PayPal’s Stablecoin Proposition​

At the risk of sounding like a broken record (for several weeks in a row), ETH had no notable price movement over the past week. Even with a CPI report today that came in lower than expectations, crypto prices barely budged while equities reacted – showing that crypto and equities may be in the process of decoupling their correlation. What is also notable is that ETH price has been stickier than even BTC, despite ETH being historically a higher beta asset. This is likely due to more near-term catalysts for BTC on the horizon – namely an update on the ETF applications – while ETH has no notable “price catalysts” even though the ecosystem continues to see healthy growth.

So let’s examine some of the healthy fundamental growth that has been occurring. The biggest news for the ecosystem over the past week was the announcement of PayPal’s stablecoin,  called PYUSD. PYUSD represents one of the first fully regulated stablecoins (in addition to Circle’s USDC) launched by a financial institution in the US. This is a very big deal – the proliferation of stablecoins has been a bit of a chicken-or-egg problem, where everyone wanted to see a first mover before committing. PayPal is that first mover.

One important conclusion from the 2020-2022 crypto cycle is that stablecoins are, for now, the killer app for crypto. Stablecoins found instant product-market fit by creating a digital representation of the dollar (the global reserve currency) and allowing onchain access. As a result, despite the bear market over the past year, the market cap of stablecoins remains over $100bn as demand for dollars on crypto rails remains insatiable.

Stablecoins also represent an incredible business model for operators, resulting in very profitable businesses as the digital stablecoins that are issued pay 0% interest, while the underlying collateral backing stablecoins can include “cash equivalents” including T-Bills and government money market funds, which pay 5%+ due to the rising rate regime of the past year. Therefore, stablecoin issuers are able to capture an effective “arbitrage” by “borrowing” at 0% and “lending” at 5% in assets that are considered the least risky in the investment spectrum. So, why does every bank and financial institution not jump on the stablecoin opportunity?

The answer is regulation – or the lack thereof. Since there are no clear rules for stablecoins (even though stablecoin bills have recently been making their way through Congress), no institution other than Circle has approached the stablecoin sandbox. This has resulted in offshore issuers like Tether building stablecoin businesses (USDT market cap is $80bn+). This is not ideal, which is why PayPal entering the fray with a regulatory stack (Paxos as custodian, clearly defined collateral that will represent cash and cash equivalents, disclosure requirements under NYDFS) is so positive for the space as it sets a precedent and a launchpad for the proliferation of stablecoins. And a healthy, regulated stablecoin framework is very beneficial to the US, as it helps digitize the reserve currency with additional distribution avenues.

Crypto has had a tough adoption path, as most users will not self custody. However, PayPal already has 435 MILLION users that will have access to PYUSD within the PayPal / Venmo apps. This could be a true catalyst for mass adoption via frictionless access to crypto and stablecoins. A notable fact: PYUSD is issued on Ethereum!

Pros and Cons

• What are the implications of PYUSD being issued on Ethereum? It shows that regulators may be becoming comfortable with Ethereum as a settlement layer. While it is still too early to conclusively argue that point (the status of ETH as a security or commodity is still up in the air), the fact that most major stablecoins live on Ethereum and that Ethereum has been around the longest (other than BTC, which is not a smart contract chain) shows that precedent may be set over time.
• However, it is important to note that PYUSD is not perfect. The code for the smart contract is publicly available, and PYUSD contains “freeze,” “unfreeze” and “wipe” functions for a centralized actor (e.g., PayPal) to control stablecoin supply. While this seems draconian, this is how the existing banking system works, where banks have the ability to freeze assets due to suspicious activity. Stablecoins will therefore need a similar regulatory framework.

ETH Economic Snapshot

• Finally, we take a look at the weekly state of Ethereum. Although innovations like the PYUSD stablecoin should increase activity on Ethereum and therefore translate to higher ETH fees, fee revenue remains in the doldrums, with annualized fees over the past week dropping below 1mm. This is likely due to the ongoing bear market sentiment.
• However, the supply of staked ETH continues to increase, topping 23mm. There are currently zero validators in the exit queue and nearly 68,000 validators in the entry queue, with a wait time of 27 days for new validators to stake.
• As a result of low fees plus a high validator count, the ETH staking yield continues to drop well below 5%.