The Lifeblood of DeFi: Stablecoin Overview
Rather than rehash the widely-reported LUNA/UST saga, I’ll take a step back and cover the basics of stablecoins while taking a closer look at a few different stablecoins in this multi-part series.
This blog provides a high-level overview of stablecoins and focuses mainly on USD stablecoins. The second blog in this series will dive deeper into assessing the risk of a stablecoin using the most popular stablecoins, USDT and USDC as examples.
What are Stablecoins?
Stablecoins are digital tokens designed to maintain a 1-to-1 peg to a nation’s fiat currency. Unsurprisingly, the most widely-used stablecoins are pegged to the US Dollar (USD) and are intended to maintain a value of $1 USD at all times. They can be thought of as a digital representation of a US Dollar. The top ten stablecoins by market cap in mid-May 2022 are shown below.
Source: https://coinranking.com/
Since a USD stablecoin is theoretically always worth $1, it allows a buyer/seller to enter and exit USD stablecoin positions at any time without a change in the value of the token (always $1 USD). The theoretical zero volatility makes stablecoins an important instrument in the cryptoverse for lending, borrowing, saving, or simply transferring value. The value transfer can be a peer-to-peer transfer of stablecoin, similar to a Venmo transaction. The ability to transfer money nearly instantaneously through a distributed, permissionless ledger system (a.k.a. on-chain) is a huge upgrade compared to traditional payment rails which can take 2 to 3 business days for a bank transfer to clear in the US. Or, value transfer can happen by exchanging between cryptocurrencies such as a BTC to stablecoin transaction which should eliminate an investor’s downside risk since stablecoins have, theoretically, zero volatility.
The initial use cases for stablecoins resulted in so much demand that depositors can now earn attractive yields compared to interest offered by traditional US retail banks. Thus, driving another use case — an alternative to a traditional savings account. For example, in May 2022, blockchain.com, Gemini and BlockFi offer between 8%-10% or greater APY on stablecoin deposits.
The high yields on deposits are also supported by the ever-increasing appetite for stablecoins since their stable nature makes them an ideal source of collateral. The collateral is used to back loans denominated in other cryptocurrencies which ultimately fuels liquidity used on DeFi platforms.
While a stablecoin is used as collateral, it becomes illiquid and is effectively taken out of circulation. This increases the demand for newly-minted stablecoins, resulting in a larger total supply that eventually circulates into crypt DeFi platforms and Dapps. As shown in the figure below, the amount of USD stablecoins in circulation have nearly doubled in the past 12 months from about $86 billion to $154+ billion! If the snapshot was prior to the LUNA/UST collapse roughly two weeks ago, the total stablecoin supply would have been over $180 billion.
Source: The Block, Coin Metrics
While stablecoins are extremely useful, and some would argue critical to the movement of liquidity within crypto markets, they do not come without risk. The underlying value of a stablecoin should never change, and the word “should” is important because the measure of a stablecoin’s actual value is dependent upon various factors such as the value of reserves guaranteeing the stablecoin, the type and mix of reserves, current buy or sell pressure, and mechanics that control equilibrium between the reserve asset(s) and the stablecoin itself.
Part 2 of this series will explore fiat-backed stablecoins by analyzing a couple of the most popular stablecoins in circulation.
Our 4-part blog series on stablecoins includes:
Lifeblood of DeFi: Stablecoin Overview
Lifeblood of DeFi: Fiat-backed Stablecoins
