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Just two stablecoins (Tether and USDC) account for 90% of the market value of the stablecoin industry.
Now that stablecoins are being integrated into the traditional financial system, investors need to be aware of the risks.
New stablecoin legislation could fix any potential problems of concentration by encouraging many more issuers to emerge.
According to the latest stablecoin research from The Motley Fool, just two stablecoins -- Tether (CRYPTO: USDT) and USDC (CRYPTO: USDC) -- account for a whopping 90% of the $250 billion stablecoin market. In terms of market cap, nobody else even comes close.
That might not have mattered as much just 12 months ago, before stablecoins started to go mainstream. But stablecoins are steadily being integrated into the traditional financial system, so any concentration in the stablecoin industry now has potential implications for investors everywhere. Let's take a closer look.
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Within the crypto industry, one of the rallying cries has always been "decentralization." The only way to eliminate risk, according to the original crypto purists, was to decentralize everything as much as possible. For example, when Bitcoin launched back in 2009, ownership was supposed to be as decentralized as possible, to eliminate the risk of any individual, corporation, or government controlling it.
In fact, the ultimate goal was to create a "trustless" system, in which you did not have to trust any single market participant for the crypto system to work. That's what made Bitcoin (and every other cryptocurrency) special. In comparison, the traditional financial system is all about counterparty risk. It is a system based on trust. In other words, you have to be very careful about who you do business with.
So that's why concentration of any kind tends to raise warning flags within the crypto industry. Look at what's happening now with the ownership of Bitcoin -- instead of being completely dispersed, Bitcoin is now falling into the hands of a few big players, such as Bitcoin treasury companies and the investment firms that run the spot Bitcoin exchange-traded funds (ETFs).
Image source: Getty Images.
And, of course, concentration now exists within the stablecoin industry. Tether has a staggering $164 billion market cap, while USDC has a market cap of $64 billion. The next closest competitor is Dai (CRYPTO: DAI), with a tiny market cap of just $5.4 billion. If you were an economist, you'd probably call this a duopoly. And, as you learned in your Economics 101 class, there's only one thing worse than a duopoly: a monopoly.
It's easy to ignore the potential risk that stablecoins might pose to the financial system. After all, the word "stable" is hard-coded right into their name. A stablecoin always trades for $1, right? So what could possibly be risky about stablecoins?
As it turns out, a lot. Stablecoins must maintain their 1-to-1 peg to the dollar at all costs. In theory, at any time, an investor can exchange one stablecoin for $1, no questions asked. To do that, issuers back their stablecoins with cash and cash equivalents.
But here's the thing: There have been several cases in the past few years when stablecoins dramatically lost their peg. For example, amid the regional banking crisis of 2023, USDC briefly depegged. As it turns out, $3.3 billion of the cash that was supposed to back the stablecoin was in the bank vault of Silicon Valley Bank, and that caused a brief panic in the market. Tether, too, has had multiple instances when it lost its peg.
One of the most catastrophic depeggings of all time took place in 2022, when TerraUSD (UST) lost its peg to the dollar, wiping out $45 billion in value and bringing down the entire crypto market. It turns out that TerraUSD was an algorithmic stablecoin that relied on algorithms, not cash, for backing. Needless to say, what once seemed like a stroke of financial genius now seems like an act of financial insanity.
Even before TerraUSD lost its peg, finance professors at Yale warned of the potential risks of stablecoins. As they saw it, stablecoins could unleash financial chaos that could take down the entire financial system.
Think of a classic bank run, and apply this analogy to stablecoins. Holders of stablecoins panic, rush to redeem them for $1 in cash each, only to find out that there is not enough cash to go around for everyone. If someone doesn't step in immediately to provide a liquidity backstop, bad things happen.
That's why the new stablecoin legislation, known as the Genius Act, is so important. It is supposed to remove all the obvious weak links in the system. For example, it specifically says that all stablecoins must be backed 1-for-1 with cash or cash equivalents. No funny business with algorithms or anything else. And it mandates monthly audit reports on those reserves, just to make sure that all the cash that's supposed to be in the bank vault is actually in the bank vault.
The Genius Act also opens the door for many more participants to issue their own stablecoins. Already, a mix of retailers, fintech giants, and Silicon Valley companies have hinted that they might launch stablecoins of their own. The introduction of so many stablecoins at one time might be a bit confusing for investors, but they might end up saving the modern financial system because this diversification will spread risk rather than concentrate it.
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Dominic Basulto has positions in Bitcoin and USDC. The Motley Fool has positions in and recommends Bitcoin. The Motley Fool has a disclosure policy.
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