DeFi shines, but stablecoins do even better

The general consensus is that DeFi performed very well in the third quarter of 2020. What’s overlooked, though, is that stablecoins have quietly established themselves over the same period. Over the past ten months, stablecoins have grown from a supply of approximately $5.7 billion to over $22 billion. Even if we take into account that investors opted to switch to stablecoins around Q2 to avoid Bitcoin’s volatility, Q3 shows stablecoin supply expanding from $10 billion in May to over $22 billion today, an increase of about 120% .

Tether continues to establish itself as the leader, with nearly 6 times the supply of its closest similar regulated stablecoin. Given the lack of publicly verifiable audits, Tether's market dominance is both stunning and problematic. From previous analyses, it is increasingly evident that, due to the desire to use"stable assets", the market's preference for digital assets has slowly shifted from speculative to practical. One of the reasons I believe this is that a lot of people in the market today are trading against Tether instead of Bitcoin. Stablecoins may have helped dampen bitcoin’s volatility as people sold against it being the default currency.

The limitations of the first layer lead to transactions close to the limit

The rate at which stablecoin transactions are happening may be slowly approaching its limit, at around 8 million transactions per month. This is partly due to the higher fees for transferring funds on Ethereum. Today, USDT withdrawal fees on the Ethereum network via Binance are around $4-$6 (depending on network congestion). Now that solutions are emerging for tokens like Tether and USDC, consider second-layer solutions or alternative networks. However, their ecosystem has not developed like the one on Ethereum. In terms of growth rate, there was only a 20% increase in the third quarter of 2020, while it was almost 100% in the second quarter.

Like many other metrics, Tether accounts for most of the country's growth. From the beginning of 2020 to the present, its dominance in transaction share has reached 80%, up from 75% in 2019. Interestingly, DAI and USDC have roughly the same number of transactions despite one being a fully regulated centralized entity and the other a decentralized alternative. This is important because it highlights the extent to which a community can replace a centralized entity. Tether’s 80% dominance is largely a result of exchanges integrating the asset in its early days.

In contrast, USDC is mainly focused on application-specific use cases (eg: remittances) and institutions that want to have a token-based transfer mechanism. DAI, on the other hand, is primarily a community-driven experiment that has managed to gain similar market share without the regulation that USDC has today. When we look at different metrics, DAI is slowly becoming a leading contender for a relatively more decentralized stablecoin mechanism.

The value of circulation on the chain reached 428 billion US dollars in this quarter

The view in “The State of Stablecoins in Q2” is that trading interest due to heightened market volatility in the wake of the coronavirus outbreak is the main driver of stablecoin growth. In the third quarter, we saw consistently higher transaction volumes each month. In September of this year alone, there was more money flowing on-chain than in the entire first quarter. Part of the reason for the revival of interest may be DeFi. The ability to earn returns on non-volatile assets (e.g. USDC, DAI) likely drove stablecoin growth this quarter.

In the process of sorting out transaction volume data, there are two important points worth noting.

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In terms of adoption, who will have the upper hand between DeFi and exchanges?

In the second quarter of 2020, people need exchanges for efficient token circulation. DeFi-based projects are slowly changing this. One of the reasons I believe this is the case is that DeFi projects now lock up more stablecoins than CeFi-based projects. Uniswap's smart contracts have more locked ETH than Huobi. Centralized exchanges like Binance started offering liquidity mining-based products this quarter, partly because DeFi projects are now more capital efficient than their centralized alternatives. Another reason I believe this is the case is that USDC and DAI — two projects that are so crucial to DeFi today — have seen their percentage locked in smart contracts skyrocket from Q2 onwards. In Q1, less than 20% of their supply was on smart contracts. Right now, it's more than half of their supply. DeFi projects are really black holes for stable assets.

utility"utility", rather than idle and opportunistic.

next step

Over the next year, I foresee three important paradigm shifts.

1. The emergence of second-tier solutions makes new retail applications possible. In the current state, small transactions are not possible on stablecoins. I think users would rather endure the pain of waiting 10 minutes for XDAI transfers than accept 3 days for international wire transfers. This is the awesomeness of the second layer. This in turn will create entirely new business models. 2. Regulatory moats will become an increasingly important advantage. Singapore is one region that is playing to this advantage. With DBS launching its exchange, the signal is pretty clear that the country is experimenting with digital asset-based projects. Likewise, Bermuda has opened up to experiments with CBDCs. For projects around stablecoins, choosing a friendly and encouraging region can make a world of difference to their growth. 3. The role of the financier will change. In traditional markets, venture capital is a necessity given the time it takes to build, deploy and scale a business. In DeFi, projects like harvest.financial have attracted $1 billion in locked value without their identities being known. In 2020, venture capital can rely on existing community users to build a sustainable business. In these cases, market know-how and expertise will be more valuable than capital alone in scaling the venture. That's why the next big fund won't be like Y Combinator or Sequoia.

These predictions may all be wrong and are for informational purposes only.