The Silent Threat to The Biggest Tokenization Success

When people ask me what the single most successful use case for tokenization is, my answer is always the same—and it’s stunningly simple: stablecoins or privately issued tokenized cash.

Here’s why:

• $200B market cap (+1,000,000% in just a decade)

• $10T+ annual transaction volume (beating Visa, Mastercard, and PayPal combined)

• 25M monthly users (imagine when this hits 250M or 1B!)

• 99.99% reduction in fees and processing time compared to traditional cross-border bank wires

Stablecoin is the front-end for digital assets adoption that has the most reach, impact and utilities out of all digital assets. 

However there is a massive hidden problem with this success story that no one likes to talk about - fragmentation. Stablecoins are fragmented across three critical areas:

1. Risk management & disclosure requirements

2. Regulatory & compliance requirements

3. Jurisdictional product availability

Think about it this way: when you spend, send, or invest $1 from a JPMorgan or Citigroup account, it doesn’t matter to the market—it’s just $1.

But with stablecoins, branding matters. The $1 stablecoin you hold could be rock-solid or completely worthless based solely on who issued it.

This means:

• Average consumers need to become bank credit analysts, evaluating the complex balance sheets of stablecoin issuers to ensure their $1 won’t vanish.

• Large institutions remain hesitant to embrace stablecoins due to these risks.

  
  

Why does this matter? Stablecoins are at the tipping point; it is at hundreds-of-billions market size with mostly crypto-native users but scaling to a hundreds-of-trillions asset class with billions of mainstream users and big institutions requires more robust product design. But without addressing fragmentation, that leap won’t happen.

In this Weekly Research issue, we will dive into various components of the problem (or opportunity depending if you have an enterprising mind) and explore what a solution would look like.

Let’s dive in

Stablecoin Market Fragmentation

According to data from DeFiLlama, there are:

• 100+ stablecoin products making up the $200B

• 20 stablecoin products with 100M+ AUM

• 6 stablecoin products with $1B+ AUM

While there are many different nuances with each, the fundamental business model of stablecoin involves two parts. First a stablecoin issuer takes in cash and then it mints an equivalent amount onchain while invests the cash across different assets to generate a return for itself. The assets it purchases and holds on its balance sheet determine the likelihood whether the onchain representation of its reserves is fully collateralized or not. The users are exposed to an issuer’s solvency risk when they deposit their cash at the issuer. 

Risk Management & Disclosure Requirements

There are many layers of risk involved in the execution process of generating the return at a stablecoin issuer, including the following major risks:

• Asset custody safety

• Asset reserves quality

• Operational control

• Counterparty risk

The depegging of the onchain stablecoin value from $1 has been a frequent expression of market’s assessment of the issuer’s solvency risk, liquidity issue or undercollateralized position. Here is an S&P Global article on stablecoin depegging history.

If this were to happen at a bank, it would lead to a bank run and require government intervention and committee inquiries. So how can this be allowed to happen in the stablecoin world? There is no lender of last resort in the stablecoin world. Even the largest stablecoin issuer Tether only has an equity buffer of $14B. Hardly enough to be the backstop of a $200B market. 

Regulatory & Compliance Requirement

Unlike banks that have to comply with strict and well established rules regarding funds segregation, reserve asset eligibility and counterparty risk management practices, there are only very few jurisdictions in the G7 that have specific regulations for stablecoin issuers, namely only Japan or the EU. 

For example, the biggest stablecoin issuer, Tether, with 70% market share resides outside these two jurisdictions and has neither a regulatory framework nor disclosure requirements to follow. Since it controls 70% of the stablecoin market, it means a large part of the stablecoin market is unregulated. This can be easily seen in Tether’s reserve asset holdings data according to S&P Global below.

Notice the large portion of the reserve holdings are in Others category? By Sept 2024, 17% of the Tether reserves are held in assets that are NOT normally deemed low risk.

However, this problem is not unique to Tether. Apart from Circle’s USDC and PayPal’s PYUSD stablecoin, 8 out of the top 10 stablecoin products on DeFillama do not fall under any jurisdiction’s regulatory framework or disclosure requirements. 

This means the users are fully exposed to solvency, interest rate, and other risks and they don’t even have information to assess these risks. Despite its utilities and benefits, this type of risk set up is clearly unworkable for big financial institutions to adopt many of these products.  

Jurisdictional Product Availability

With the advent of the MiCA regulation implementation in Europe, exchanges operating in the EU are delisting crypto assets that do NOT meet the regulatory requirements, and Tether is among them. For example, Coinbase just issued a notice to users in the EU restricting access to DAI and USDT, two of the top 5 stablecoins.

The result is access fragmentation in products that users may want to have for better liquidity or allocation opportunities. A particularly painful impact for the EU users when it comes to losing access to USDT is that USDT is the single most liquid and widely accepted stablecoin currently worldwide.

The institutional equivalent of this is saying tokenized USD by JPMorgan and Wells Fargo is not allowed in major G7 jurisdictions. Can you imagine the adoption behavior for these tokenized cash products if they are not allowed in major markets? 

Changes for Adoption-Ready Mass-Market Product

First, the above regulatory compliance, risk management and reporting issues should be addressed and become table stakes for all major stablecoins. These challenges should not touch the front-end users at all. They need to be resolved and abstracted away from the user experience. 

Luckily there are signs that regulatory framework and supervision guidance are in the works in many of the major markets in the world. You can read more on the current G7 stablecoin landscape here.

Once these risk management issues are resolved and regulators get comfortable with the end-product, the fastest way to scale to billions of users and trillions in capital is probably having established financial institutions leveraging their distribution channels. This probably involves consolidation in the market where leading regulatory compliant players emerge with network effect.

Certain institutions are already taking early steps. For example, Societe Generale Forge is one of the few players focusing on the nascent MiCA compliant EUR stablecoin market. 

Third key unlock is abstracting away the fragmentation in blockchain specific stablecoin availability. Currently the application layer is fragmented along the lines of blockchain networks. This is like having your brokerage app only work with certain banks. Users shouldn’t have to navigate between hundreds of blockchains when they want to make a transfer, a purchase or an investment. They should just be able to do the transaction on the front-end and the rest of the work needs to be sorted out on the back-end.

This is getting slowly solved by interoperability solutions such as LayerZero.

Conclusion

Stablecoins are poised to be the first tokenization success to achieve a trillion-dollar market cap and global ubiquity. Why? Because they’re simply faster, cheaper, and more seamlessly global than any existing payment system. Just look at the comparison chart below—it’s not even close.

But to reach this milestone faster and with fewer roadblocks, we need to tackle the biggest challenges holding stablecoins back:

• Regulatory Clarity: Risk management, disclosures, and compliance must become standard.

• Liquidity Unification: Fragmentation across markets needs to be solved with cutting-edge tech and distribution aggregation.

  
  

The potential is massive, but so is the urgency to get it right. If we do, stablecoins will redefine how the world transacts.

Want to learn more about the current stablecoin adoption landscape? Get started here. 

Disclaimer: This content is for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice.