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The Endgame for Stablecoins

Vishal Kankani
June 6, 2024 | 9 minute read

Today, we’re proud to announce our investment in Mountain Protocol, the issuer of USDM, a permissionless, yield-bearing stablecoin backed entirely by US Treasuries. We led the Series A round, which also included Castle Island Ventures, Coinbase Ventures and others.

Stablecoins are among the largest addressable markets in crypto. And to unlock the lion’s share of the market, we believe that a stablecoin should:

  1. make earning a base yield the default;
  2. hold assets with the same sovereign risk as the underlying fiat currency;
  3. have at least 1:1 backing with such assets – not just a tokenized trading strategy;
  4. hold assets backing the stablecoin in a bankruptcy-remote structure;
  5. be prudentially regulated in a respected jurisdiction.
  6. be able to freely move around on-chain as standard ERC20 and SPL tokens (no transfer restrictions)
  7. be auto re-basing for butter UX (everyday when you open your wallet, there are more tokens than yesterday because of accrued interest)

Stablecoins have existed for about a decade. And yet, USDM is the first stablecoin that satisfies all of the above requirements. Today, USDM is live on Ethereum, Polygon, Arbitrum, Optimism and Base with plans to expand to other networks soon, including Solana. It has been audited by Open Zeppelin and is regulated by the Bermuda Monetary Authority.

Yield Is The Final Frontier

Stablecoins should explicitly be boring products. They should not be volatile. Banking crises should not impact stablecoins. Stablecoins should be so boring that the media forgets they even exist.

There are very few opportunities to make stablecoins meaningfully better than what USDC and USDT already provide. Trust in the issuer is table stakes. Having a clear bankruptcy remote structure is paramount and is a clear differentiator for USDM vs. these incumbents. USDM is also backed entirely by US Treasuries, making it safer than other fractional or multi-asset stablecoins.

Beyond trust, we contend that there is only one killer feature that can compete with the liquidity and brand recognition that USDC and USDT offer: yield. Specifically, auto-rebasing for yield accrual (i.e., users don’t have to do anything to accrue and claim their yield). Yield-bearing stablecoins are the future of crypto-native checking accounts.

Of the roughly $160B in stablecoin circulation, more than 95% are USD denominated stablecoins. Short term US treasury bill yields at the time of writing are approximately 5%, and yet these stablecoin issuers do not share that yield with their users. Assuming a 5% interest rate, this amounts to roughly $8B per year that could have potentially been shared with stablecoin users. We expect this number to grow by an order of magnitude as stablecoins continue to grow and ultimately exceed $1T in circulation in the coming years.

Mountain Protocol’s USDM is a stablecoin that behaves just like USDC or pyUSD; meaning, it is also backed by short term US Treasuries (notably USDT is not fully backed by US Treasuries). However, unlike USDC or pyUSD, USDM is natively yield-bearing, giving its users the ability to earn yield daily via auto-rebasing without taking on any additional risk assumptions. Rebasing means that users earn more USDM by just having the stablecoin in their wallet and without having to stake, lend, or do anything at all; if they hold a balance the number of stablecoins in their wallet will increase relative to the yield they earn. Every day when users open their wallet, there will be more USDM coins than the previous day because of accrued interest. USDM currently yields 5% APY.

The current stablecoin leaders don’t share any portion of the reserve yield they generate with their users. This is unsurprising given how lucrative the current business model is and the lack of competition. If they shared ~90% of the yield, that would immediately reduce revenues by roughly 10x. We see a similar version of this story playing out in real time in the bitcoin ETF space where GBTC is still charging 1.5% fee whereas Blackrock’s bitcoin ETF, IBIT, only charges a 0.25% fee. It must then come as no surprise that IBIT recently surpassed GBTC in AUM. At least in the case of GBTC, some holders are sitting on large capital gains and that can keep them from redeeming. The case to not share yields is even weaker with stablecoins because there are no capital gains stablecoin holders seek to protect by staying locked in a higher fee product.

USDM is built to be the safest yield-generating stablecoin onchain. Although there are many other yield-bearing stablecoins in the market, their sources of yield require riskier strategies (from secured lending, basis trade, unsecured lending and more), which we don't think can ever become safe enough for these coins to be considered as a trusted and safe stablecoin, much less a ubiquitous, world-wide currency. Others that are backed by US Treasuries choose to get regulated in newer, less proven jurisdictions, which introduces a different form of risk.

The business model of Mountain Protocol is straight forward. It makes money by keeping a “net interest margin,” which is calculated by tracking the difference between yield generated from US treasury assets versus the yield passed on to users in the form of USDM yield. We think that stablecoin issuers should be fairly compensated for their work, but also believe that current issuers are being overcompensated, and have no incentives to change the status quo.

The Prudential Regulation Moat

If you believe, like we do, that stablecoins will be the primary settlement currency of the future, then logic dictates that stablecoins will be systemic to the global financial system. Consequently, regulators will want to ensure that stablecoins do not fail.

Mountain Protocol is prudentially regulated by the Bermuda Monetary Authority, arguably the best regulator today for yield-bearing stablecoins. USDT and USDC, the current market leaders that account for about 90% of stablecoin circulating supply, are not. Unlike securities regulation, which is focused on disclosure, prudential regulators go a step further to proactively manage risk to ensure these systemically important products do not fail. Prudential regulation requires banks, payment companies, insurers and other financial organizations to measure and manage risks across different scenarios, hold adequate capital and liquidity as dictated by stress tests, and have in place workable recovery and resolution plans. Getting prudentially regulated is a non-trivial endeavor, which takes ~12-24 months to secure and requires extensive work to maintain, including financial, risk, compliance, governance, cyber external audits, regulatory reporting, detailed governance processes and more.

After collaborating closely with regulators, Mountain Protocol was granted a license by the Bermuda Monetary Authority to issue USDM under this regulatory framework. Bermuda is experienced with regulating large complex institutional products like re-insurance, a roughly $300B industry, and is also considered a top-tier jurisdiction for trusts and private wealth management industry, a trillion dollar plus market. Bermuda is the leader for the issuance of insurance-linked securities (ILS), highlighted by the fact the Bermuda Stock Exchange (BSX) boasts 785 listed issuers and $38.4 billion in market capital outstanding, which represents a roughly 92% global ILS market share. More importantly, Bermuda is emerging as a leader in the regulation of digital assets and fintech. Furthermore, Bermuda has a robust court system, following common-law that allows USDM holders to be able to trust a proven jurisdiction. Mountain Protocol is not alone on this assessment. Most of the institutional players in the space are moving or have moved to Bermuda, most notably Coinbase for their International Exchange.

Mountain Protocol has been working on getting these licenses in place for the last 18 months. This head start gives them an opportunity to build up liquidity and brand recognition to become the leader in the yield-bearing stablecoin category.

The Bull Case For USDM

Trust and Safety are prerequisites for becoming a widely-used stablecoin. The defining feature, however, is yield sharing. Markets are mercenary, and the stablecoin that earns users the most without taking on additional risk assumptions will be the king.

As stablecoins proliferate, we are optimistic that USDM will become the market leader and scale to billions of people for the following reasons: 1) USDM auto-rebases, which is the only way to scale stablecoins to billions of people (safest UX). Anything else is just a headache that a user won’t sign up for. 2) USDM also has line of sight on abstracting away multi-chain complexity, thus allowing users to hold USDM wherever they trade. 3) We believe holding USDM is effectively the same risk profile as holding US Treasuries. As more yield-bearing stablecoins emerge, the source of USD yield must have the same sovereign risk profile as USD, otherwise users will be taking a materially different risk than they think they are. 4) USDM has the strongest regulatory moat today. Trusted regulatory positioning will become increasingly important as stablecoin legislation gets carved out in the years ahead. Most stablecoin legislation globally deems stablecoins as digital money and thus implements prudential regulation for stablecoin issuers; this includes MiCA (Europe), VARA (Dubai), MAS (Singapore) and, naturally, the BMA (Bermuda). Most of the bills in the US Congress also follow this principle. USDM is significantly ahead in this regard.

Low Hanging Fruit

Today, USDM is used by Treasury Managers to keep their stablecoin assets safe and earn yield. More companies are likely to hold increasing percentages of their balance sheets in stablecoins. With trillions of dollars sitting in corporate treasuries, this is a massive opportunity. It should not come as a surprise that Mountain Protocol has been successful at attracting sophisticated risk-averse buyers who buy and hold. Separately, there is a clear global demand for dollars from people living in high inflation countries and/or unstable regimes to protect against declining purchasing power. If you are a fintech firm offering dollar exposure in these places, USDM makes a lot of sense as it also gives the yield without asking users to do anything beyond holding USDM in their wallets.

Beyond treasury management and dollar savings, the other obvious use case for USDM is derivatives collateral. Derivatives markets are measured in hundreds of trillions of notional—without exaggeration. Leverage seekers need to post collateral, which just sits with counterparties and is measured in many billions. In that sense, it’s obvious that traders should post collateral that generates yield. In traditional finance, US Treasuries are a respectable form of collateral with very limited haircuts. Thus, a well-regulated, trusted, liquid, yield-bearing stablecoin with a bankruptcy remote structure in place is a complete no-brainer for derivatives collateral purposes and derivatives exchanges should take note. That’s USDM.

We are excited to back Martin, an Argentinian who understands the global importance of stablecoins first hand, Matias, who has built secure and scalable crypto tech previously, and the team in their journey. The company also has a stellar board of advisors, including Matt Homer (GP at Department of XYZ, former NYDFS regulator and a fintech veteran), Jeff Baron (CCO Coinbase International), Nic Carter (GP Castle island Ventures), and Firas Habach (Head of Compliance, Sygnum Bank).

If you are interested in geeking out about the product structuring of USDM, we strongly encourage you to check out their docs here. It details their licenses, custodians, auditors, and much more. If you are interested in partnering with Mountain, please reach out to Martin directly or me here. If you are building something interesting powered by stablecoins, we would love to hear from you.

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