Google wasn’t the first successful search engine. Facebook wasn’t the first runaway social network, either. Tether and Circle’s USDC may be considered first-generation stablecoins. Could a new wave of stablecoins take them over? Tether reported first-quarter profits of $4.52 billion, a huge success for a small team. The question is whether it is sustainable.
Luca Prosperi, CEO of M^0 Labs, believes he has the formula for the next generation of stablecoins. He makes grand claims like the M^0 protocol becoming a central bank stablecoin. Big visions are not uncommon in the crypto world, but there are hints that this may be more than just excitement. First, the protocol infrastructure is just starting up and doesn’t have a lot of traction, but it was able to raise two funding rounds of $22.5 million and $35 million. The latter was led by Bain Crypto with participation from major market makers.
Two other aspects caught our attention. First, the M^0 protocol is a decentralized protocol. The issuance of M stablecoins is coordinated by multiple approved “minters” that are expected to comply with local regulations.
Stablecoin incentives
Second, Circle and Tether, the major stablecoin issuers today, appear to retain the majority of the interest earned on their stablecoin reserves. Meanwhile, other people do the work.
Consider the cryptocurrency exchange Binance. As of early June 2024, Binance held $25 billion in Tether, much of it held for its customers. Tether will earn more than 5% on $25 billion. What if another stablecoin comes along and shares a large portion of it, say 4%, with Binance? This equates to $1 billion a year for Binance.
The M^0 protocol shares the majority of its interest income with authorized distributors called earners.
This model applies equally to market makers. Currently, Tether is the coin of choice for traders, but that could change if market makers are formally incentivized to hold another stablecoin. It’s no coincidence that some of the latest M^0 backers are market makers, including Galaxy, Wintermute, GSR, and Caladan.
However, this is not to say that Tether and USDC do not distribute rewards, but perhaps more ad hoc.
USDC and Tether Benefits
Coinbase was a co-founder of the USDC stablecoin, which is now fully managed by Circle. Coinbase will pay 2.6% to the MakerDAO stablecoin protocol on a portion of MakerDAO’s USDC holdings (USDC cannot be re-lent).
If you look at Tether, it makes loans to cryptocurrency companies and provides them with a kind of soft reward. When the company announced its impressive $4.5 billion revenue for the first quarter of 2024, the CEO commented that X was approaching $1 billion in net income. Part of the difference could be incentives.
My summary of Tether’s Q1 2024 certificate. Another great quarter!
As of March 31, 2024:
– Profit for the first quarter of 2024 was $4.52 billion. Net operating income is approximately 1 billion, derived primarily from Treasury bills. The rest came from gains from the appreciation of Bitcoin and gold positions.
-… https://t.co/kCBYQw9JGx
— Paolo Ardoino 🤖🍐 (@paoloardoino) May 1, 2024
With decentralization and incentives as M^0’s signature features, we asked Prosperi what he thinks makes M^0 different from other new stablecoin projects. He responded that it’s the all-star team, the vision, and the depth and quality of the investors. Prosperi himself has a strong background with stints at Oliver Wyman and Morgan Stanley. He was also involved in the MakerDAO stablecoin protocol, along with one of the co-founders who joined the protocol from its early days. Last year, M^0 hired Joao Reginatto, Vice President of Stablecoin Products at Circle. He had been with the company for eight years.
But what’s interesting is the vision.
M^0 Vision
At first glance, the M^0 protocol looks like a potential competitor to Tether and USDC, with added decentralization and incentives. Although the M stablecoin’s reserves are in U.S. Treasuries, this model is more similar to MakerDAO, a protocol that started by overcollateralizing Ether deposits to mint the USD stablecoin DAI. Currently, the third-largest stablecoin (with a market capitalization of $5.3 billion) has much more diversified collateral, with various cryptocurrencies accounting for less than half.
The concept is to distribute Mint Hark from MakerDAO. Previously, others have referred to the Maker Protocol as the central bank of DeFi. This is because it is intended to create non-volatile assets. Prosperi described Maker as a centralized repository window. He used the same terminology to describe the M^0 protocol.
“We want to create an infrastructure where a lot of people can come and access this centralized repo window and mint the same coins, just like a lot of commercial banks go to the central bank and mint the same dollars,” Prosperi said. said.
He believes that stablecoins like USDC are more of a payment product and just one function of money.
“The back end of currency creation remains untouched,” he told USDC. We are reinventing the way we bypass the traditional banking system and actually create money in a more transparent way. ”
“We have ambitions to reinvent the entire stack,” he added. “The ambition is not to create a payment product, but to reinvent the monetary system.”
Banking System Exposure
In his view, Circle is very sensitive to the banking system. Circle is notorious for holding a depegging event in March 2023 when Silicon Valley Bank collapsed. This involved $3.3 billion in cash balances out of $43 billion in reserves.
Prosperi emphasized that a significant portion of USDC’s reserves are in reverse repos rather than in U.S. Treasuries (56% as of April 24, sometimes more than two-thirds). In other words, Circle (or BlackRock for that matter) lends cash to banks, which guarantee the loans with the Treasury. Therefore, even though the risk is covered by U.S. Treasuries, there is credit exposure to banks. That seems fine, but there are times when the entire system becomes vulnerable. The Basel Committee recently considered whether to allow reverse repos of eligible stablecoin reserves. Ultimately, he said, it’s okay if it’s overcollateralized.
Mr Prosperi said: “Banks are low-margin, 20x leveraged institutions. 99% of the time it works. Sometimes it doesn’t.” In his view, optimizing both liquidity and solvency is It is difficult to say that M^0 selects the ability to pay. I don’t use repositories or reverse repos. Initially all reserves are held in the Treasury.
Part of Mr. Prosperi’s desire to avoid banks stems from his career investing in bank bonds. He also doesn’t think “we don’t need them anymore.” There’s another, very cryptographic angle. “We are building for a future that exists primarily on chain,” he said.
No blacklist in core design
Many mainstream stablecoins, such as Tether and USDC, support freezes and blacklists. “Having a blacklist feature at the core of a stablecoin contract is an absolutely devastatingly bad design,” Prosperi said.
He said that “most” chain projects are adopting DAI because they can’t afford an external switcher. And that is why the original DAI collateral was Ether, despite the volatility.
Local M publishers can add another layer if freezing functionality is required in a particular jurisdiction. Effectively, they will be creating a wrapped version of the M stablecoin that avoids impacting others within their jurisdiction.
Beyond the euro dollar
Many stablecoin issuers do not like the term “stablecoin”. Cryptodollars are a popular alternative. Prosperi was keen to emphasize that M Stablecoin targets the Eurodollar market, or the offshore dollar market.
The natural question is: What will the future hold? Is there an M Euro? That is not Mr. Prosperi’s vision, but his influence will diminish as the governance of the protocol becomes more decentralized.
Looking at web3 so far, the dollar is dominant across borders in blockchain. Prosperi believes the dollar’s dominance will continue for some time. However, in 20 years, he is envisioning a basket that combines international currencies and virtual currencies. You can see the combined shades of Facebook’s Diem and MakerDAO.
He also believes that CBDCs can coexist with CBDCs because they bypass the commercial banking model. One of Mr. Prosperi’s comments was that “if we hit the supply ceiling of U.S. Treasuries relative to the dollar, that means we’ve done a pretty good job.”
It is too early to predict whether the M^0 protocol will represent a second wave of stablecoins. One area that is likely to become more prominent is the incentives offered to stablecoin sellers.
This week, Ledger Insights will publish a report on bank-issued stablecoins and tokenized deposits, featuring over 70 projects. Sign up to receive release notifications.
