The Rise of Stablecoins
Stablecoins are on the rise. Banks, companies, and foundations behind protocols are diving deeper into stablecoins. Some are testing them out for payment while some are creating their own versions. For instance, some recent developments:
Near Protocol is launching its own stablecoin — USN
Tron Protocol is launching its own stablecoin — USDD
What is driving the interest in stablecoins? What are the use cases and where are we going?
Quick Background
Stablecoins are cryptocurrencies that are stable in value. For instance, the USDC (“USD coin”) stablecoin, issued by the public company Circle, approximates to the value of USD so 1 USDC = 1 USD.
Types of Stablecoins
I like to breakdown stablecoins into two classifications.
1- Fiat-backed stablecoins are tokens that are backed by the fiat currency (e.g., US dollars) or its equivalent. The point is that for every stablecoin issued, there would be cash sitting in the bank to back that stablecoin. So companies could issue stablecoins and manage the cash in their bank accounts. However, companies may sometimes hold “cash-equivalent” or “low-risk assets” other than just holding cash to diversify and generate additional revenue.
Some examples (and the market cap as of 4/25/2022) are:
- USDT — Tether — $83B
- USDC — USD Coin — $49.9B
- BUSD — Binance USD — $17.7B
- TUSD — TrueUSD — $1.35B
2- Market-driven stablecoins are tokens that retain the value of the fiat currency (e.g., 1 USD) via programming mechanisms that use the fiat value of other cryptocurrencies. There are different ways different protocols do this but the point is there is no cash backing the stablecoins but rather the price is stabilized through a combination of market incentives and algorithms.
Some examples are:
- UST — TerraUSD — $18.28B
- DAI — $8.66B
- FRAX — $2.7B
- USDN — NeutrinoUSD — $947M
Stablecoin Use Cases
What’s the point of these stablecoins? We already have cash and we can send money digitally using apps like Venmo and Cash App right?
1- Remittance: Stablecoins (and all tokens issued on a public blockchain as a matter of fact) are superior than legacy financial systems in terms of remittance.
If I want to send cash from the US to let’s say, my friends in South Korea, it would take days for them to receive the amount. Sending stablecoins, however, to my friends in South Korea would only take a matter of few minutes (or even seconds).
If I want to transfer my money from one bank account (e.g., Chase) to another bank account (e.g., Wells Fargo), it could take up to 24 hours. But if I am sending stablecoins from Coinbase to Binance, it only takes a few minutes or seconds.
When sending money from a platform to platform or from country to country, stablecoins are faster and more efficient.
2- Liquidity for Decentralized Applications (Dapps): Dapps — that allow users to trade, stake, borrow, lend, and earn interest (without the need for user identification) need stablecoin liquidity.
For instance, let’s say I want to buy a token on a decentralized exchange (e.g., Uniswap) since Coinbase does not list the token. I could buy ETH on Coinbase, send ETH to my wallet, and buy the token on Uniswap using ETH but that would subject me to the price fluctuations of ETH during the time it takes me to buy ETH, send ETH, and buy the token. Rather, if I buy stablecoins on Coinbase, send them to my wallet, and buy the token, then I am able to buy the token at a more predictable price.
Furthermore, there a ton of arbitrage opportunities in these Dapps so stablecoins would be needed to capture those opportunities.
But why can’t these Dapps just allow cash?
Well — technically they can, using certain service providers. But to integrate cash, they would need to collect the identities of the users as there is currently no way to send cash online without exposing the identity of the user. Users need to link to their bank/finance app accounts, which all collect identities. So introducing cash and collecting identities would go against the ethos of “permission-less decentralization”.
And as mentioned above, stablecoins are faster than sending around cash so there is less incentive to integrate cash.
Therefore, as long as USD (or any fiat currency) is the main unit of account, Dapps will need stablecoins.
3- Yield: As per the reasons above, there is a demand for stablecoins. And this demand creates opportunities to lend the stablecoins and earn yield on them. Users could deposit stablecoins into protocols that lend to borrowers and earn yield.
For instance, the Anchor Protocol — a protocol on the Terra Ecosystem — has been consistently yielding ~20% APY on the deposited UST stablecoins.
So…where are we going?
Every year - I feel like there are more companies/banks issuing fiat-backed stablecoins and more protocols creating their own versions of market-driven stablecoins. For instance, there are talks about creating an algorithmic stablecoin on top of the bitcoin network using lightning.
It almost seem like the “digital dollar” is already here and all the government really needs to do (if they want to move forward with the CBDC) is to nationalize one of these big stablecoin players.
Or are we trending towards the denationalization of money so that stablecoin issuers need to create incentives for people to use their stablecoins? For instance, the UST stablecoin has been blowing up primarily because of the ~20% APY that the Anchor Protocol provides on deposited UST.
What does competition between different stablecoins look like? Will the primary drivers be utilization, yield opportunities, speed, and/or trust?
I wouldn’t be surprised if stablecoins are used for mainstream payment in the next few years and replace the current legacy financial system. But what happens afterwards? Using stablecoins still keeps us in a fiat-based system. Will we stay there or is this an intermediate stage towards something else?
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