From Arbitrage Tool to Financial Infrastructure: A Deep Dive Into Stablecoins' Evolution and Market Challenges

The recent success of major stablecoin platforms entering public markets has reignited investor enthusiasm around digital dollar infrastructure. However, beneath the surface lies a complex history of market pressures, competitive moats, and structural challenges that newer entrants will struggle to overcome. This analysis, drawing from perspectives like those shared in Arthur Hayes’ recent blog reflections, examines why the stablecoin landscape is far more consolidated than it appears.

The Origins: How Banking Barriers Birthed USDT

In crypto’s early days, accessing reliable fiat on-ramps was a nightmare. Traders in 2013-2014 faced a brutal reality: exchanges lacked solid banking relationships, pushing users toward risky peer-to-peer transfers or using local agents as middlemen. The infrastructure was so fragile that exit scams and banking account freezes were routine occurrences.

This structural gap created an opportunity. By 2015, what started as an internal solution for a major exchange evolved into something far more significant: a blockchain-native dollar that could move 24/7 without traditional banking intermediaries. Using the Omni protocol on Bitcoin, then later migrating to Ethereum as an ERC-20 token, USDT solved a real problem—not through technological innovation, but through solving genuine market friction.

The timing was crucial. Chinese traders faced capital controls, volatile local currencies, and difficulty accessing dollar-denominated assets. USDT became the “digital dollar savings account” for millions across Asia. More importantly, the team behind it understood the Chinese market deeply and built trust within the community during a critical window when traditional finance was retreating from crypto.

The Explosion: Why Altcoin Trading Locked in Market Leadership

The real turning point came after Ethereum’s mainnet launched in July 2015. New cryptocurrency-only platforms emerged to capitalize on the altcoin boom, but they faced an unsolvable problem: traders wanted to price assets in dollars, yet these platforms couldn’t accept fiat deposits.

Enter USDT’s Ethereum integration—a deceptively simple move with profound consequences. Suddenly, any platform supporting Ethereum could seamlessly offer dollar-priced trading pairs without touching traditional banking. Capital entry points (tier-1 exchanges with banking relationships) could now efficiently connect with speculative platforms where retail traders congregated.

Between 2015 and 2017, this network effect became unstoppable. The dominant stablecoin wasn’t chosen through superior technology—it was selected by market structure. Once enough liquidity pooled around a single standard, switching costs became prohibitive.

Meanwhile, traditional banking relationships continued deteriorating. As regulatory scrutiny intensified, correspondent banking relationships that crypto platforms once relied upon began collapsing. A particular region became a temporary haven for exchange banking operations, but even that unraveled as major U.S. financial institutions pressured local banks to exit crypto entirely.

By 2017, the dominant stablecoin had become the only practical solution for scalable dollar flows in crypto markets. The moat was complete.

The Tech Giant Threat and Regulatory Retaliation

In 2019, a major social media platform announced plans to issue its own digital currency, designed to operate through its messaging apps and reach billions of users globally. The proposal was direct: bypass traditional banking infrastructure entirely and create an alternative payment network.

The response was swift and political. Regulators across multiple jurisdictions mobilized against the threat. The project was shelved—a cautionary tale demonstrating that stablecoins aren’t merely payment tools. They’re instruments of financial sovereignty. Whoever controls stablecoin issuance controls offshore dollar flows.

However, the political landscape has shifted. Recent administrations have shown skepticism toward traditional banking oligopolies. Major social platforms are quietly restarting relevant initiatives, attempting to embed stablecoin infrastructure directly into their ecosystems.

For stablecoin entrepreneurs, this is catastrophic news. Social platforms will build everything in-house—achieving closed-loop control of issuance, distribution, and custody. The “proof of concept” partnerships that startups tout to investors will never translate into real banking adoption. Traditional financial institutions won’t collaborate with third parties on stablecoin infrastructure; everything will be done internally, if at all.

The Profitability Trap: Why Success Cannibalizes Competition

Here’s the uncomfortable truth about stablecoin economics: the business model is extraordinarily profitable, but only for those with existing distribution infrastructure.

The dominant stablecoin issues tokens without paying interest to users. Instead, all deposited funds flow into short-term government securities. When interest rates surged in 2022-2023, annual profits skyrocketed—not because of operational excellence, but because of macro tailwinds. The business essentially prints money with no acquisition costs, minimal operating expenses, and virtually zero regulation.

Compare this to traditional banking: the most efficient global bank employs over 300,000 people to perform functions that the dominant stablecoin handles with fewer than 100 staff members. Banks are, in many ways, “employment programs for the overeducated”—maintaining bloated compliance departments and regulatory bureaucracies that stifle innovation and efficiency.

Any new entrant without pre-existing distribution faces an impossible math: to compete, they must offer higher interest rates to attract deposits. But paying interest to users means surrendering the net interest margin (NIM)—the core profit engine. A platform without scale can’t sustain this model long-term.

One recently listed stablecoin issuer demonstrated this dynamic perfectly. It structured its entry by ceding 50% of net interest income to a major exchange in exchange for distribution access. This deal makes economic sense for both parties but illustrates the brutal reality: new competitors must surrender most profits to secure distribution. Eventually, insufficient profitability leads to collapse.

The Consolidation Thesis: Why Latecomers Are Doomed

The distribution channels through which stablecoins reach users have been completely monopolized:

• Exchange platforms are controlled by established players with deep crypto market integration
• Social media companies are building proprietary systems with no intention of partnering with outsiders
• Traditional banks will only deploy blockchain infrastructure they own outright, under strict regulatory constraints
• Entrepreneurs without these assets face an insurmountable barrier to entry

A third-place stablecoin managed explosive growth in 2024 by building novel collateral structures, but even this success doesn’t solve the distribution problem. Without access to millions of pre-existing users, growth remains constrained.

The proliferation of new stablecoin projects will continue—each pitching narratives about “replacing banking” or “reshaping payments.” Investors will hear familiar stories about traditional financial expertise, regulatory compliance, and institutional partnerships. But the structural reality remains unchanged: distribution wins, and distribution belongs to those who already have it.

The Regulation Wildcard and Future Scenarios

The stablecoin industry’s trajectory now depends almost entirely on regulatory frameworks. Three scenarios are possible:

Scenario 1: Permissive Regulation - If regulators allow stablecoins to compete with traditional deposits on level terms, offering market-rate interest, explosive growth follows. However, this also creates incentives for financial engineering and leveraged carry strategies. History suggests the result: a modern iteration of familiar Ponzi structures, where high returns derive from excessive leverage and asset quality degradation rather than genuine yield.

Scenario 2: Restrictive Regulation - Tight constraints on underlying assets, usage rights, and interest payments would quickly deflate the bubble. But regulators typically act after problems emerge, not before.

Scenario 3: Status Quo - Continued ambiguity and selective enforcement. Capital continues chasing the spread differentials created by interest rate premiums, barrier-protected distribution channels, and dollar dominance. Risk and reward maximize before the inevitable contraction.

Regardless of path, one fact is unambiguous: for new stablecoin projects launching today, the distribution game is essentially over. The windows of opportunity have closed. The profitability moat belongs to platforms with either massive user bases or deep traditional finance integration—categories that exclude 99% of new entrants.

Conclusion: The Carnival Before the Reckoning

The current stablecoin wave isn’t driven by technological superiority or revolutionary breakthroughs. It’s driven by macro tailwinds (elevated interest rates), structural deficiencies in traditional banking (bloated cost structures, regulatory fragmentation), and the basic arbitrage that stablecoins exploit: offering superior service at far lower cost.

This remains a valid narrative, and it will drive capital inflows for some period. But narrative sustainability depends on regulatory tolerance and continued macro conditions. When either shifts, the frenzy will recede—and the “Circle replicas” flooding into the market will evaporate.

For investors, the short-term opportunity remains real. For entrepreneurs, the stablecoin space is already written: dominated by incumbents, impenetrable to newcomers, and dependent on political winds that shift unexpectedly. Understanding this landscape—rather than betting against it—is the only rational path forward.