Stablecrypto’s — Crypto’s killer App | by Marc Arjoon | Sep, 2022


Fiat-backed stablecryptos are the leaders in the stablecrypto market as they offer both scalable liquidity and strong stability. However, alternatives are still being experimented with.

  • Since January 2021, stablecryptos have grown 450% to $154bn.
  • Tether, Circle and Binance account for over 90% of all issued stablecryptos.
  • Growth of stablecryptos and growth of Total Value Locked (TVL) are highly correlated.

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Introduction

In this report, we explore the purpose of stablecryptos, the different types and risks and the current state of the market.

Stablecryptos are a type of crypto-cryptocurrency that are pegged to a non-volatile asset (such as the US dollar). These stablecryptos address the issues of inherent volatility risks within the crypto-crypto space and help to facilitate more predictable transactions. As evidenced below, stablecryptos have become quite popular. The total value of all stablecryptos grew ~450% from $28bn in January 2021 to $154bn in August 2022.

The sharp drop seen in May 2022 arose from the collapse of UST, a stablecrypto native to the Terra blockchain which also collapsed as a result. The dissolution of the UST highlights that not all stablecryptos are made equal and each type poses its own trade-offs and risks. There are three types of stablecryptos; i) Fiat-backed stablecryptos, ii) Collateralised debt positioned stablecryptos and iii) algorithmic stablecryptos. We examine these three types in greater detail below. Despite these issues and extra layers of trust, fiat-backed stablecryptos are by far the most popular type on the market with over 90% market share.

Collateralised debt positioned stablecryptos

Collateralised debt positioned (CDP) stablecryptos differ from fiat-backed in the following ways: i) they are native to the blockchain (no physical bank account), ii) they are overcollateralised and iii) they are backed by crypto-crypto-assets (including fiat-backed stablecryptos).

Below we show a breakdown of the market share for the leading CDP protocols. MakerDAO is the clear leader as it pioneered the concept of CDPs in 2017. As of August 2022, the market value of all CDP stablecryptos stood at ~$12bn.

Algorithmic Stablecryptos

Algorithmic stablecryptos are a relatively new concept and distinct from the other two stablecrypto types. Instead of relying on a reserve of assets, algo-stablecryptos maintain their peg through algorithmic incentives or systems. For instance, rebasing was an early technique used to control the peg such that the supply of the stablecrypto would change based on the price. A lower price would cause the supply to reduce and vice versa. However, this mechanism was unable to maintain stability over longer periods.

Below we show a breakdown of the market share for the leading algorithmic stablecryptos. The algo-stablecrypto market is valued at $3.7bn yet is more competitive than the others with the market leader, FRAX, opting for a partial reserve + algorithmic model.

The Stablecrypto Trilemma

The blockchain industry is known to love its trilemmas and stablecryptos are no different. The end goal for the “ideal” stablecrypto is to be i) stable, ii) scalable and iii) decentralised. So far, no stablecrypto has been able to fulfil all three criteria.

Source: CoinShares

Fiat-backed stablecryptos are scalable since it’s as easy as depositing dollars in a bank account. They’re also very stable as they’re essentially backed one-to-one by those same dollars in the bank. However, they are clearly not decentralised as there are only a few large, regulated entities which can mint these stablecryptos, to begin with. Stablecrypto issuers also have the ability to freeze these funds, preventing specific addresses from spending them.

On the other hand, CDPs can be decentralised so long as the crypto-crypto assets backing the borrowed stablecryptos are decentralised as well. CDPs are also stable thanks to resilient risk management practices. Not every asset can be used as collateral, only those deemed pristine enough by the DAO. Furthermore, the mandated overcollateralization of these debt positions is the main factor driving this stability. However, requiring users to overcollateralise and borrow a fraction of their deposits is not inherently scalable.

Lastly, algorithmic stablecryptos can possess both decentralisation and scalable properties. The algorithm dictates the mechanism so no one entity is in control — ideal for decentralisation. Likewise, the algorithms used tend to make it easy to create or burn the token allowing for increased scalability. Despite these dynamic capabilities, algo-stablecryptos seem to continuously fail at maintaining a peg. A persistent peg for stablecryptos may rely on faith more than a specific algorithm yet the search for the perfect algorithm continues.

State of the market

While stablecryptos have become increasingly popular, the collapse of UST not only shrank the market size but also spurred redemptions in other stablecryptos as well. Despite this implosion, the importance of stablecryptos remains prominent across the entire ecosystem. We see below that the correlation between the growth of Total Value Locked (TVL) and the growth of stablecryptos is persistently strong.

The above correlation analysis results in a correlation coefficient of 0.80. This strong link may be an important indicator moving forward for the health of the DeFi landscape.

Zooming out a bit, with a first-mover’s advantage, USDT has long been the market leader although USDC has been gaining traction and is widely seen as more legitimate. We show a breakdown of this stablecrypto growth below.

As shown above, the vast majority of stablecryptos (c.90%) are issued by Circle (USDC), Tether (USDT) and Binance (BUSD). These cryptos are mostly backed by US Cash & Cash equivalents & Other Short-Term Deposits & Commercial Paper held in bank accounts to help maintain trust in the peg. We show a breakdown of these issuers’ reserves below.

Tether has the riskiest reserve holdings and reports its breakdown on a quarterly basis.

Circle’s reserves mostly consist of short-duration U.S. Treasuries and reports its breakdown on a monthly basis.

Binance’s reserves are split between U.S. Treasury debt and U.S. Reverse Repos. Binance also reports its breakdown on a monthly basis.

The integration of stablecryptos within the traditional financial system provides easier access for users and adds to their legitimacy. In fact, on August 15th 2022, the US Federal Reserve’s governing board unveiled guidelines that will standardize applications for “master accounts” from institutions “with novel charters,” including “crypto-cryptocurrency custody banks and their trade associations.” What this means is that these stablecrypto issuers now have another path to become further integrated into the traditional banking system.

Conclusion

Stablecryptos have found product-market-fit within the crypto-crypto industry. In fact, more projects continue to enter the stablecrypto space with the fiat-backed entrant poundtoken getting the greenlight from the Isle of Man’s Financial Services Authority and Circle’s Euro Coin (EUROC). Algo stablecryptos like USDN and USDD have also started to grow (though both have already depegged). Lastly, DeFi protocols Curve and Aave have both announced their intention to release CDP stablecryptos in the near future. The appetite for stablecryptos, from both the demand and supply side, is clearly as strong as ever. The total addressable market for stablecryptos is trillions of dollars and given the already resounding success of these tokens, it is without a doubt crypto-crypto’s killer application.

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