the HLP vault demonstrated vulnerability to coordinated actions targeting long-tail assets with limited liquidity.

Cross-Exchange Coordination: The timing of futures listings on centralized exchanges during the incident raises questions about information sharing and coordination across market venues.

Institutional Considerations

For sophisticated investors evaluating exposure to DeFi derivatives, this incident highlights important due diligence considerations:

Analyzing governance mechanisms and intervention frameworks
Understanding market exposure and concentration risks in liquidity pools
Evaluating the robustness of oracle and price discovery mechanisms
Assessing the transparency of position data and its potential game-theoretic implications

DACM's Perspective

While incidents like this may appear to undermine crypto market credibility, they actually represent necessary growing pains in market structure evolution. Traditional financial markets developed robust mechanisms through similar trial-and-error processes over decades.

We view these events as valuable learning opportunities that ultimately strengthen the ecosystem. The most successful protocols will adapt their designs based on these lessons, implementing more robust risk management frameworks while preserving the benefits of decentralization.

For institutional investors, the key takeaway isn't to avoid DeFi, but rather to approach them with appropriate risk management protocols and a sophisticated understanding of their evolving market structures.

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Established in 2017, DACM is an institutional investor focused on the digital asset sector. Our team invest across the digital asset sector, from early-stage venture partnerships to listed and derivative markets. DACM has developed a fundamental investment philosophy designed for family office and institutional investors, tested across multiple market cycles.

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