Stablecoin Analysis: The “Compass” that navigates crypto’s cash flow

Currently, there are various Stablecoins such as USDT, USDC, DAI, ESD,... but their mechanisms are totally different. That is why in this article, I will thoroughly analyze the Stablecoin sector and give you some detailed information about:

• What is Stablecoin? What is the role of Stablecoin in the market?
• How many types of Stablecoin are there? The strengths and weaknesses of each of them?
• How does Stablecoin influence the DeFi market?
• Some interesting insights on Stablecoin.
• Some tools to track Stablecoin indexes.

As there will be a lot of specialized insights, it is advisable to take note of some useful points for yourself. Moreover, every part is linked to another in order, so don’t skip any part. Now let’s begin.

Disclaimer: The purpose of this article is mainly for providing constructive information and personal viewpoints, not financial advice. Investing in the crypto market is highly risky, so Do Your Own Research before investing.

Stablecoin Definition

The word Stablecoin is combined by “Stable” and “Coin”:

• “Stable” in Stable Assets: Stable Assets are considered assets that have a high stability along with a low price volatility, compared to other assets in the market. They can be Fiat-currencies like USD, EUR, JPY, or commodities like Gold, Silver, Oil,...
• “Coin” represents the cryptocurrency market: Assets will be digitalized and tokenized as coins.

Generally speaking, Gold or silver being tokenized into a cryptocurrency can be regarded as a Stablecoin; Fiat-currencies can also be considered as Stablecoins in the same way.

However, this article will focus only on the most frequently used Stablecoins in crypto - the Stablecoins that have their values pegged to $1. 

The role of Stablecoin in DeFi

At the moment, the cryptocurrency market is worth more than $2,200B, indicating that the circulating cash flow in the market is extremely huge and there exists a high demand for trading, storing or investing in crypto assets.

Nevertheless, not every Fiat-currency is supported by crypto exchanges. If Stablecoin does not exist, users first have to swap the Fiat-currency of their country to USD (since USD is accepted worldwide as a payment currency), then continue to exchange through an intermediary (like a bank) with high cost, high spread, complicated procedures,... before acquiring any cryptocurrency token.

Stablecoin was invented to solve this problem. The strengths of Stablecoin can be seen as a combination of 2 factors:

• Fiat-currency: A really stable type of asset backed by the economy of a whole country, especially USD.
• Cryptocurrency: Based on the blockchain technology, transparent, can be stored and transferred across the globe easily.

In the crypto market, Stablecoin has the role of:

• A storing asset during market corrections.
• A commonly used asset connecting investors to other cryptocurrencies.
• A bridge between the crypto market and the traditional market (using Fiat Currencies).

It is believed that Stablecoin is the perfect combination of Fiat-currency’s value and cryptocurrency’s convenience on the blockchain network. Stablecoin will help users invest in the fastest way, access the largest number of crypto assets, and especially eliminate the unnecessary intermediary process.

Different types of Stablecoins

USDT, USDC and DAI are the three most popular Stablecoins. However, the world of Stablecoin is much more enormous than that, which can be divided into 4 main types with different capabilities of optimizing capitals.

• Full-reserve Stablecoins (Centralized Stablecoins).
• Over-collateral Stablecoins (Decentralized Stablecoins).
• Non-reserve Stablecoins (Algorithmic Stablecoins).
• Partial-reserve Stablecoins (Fractional-reserve Stablecoin).

In this part, I will analyze the mechanism, strengths and weaknesses of each of them.

Full-reserve Stablecoins (Centralized Stablecoins)

Full-reserve Stablecoins are the Stablecoins that are backed by a Fiat-currency in real life. The most well-known cases are USDT, USDC and BUSD being backed by USD, which means that for every 1 USDT minted on the blockchain, 1 USD is reserved in real life.

The attributes of a Full-reserve Stablecoin:

• 100% backed by USD ⇒ Extremely stable.
• Controlled by an organization or a company (Centralized).
• The most common in the market.

Full-reserve Stablecoins, or Centralized Stablecoins, are governed by an organization in terms of their Total Supply and Circulating Supply. More specifically, USDT is controlled by Tether, USDC is controlled by Circle, and BUSD is controlled by Binance and Paxos.

• Strength: High stability (pegged to $1), low volatility, and widely used.
• Weakness: Legal issues and transparency.

If you pay attention to the news regularly, you will notice that Centralized Stablecoins have faced FUDs about legal issues on a regular basis, especially Tether USDT. Since 2016, Tether has been suspected of manipulating the market with Bitfinex.

The biggest FUD is that Tether has been minting more stablecoins than the reserved fund in the bank. If this is the case, the chance of Tether manipulating the market is totally possible. Nonetheless, USDT has survived from 2016 to now and has sustained effective productivity.

Over-collateral Stablecoins (Decentralized Stablecoins)

Over-collateral Stablecoin is the second most popular type of Stablecoin, which is created when the value of the collateral is higher than the value of the minted Stablecoins. The most prominent Over-collateral Stablecoin is DAI - a stablecoin generated by MakerDAO, a lending protocol.

The attributes of an Over-collateral Stablecoin:

• Minted through lending protocols.
• Minting 1 DAI requires a larger amount of collateral (low capital efficiency).
• Highly stable if the market does not crash.

To mint DAI onto the market, users need to collateralize other cryptocurrencies so that their total value is at least 150% as much as the number of DAI being minted. If the price of the assets falls below the allowable threshold, those assets will be liquidated to ensure the value of the minted DAI.

This has kept DAI’s price stable and pegged to 1 USD. Nonetheless, this approach limits the scalability of DAI tokens as its mechanism is not capital-efficient (minting DAI always requires a larger amount of collateral value).

Some prominent Over-collateral Stablecoins: MakerDAO (MKR & DAI), Venus (XVS & VAI), Party Parrot (PRT & PAI),...

• Strength: By using the Over-collateral mechanism, their prices are stable at around $1.
• Weakness: However, the crypto market is incredibly volatile; in case a Flash Dump happens, a massive amount of assets will be liquidated immediately.

And that is exactly what happened on March 12, 2020. When a Flash Dump took place, the ETH price was halved within 2 days, not to mention the Ethereum network being congested. Unfortunately, this resulted in enormous asset liquidations.

In terms of capital efficiency, Over-collateral Stablecoins cannot utilize funds since the number of Stablecoins allowed to be minted accounts for only 75% of the collateral value, or even 50% if users want to avoid a Flash Dump as mentioned.

In fact, most lending protocols allow depositing collateral to borrow other Stablecoins like USDT or USDC, instead of the Over-collateral mechanism like DAI. That is the main reason why MakerDAO is dominating the Over-collateral Stablecoin segment.

Non-reserve Stablecoins (Algorithmic Stablecoins)

Non-reserve Stablecoins, or Algorithmic Stablecoins, are Stablecoins that are minted without any backed reserve. Protocols use algorithms to constantly adjust the Circulating Supply of the Stablecoin to keep its price at $1.

The attributes of an Algorithmic Stablecoin:

• No collateral assets are required (High capital efficiency).
• Usually needs 2-3 side tokens to adjust the price.
• Ineffective (Unable to peg the price to $1).

Algorithmic Stablecoins include 2 main types: Rebase Model and Seigniorage Model.

1. Rebase Model

Stablecoins following the Rebase Model use only 1 token, which apply algorithms to modify the token’s Circulating Supply and influence the price. The most prominent project using this model is AmpleForth (AMPL).

Every 24 hours, the AMPL supply will be changed depending on the AMPL price:

• If AMPL > $1, increase the AMPL supply.
• If AMPL < $1, decrease the AMPL supply.
• If AMPL = $1, remain the AMPL supply.

The Rebase process directly affects the number of tokens that a user has. As a result, the supply-demand equilibrium is maintained to put AMPL price back to its peg.

Some prominent Algorithmic Stablecoins following the Rebase Model: AmpleForth (AMPL), BASE Protocol (BASE), Yam Finance (YAM),...

2. Seigniorage Model

Stablecoins following the Seigniorage Model use 2-3 side tokens in the process of operating and sustaining the token’s price. Generally, one token is a Stablecoin, and the other is a token applying some mechanisms such as Burn-Mint, Stake-Earn,... so as to increase/decrease the supply/demand of the Stablecoin and keep it at pegged value.

Some prominent Algorithmic Stablecoins following the Seigniorage Model:

• 2 token model: Fei Protocol (FEI & TRIBE), Empty Set Dollar (ESD & DSU), Terra UST (LUNA & UST),...
• 3 token model: Basic Cash (BAS, BAC & BAB), Mithril Cash (MIS, MIC & MIB), Basis Dollar, UCASH, Dynamic Supply, BCash.fi,...

Strength: No capital or collaterals are needed. 

Weakness: Theoretically, Algorithmic Stablecoin can resolve the limitations of Full-reserve Stablecoin and Over-collateral Stablecoin. In reality, Algorithmic Stablecoin is the most inefficient and unproductive type since its price cannot be sustained at $1 due to the extremely high sell pressure.

This is the case since Algorithmic Stablecoin projects normally take it for granted from the beginning that they have a strong and solid community to support them in sustaining the token’s price. They rely on the belief that the Incentive Program can attract a large number of supporters for the project.

In fact, the Incentive Program (Farming) is not persuasive enough to encourage users to follow the project in the long term. Users focus only on farming with high APR and then sell the rewards earned ⇒ create sell pressure > buy demand ⇒ fail to peg price.

In addition, Algorithmic Stablecoins are not widely applied in the market. Except for Fei Protocol and Terra USD - the two most functional Algorithmic Stablecoin projects at the moment, no other projects in this sector are standing out.

Partial-reserve Stablecoins (Fractional-reserve Stablecoins)

Partial-reserve Stablecoins, or Fractional-reserve Stablecoins, are the combination of Full-reserve Stablecoins and Algorithmic Stablecoins. The first and most exceptional example is Frax Finance.

The attributes of a Partial-reserve Stablecoin:

• Only a small amount of collateral is needed (average capital efficiency).
• Better price control than an Algorithmic Stablecoin but more volatile than a Full-backed Stablecoin. 
• Inefficient due to no application.

To mint 1 FRAX (a Partial-reserve Stablecoin), users need to own some Stablecoins (currently USDT and USDC) to subsidize the price of 1 FRAX. The ratio can be adjusted according to Frax Finance, with the collateral rate ranges from 50% to 100%. 

Some prominent Partial-reserve Stablecoins: Frax Finance (FXS & FRAX),...

Strength: Average capital efficiency, the combination of Full-reserve Stablecoin (collateral-needed) and Non-reserve Stablecoin (algorithm-based).

Weakness: Frax Finance is currently the only project applying this approach, showing that not many developers are interested in this segment. Real-time data also indicate that the Market Cap of FRAX is really small, and FXS does not have many applications in DeFi or CeFi.

The attributes of a successful Stablecoin

After going through the strengths and weaknesses of each Stablecoin type, we will now look into the factors that create a successful and effective Stablecoin. Afterwards, you will be able to visualize the work and expansion process in the crypto market.

Note: The information in this part will be used to help detect potential Stablecoins in the latter part. This article will lead you from basic to advanced, so don’t skip any part!

For a Stablecoin to work efficiently in the market, they need to have the full stack of 4 factors, including:

• Transparency.
• Stabilization.
• Scalability.
• Applicability.

Transparency

Transparency can be regarded as the basic foundation of a valuable Stablecoin. Who are the backers of that Stablecoin? If a Stablecoin is backed by enormous and reputable backers, it will be a trustworthy one for both retail users and whales to use for trading and storing. For instance:

• USDT is backed by Tether and Bitfinex.
• USDC is backed by Circle and Coinbase.
• BUSD is backed by Binance.
• DAI is backed by MakerDAO, a top #2 lending protocol.
• UST is backed by Terra Foundation and LUNA.

The transparency of a Stablecoin can be evaluated through the users’ access to tracking tools, or in other words, whether users can track the token’s Total Supply and transactions on the blockchain. However, in the case of Centralized Stablecoins like USDT or USDC, their transparencies are still questionable as it is not certain if the amount of USD locked inside the Vault of Tether or Circle is relative to the minted Stablecoins.

Stabilization

The next element to consider is Stabilization, which is also an indispensable feature of a Stablecoin. Back to the original purpose, Stablecoin was created as a tool to avoid all the volatility in the crypto market. 

Therefore, if a Stablecoin cannot sustain its peg steadily, that Stablecoin cannot be used as a storing asset. In the illustration below, the two Stablecoins DAI (MakerDAO) and USDP (Unit Protocol) will be compared.

While the DAI price was able to remain stable around $1, the value of USDP usually dropped to $0.95, losing 5% compared to 1 DAI.

If Transparency and Stabilization are the requirements for a Stablecoin to work productively, then Applicability and Scalability are the two factors that help a Stablecoin expand extensively in the market.

Extra analysis: The paradox of Stabilization 

Most Stablecoins peg their prices to USD, a Fiat-currency being backed by the whole United States economy. As a result, they are considered more stable than other highly inflationary currencies and highly volatile assets on the stock or cryptocurrency market.

But are Stablecoins really “Stable” if they are USD-pegged?

According to the statistics provided by HowMuch, from 1913 to 2019, the intrinsic value of the Dollar currency has been reduced by 90%.

Which means that, if in 1913 $100 could buy 10 kg of rice, in 2019 100$ could only buy less than 1 kg of rice. This happened due to the US abandoning the Gold and Oil standards, allowing FED to freely print money without any physical assets backing its value. This event created huge inflation in USD.

So was the recent price surge of Bitcoin a result of the pump scheme or of the declining USD value?

Scalability 

Scalability can be considered the Network Effect of a Stablecoin. When a Stablecoin expands its operating range, a corresponding amount of influence also increases.

On CeFi platforms, especially Centralized Exchanges, USDT is a gigantic force as it is used as the primary trading asset on some biggest exchanges at the moment, such as Binance, Huobi, FTX, OKEx, KuCoin,...

On DeFi platforms, USDC is having the greatest impact because it is the most common asset when it comes to creating Liquidity Pools. Even though USDC was released 3 three years after USDT, it has quickly issued its stablecoins on multiple developing DeFi ecosystems like Ethereum, BSC, Polygon, Fantom, Solana,...

Besides USDT and USDC, BUSD is another rapidly growing Stablecoin thanks to Binance as it is not only used as a trading asset on Binance Exchange, but also implemented in DeFi protocols on Binance Smart Chain.

Applicability

Given that a Stablecoin is widely expanded, at the same time exerting a considerable influence on the crypto market. The next step for it is to improve the Applicability.

For example: 

• USDT is mainly applied to OTC (Over The Counter) markets as USDT possesses high liquidity with low slippage.
• Stablecoins like USDT or USDC are broadly accepted by DeFi Protocols, allowing them to be used for Swapping, Lending, and Farming easily.

Applicability needs to be developed alongside Scalability after Transparency and Stabilization are solidly built.

Most prominent Stablecoins in the market

We have gone through some basic attributes that make a successful Stablecoin. However, the Stablecoin segment is extremely competitive with a high domination ratio.

Top 10 Stablecoins in the market account for 96% of the Stablecoin Market Cap. Why are the highest-ranked Stablecoins so dominant? In this part, we will seek the answers by analyzing the Case Studies of 5 Stablecoins with the largest Market Cap, including:

• Tether (USDT): Represents Centralized Stablecoins in CeFi.
• USD Coin (USDC): Represents Centralized Stablecoins in DeFi.
• Binance USD (BUSD): Represents Centralized Stablecoins in both CeFi and DeFi.
• Dai (DAI): Represents Over-collateral Stablecoins in DeFi.
• TerraUSD (UST): Represents Full-reserve Stablecoins using the algorithmic mechanism together with LUNA.

Tether - USDT 

• Market Cap: $68B (#1).
• Number of chains deployed (including Wrapped assets): 17.

Tether (USDT) is acknowledged as the earliest Stablecoin in the crypto market. Up to this moment, Tether is the Stablecoin with the largest Market Cap, and having the greatest influence on the market.

Tether has the advantage of implementing an early advent, hence being able to build an incredibly strong Network Effect. Especially, all of the biggest exchanges like Binance, FTX, Huobi are using USDT as the main trading pair for other Altcoins.

Some exchanges have tried to be independent of USDT by issuing their own Stablecoins: BUSD from Binance, HUSD from Huobi. Nonetheless, USDT remains to be the most widespread among every CeFi exchange.

Not to mention on OTC markets, USDT is currently the main gateway for worldwide users to swap from Fiat-currencies to cryptocurrencies. In spite of the fact that OTC markets are still allowing the exchange of other cryptocurrencies like BTC, ETH,... USDT is still dominating the market with high liquidity, low slippage and the ability to be directly traded to other Altcoins across different exchanges.

USD Coin - USDC

• Market Cap: $32B (#2).
• Number of chains deployed (including Wrapped assets): 12.

Although USDC was founded after USDT, it possesses the advantage of being more friendly to the law system by receiving support from enormous backers, especially Coinbase. Moreover, big exchanges like Binance, KuCoin, and Huobi also use USDC.

Nevertheless, the reason behind USDC’s success is the approach to the DeFi Market. Instead of issuing a large number of Stablecoins on the Tron network like USDT, USDC quickly issued its Stablecoins on other developing DeFi ecosystems, namely Ethereum, BSC, Polygon, Solana, and Fantom.

By seizing the chance faster, Circle did not have to wait for long to take over the DeFi market and attract more users to utilize USDC in the DeFi space.

Binance USD - BUSD 

• Market Cap: $13B (#3).
• Number of chains deployed (including Wrapped assets): 3+.

Binance USD is the product made by the cooperation between Binance and Paxos (the managing company of PAX Stablecoin, recently changed its ticker to USDP). Despite the fact that BUSD was released after USDC, USDT and DAI, BUSD has the fastest growth. 

Thanks to Binance, BUSD has been broadly applied in Binance Exchange since the beginning of 2020 by being paired with myriads of other tokens, at the same time providing free transaction cost to the paired assets. 

When Binance Smart Chain exploded as a phenomenon in March 2021, Binance increased the issuing rate of BUSD on Binance Smart Chain and made it a pairing asset for liquidity pools just like USDT and USDC, which resulted in the tremendous growth of BUSD recently.

Though BUSD is applied in both DeFi and CeFi, its Scalability outside the Binance ecosystem is strictly limited. This situation is pretty understandable because no competitor wants Binance to dominate the market.

Dai - DAI

• Market Cap: $6.5B (#4).
• Number of chains deployed (including Wrapped assets): 7+.

DAI is an Over-collateral Stablecoin created by the lending protocol MakerDAO. At the moment, MakerDAO is the top 4 lending project in crypto with over $12.7B TVL (Total Value Locked). The Market Cap of DAI is around $6.5B, showing that the Collateral ratio is currently around 49%.

Not only does MakerDAO allow common assets to be used as collateral, but it also supports the collateralizing of LP tokens from Uniswap, helping MakerDAO attract many more users through its diversity. 

The advantage of MakerDAO was being founded really early, forming a substantial Network Effect. In terms of coverage across different DeFi ecosystems, DAI is even more popular than BUSD, and only behind USDT and USDC.

Terra USD - UST

• Market Cap: $2.6B (#5).
• Number of chains deployed (including Wrapped assets): 3+.

Terra USD is a very special Stablecoin as it is the combination of a Full-reserve Stablecoin and an Algorithmic Stablecoin. To maintain the peg price at around 1 USD, Terra USD is backed by LUNA (Full-reserve) and has its price adjusted by an algorithmic mechanism (transfer the price volatility to LUNA).

The success of UST comes from 2 factors:

The first is an effective work model. This was proved through the market collapse on May 19, 2021, which made LUNA price fall from $16 to $4.

If the same thing happened to ETH, MakerDAO and DAI would definitely be considerably affected as ETH was the biggest collateral asset, therefore activating a Domino chain of constant liquidations. However, after that event, UST still stood steadily thanks to the anti-price manipulation mechanism, and then quickly returned to its peg.

The second is the support from the Terra ecosystem (#3 DeFi ecosystem in terms of TVL). UST seems to be the one and only Stablecoin of the ecosystem. As a result, all protocols inside Terra try to capture the value for UST. The most prominent protocol among them is Anchor, a lending platform that allows UST saving with up to 20% APR.

Data analysis of Stablecoin

I hope that with the analysis above, you have visualized the work model of Stablecoins in the market. How can they succeed, and how can they take over the market? In this part, I will dive deeper into the influence of Stablecoins on the crypto market through data analysis.

The Market Cap of Stablecoins

Market Cap ranking: USDT (#1), USDC (#2), BUSD (#3), DAI (#4), UST (#5), TUSD (#6).

According to the data above, the Market Cap of USDT is overwhelming at $68B, two times higher than that of USDC, even though no other Stablecoins in the market can surpass USDC.

The chart above also shows the two main periods of the crypto market:

Accumulating period (2018 - mid 2020)

In this period, Stablecoins grew slowly but steadily. This matched the market condition at that time when most crypto participants were retail investors, and the DeFi market didn’t receive much attention. 

Furthermore, the Market Cap of the whole crypto market was really small, so every action from Tether brought about a huge influence. Every time Tether announced to “issue” more Stablecoins, the price of BTC pumped along.

Booming period (mid 2020 - now)

Forward to the second period, the market received more attention from whale investors and hedge funds, attracting a massive cash flow into the crypto market. The DeFi market gradually became more complete and appealing to the builders and investors.

Since September 2020 to now, the DeFi TVL has increased from $1B to more than $191B. The tremendous growth of DeFi has created a high demand for Stablecoin.

Although Tether's Market Cap is still overwhelming compared to other Stablecoins, USDC is also worth noting. If you take a close look at mid 2020, you will notice that the Market Cap of USDC rose incredibly fast, and it was at the same time when DeFi started its tremendous growth. That is the reason why when it comes to the DeFi market, I usually prioritize tracking USDC activities over others. 

⇒ USDT and USDC are the two key Stablecoins in the market, so we should follow their activities closely because Stablecoins can be regarded as the cash flow supporting the market growth.

The correlation between the Market Cap of Cryptocurrency, Stablecoin and DeFi

In the second period, the short-term price pumps of Bitcoin have been separated from Tether’s announcements on issuing Stablecoins. Nonetheless, Stablecoins will still be exerting an enormous influence on the market in the long term, as Stablecoins are the gateway for users to get access to the market and the inside assets.

More specific details can be illustrated in the pictures below. The growth of the market has brought along the demand for Stablecoins, and when Stablecoins were minted to satisfy the market’s demand, DeFi was the most rapidly growing sector.

But if you take a look at the time around May 2021, when the growth of Stablecoins slowed down, the crypto market in general and the DeFi market in particular collapsed shortly after (on May 19, 2021).

However, the Market Cap of the Stablecoin sector did not decline but actually slightly increased, showing that Tether and Circle (2 big companies in the field) did not burn Stablecoins out of the market. This indicates that the number of investors going into the market was still higher than the number of investors going out.

Consequently, in late July 2021, the crypto market witnessed a strong recovery thanks to the afore-minted Stablecoins in the market.

⇒ In the long term, the growth of Stablecoins is the key to speculate the growth of the whole crypto market. If you are following the DeFi market, don’t miss out on any moves from USDC as it is currently the fastest growing Stablecoin in DeFi.

Stablecoin Dominance

Stablecoin Dominance is the measure of Stablecoin’s Market Cap relative to the Market Cap of the rest of the coins. Here is an example of the USDT Dominance index (USDT.D) from Tradingview.

Although there are still a variety of Stablecoins in the market, the Market Cap of USDT takes up more than 50% of the market, and it has been acknowledged as the representative index of the whole Stablecoin segment, so we will analyze the movement of USDT.D.

• USDT.D increases ⇒ investors are selling Altcoins for USDT ⇒ investors hold more USDT. A typical example is the market collapse on May 19, 2021 when USDT.D rose dramatically.
• On the contrary, USDT.D decreases ⇒ investors are using USDT to buy Altcoins ⇒ the market is in the Altcoin Season. The two most recent Altcoin seasons are from September 2020 to March 2021, and from August 2021 to now.

⇒ We can rely on the USDT.D index to define the market trend, therefore understanding the right time to invest, and the right time to take profit.

Stablecoins in DeFi ecosystems

As analyzed above, Stablecoins play an important role in being the gateway for the cash flow from the Fiat-currency market to the cryptocurrency market.

If you are aware of how the cash flow in the crypto market transfers between different layers, then Stablecoins play the same role of allowing investors to transfer their funds from the crypto market (macro) to blockchain ecosystems (micro).

In this part, I will analyze 3 Case Studies of 3 blockchain ecosystems. Namely Terra, Solana and Avalanche, so you can understand the role of Stablecoins in the growth of DeFi ecosystems.

Case Study 1: How did Terra USD foreshadow the growth of the Terra ecosystem?

Recently, we have witnessed the substantial growth of the Terra ecosystem with its TVL surpassing $6B, becoming the third largest ecosystem in the market behind Ethereum and Binance Smart Chain in terms of TVL.

The increase in TVL has produced a positive effect on the LUNA price, increasing the price of LUNA 700% since the market crash in May 2021. The question is, how could the TVL in Terra increase so rapidly?

The main catalyst is the Market Cap growth of Terra UST - the one and only Stablecoin in Terra. If you notice the chart above more carefully, you can see that when the DeFi TVL in the ecosystem rose, the UST Market Cap had seen an explosive growth 2 months before that, exceeding TrueUSD (TUSD) and Paxos (PAX) - two prominent Stablecoins in the market.

Case Study 2: USDC & Solana - the cooperation that grew Solana tremendously

Since February 2021, when the crypto market was not yet active, Circle and Solana Foundation had already started to issue more USDC into the Solana ecosystem to develop DeFi. Afterwards, in May 2021, the DeFi sector on Solana began to attract more users and reached $1.5B TVL. 

During that period, the price of SOL (Solana native token) rose from $10 (February 2021) to $50 (May 2021). Even though a market crash happened shortly after, the number of Stablecoins on Solana continued to rise. In fact, the pace of issuing Stablecoins on Solana at that time was even faster than when the market was extremely active. 

And the result is crystal clear: Since July 2021 to now, the cash flow into the Solana ecosystem has not stopped, helping the DeFi TVL to reach $3B. Every token in the Solana ecosystem has been growing tremendously (SOL, SRM, RAY, MNGO, SBR, ORCA,...) especially SOL has recovered from $25 to $170 at the time of this writing.

Case Study 3: Avalanche got in the sight of Tether 

Tether has been deployed on multiple chains. Although the Market Cap of Tether on Tron and Ethereum accounts for the most, Tether has not issued any additional USDT on Tron, Omni, EOS, Algorand,... since earlier this year. Instead, Tether has now focused on Ethereum, Solana and Avalanche.

This resulted from the fact that they were the three immensely developed DeFi ecosystems. To compete with USDC, Tether quickly supported  USDT on Avalanche to help the growth of the Avalanche ecosystem, therefore assisting tokens on Avalanche (AVAX, PNG, SNOB, XAVA) in recovering after the market collapse. 

Aside from the Market Cap and Dominance index, the pace of growth is also an imperative index to track. For instance, even though the number of USDT on Solana is still incredibly small, at the same time, it is increasing at the most rapid pace compared to other ecosystems. Will that case happen again, but this time with Avalanche?

In conclusion, the investment opportunities do not come from Stablecoins, but from the movement of the market and of different blockchain ecosystems. Stablecoins help you to navigate that movement.

Note:

However, this case is only applicable to ecosystems with small TVL like Solana, Polygon, Terra, Avalanche, Fantom,... because when the ecosystem’s TVL is still insubstantial, the influence of issuing Stablecoins will be more immense, hence creating a motivation for the ecosystem to thrive.

To comprehensively developed ecosystems such as Ethereum and Binance Smart Chain, issuing Stablecoins does not matter that much as the number of Stablecoins being issued is too insignificant compared to the DeFi TVL of that ecosystem.

To speculate the cash flow efficiently, you have to:

• Analyze the macro cash flow: Different blockchain ecosystems.
• Analyze the micro cash flow: Different layers, different categories inside each DeFi ecosystem.
• Create a Watchlist filtered by categories.

Some useful tools to track Stablecoin indexes:

• Coinmarketcap: Check the Market Cap here.
• TheBlock: Follow the Supply of Stablecoins on different blockchains here.
• CryptoQuant: Follow Stablecoin Exchange Flows here.

Stablecoin reserve on exchanges

Similar to the index of BTC Inflow & Outflow, the Stablecoin Exchanges Inflow & Outflow index allows investors to track the buy demand of the market. There are 2 circumstances:

• The Stablecoin reserve on CEXs increases ⇒ investors deposit funds into exchanges to buy Stablecoins ⇒ indicate a high buy demand.
• The Stablecoin reserve on CEXs decreases ⇒ investors withdraw funds out of exchanges to take profit ⇒ indicate a low buy demand.

In the long term, this index is correct to some extent. Before Bitcoin reached ATH (All-time high) in March 2021, the Stablecoin Reserve index had increased dramatically in November 2020 (5 months before). Before Bitcoin recovered in August 2021, the Stablecoin Inflow index had also risen significantly in June 2021.

However, the crypto market moves really quickly but this index does not show responsive signs in the short term (about 1 month). That is why this index should only be regarded as an additional tool to gather more information rather than a primary one, compared to the aforementioned methods.

How have Stablecoins evolved?

After going through some prominent Stablecoins, how they work and how they influence the crypto market, we will now look at the evolution of Stablecoins, hence defining the period we are at and predicting future Stablecoin movements. 

First period (2014 - 2017): Pioneers in the Stablecoin sector

At an early stage of the first period, Stablecoins had the sole purpose of tokenizing all popular Fiat Currencies across the globe. Stablecoins were used mainly to resolve the problem of transactions’ cost and speed of the traditional financial system. 

The most prominent of all was Bitshares, a platform founded by Charles Hoskinson (Ethereum's Co-founder and Cardano’s Founder). Bitshares tokenized a wide range of currencies, including CNY (BitCNY), Euro (BitEUR), USD (BitUSD), Gold (BitGOLD),...

Nevertheless, in order to create Fiat-backed cryptocurrencies, users had to collateralize BitShares with a larger amount. As BitShares were highly volatile, the value of Stablecoins such as BitUSD, BitEUR,... was not stable. Not to mention that with low liquidity, BitShares could be easily manipulated by speculators.

Fast forward to the end of the first period which is about 2017. The crypto market started to be recognized, and other Stablecoins like DAI and USDT started to appear. DAI was created and sustained up to this moment due to the incredibly high demand for lending & borrowing in the market. The stability of DAI was also better.

Meanwhile, USDT was backed by a gigantic force - Bitfinex. Bitfinex used to be the largest exchange in 2017, until Binance attracted more retail investors to its platform though most whales still stayed in Bitfinex. The substantial influence of Bitfinex at that time was the main catalyst that kept USDT stable around its peg and stood still till now.

Second period (2018): The boom of Stablecoins

The first period was the prerequisite for the second period, which was the most booming period of Stablecoins. The market witnessed the advent of various Stablecoin platforms as this was also the time when the crypto market became “Mainstream” in 2017, after Bitcoin reached an ATH of $20,000.

The demand to invest in Bitcoin as well as the demand for Stablecoins increased. To compete with USDT being backed by Bitfinex, a variety of exchanges issued their own Stablecoins (Gemini issued GUSD), whereas payment platforms also did the same thing (Paysend).

Stablecoins became a “trend” for whales to increase their influences on the crypto market that was already small. If you take a closer look at the illustration above, you can see that in 2018, more than 57 Stablecoin platforms appeared, ranging from Full-reserve Stablecoins to Over-collateral Stablecoins and Algorithmic Stablecoins.

This was also the time when Stablecoins that later became dominant made their debuts, namely Circle (USDC), Paxos (PAX), TrueUSD (TUSD),... they are the three major competitors of Tether (USDT).

Third period (2019-2021): Selection and elimination

From my perspective, the Stablecoin sector is currently in this period. After the booming phase in 2018-2019, myriads of Stablecoin projects appeared, at the same time a large number of projects showed their weaknesses. 

Which is the main reason why in the third period, the market will begin the selection and elimination process, especially the recession of Algorithmic Stablecoin projects as they are not working efficiently (cannot maintain the peg price).

You can visualize the situation more clearly through the picture below along with the market’s real-time data. Over 200 Stablecoin projects have been developed, but the number of active and productive projects is only around 10 (USDT, USDC, BUSD,...). More and more Stablecoin projects are gradually fading into oblivion. 

Fourth period (2021+): Expand

The most important keyword to define the third and the fourth period is the Network Effect. As mentioned earlier, the Stablecoin segment is exceptionally competitive. 

Among over 200 projects, only nearly 10 of them have an influence on the market. This forces Stablecoin platforms to constantly develop and expand so as to account for as much of the market as possible, including both DeFi and CeFi.

Except for USDT dominating the market for so long, USDC is a noteworthy Stablecoin in the fourth period. Officially launched in 2018 (3 years after Tether), USDC quickly deployed its Stablecoin on 10+ blockchains and focused mainly on the DeFi market, which was growing tremendously at that time. This approach made USDC more well-known than USDT in the DeFi market.

At the moment, BUSD is still following the Network Effect improvement scheme. Binance has been listing more BUSD trading pairs, issuing more BUSD to be used in the Binance Smart Chain ecosystem, with a vision of replacing USDT and USDC.

In the future, UST will definitely increase its Network Effect by accessing the Binance Smart Chain ecosystem and the Solana ecosystem - the two ecosystems possessing the largest cash flow behind Ethereum.

Anticipate the future of Stablecoin 

Stablecoin weaknesses

We have gone through the approach and evolution of Stablecoins. So how can they be improved in the future to get rid of the current weaknesses? The answer to this question can be found in this part.

If you notice, Stablecoins are having 2 major issues without a solution which are Transparency and Applicability:

• Transparency: Centralized Stablecoins often receive FUDs about legal issues, especially Tether USDT. Since 2016 to now, Tether has been frequently suspected of manipulating the market together with Bitfinex as the market has had the tendency to go upward whenever Tether issued its Stablecoins, and the market would start a correction whenever Tether stopped.
• Applicability: Stablecoins such as USDT and USDC are broadly applied in the crypto market while that is not the case in the traditional market as they are not widely used as a payment method.

Developing Stablecoins 

Major companies are trying to create a Stablecoin that can solve both of the above problems, which can look like:

• Legally compatible with every country.
• Stable peg price, fast and transparent transactions with the blockchain technology.
• The ability to expand from Traditional Finance to Cryptocurrency Finance.
• Widely applied as a payment method in real life just like in DeFi.

4 Stablecoins that are currently developing to satisfy the above requirements are:

1. Telegram TON

Pavel Durov - the founder of Telegram has been trying to issue a Stablecoin with high stability and high liquidity. However, he gave up the project after being pressured by SEC on the legal aspect.

2. Libra

During the past time, Facebook has been trying to create Libra and make it a global currency. Libra will be backed 50% by USD, 18% by EUR, 14% by JPY, 11% by GBP and 7% by SGD. However, it didn’t take long for Libra to fail as the Congress of the United States realized the threat of a private company competing with a public bank. 

However, their ambition seems to remain enormous because after the failure of Libra, Facebook created Diem - Libra 2.0. At the moment, they have been able to cooperate with a variety of partners in the finance department in order to start expanding and integrating with social media applications like Facebook, Whatsapp,...

3. LPM Coin

JP Morgan - one of the biggest banks in the world, plans on creating JPM Coin, a Stablecoin that can replace the obsolete payment system Swift. Nonetheless, they have not made any further announcement. If JP Morgan successfully introduces their product, other major banks like HSBC, Citibank, Wells Fargo will also participate in the play.

4. CBDC 

The last Stablecoin, at the same time the most realistic one is CBDC. CBDC is short for Central Bank Digital Currency. Currently, many Western banks and China banks have been experimenting with the CBDC model and tried to apply it to their work models.

Although there are still some limitations such that it is not yet possible to be applied worldwide, CBDC can be considered a Stablecoin comprehending all the benefits that the blockchain technology brings, namely transparency, tracing ability to prevent money laundering, low transaction cost, high speed.

There is no doubt that CBDC will be applied in the future by not only commercial banks but also public banks. Moreover, the Covid 19 event taking place all around the world has shown how important CBDC can be to the global economy in the future.

When everyone has difficulties in commuting and using cash, CBDC becomes an optimal solution for the financial market to operate smoothly.

Investment opportunities with Stablecoins

In terms of investment opportunities with Stablecoins, I can distribute into 2 types:

• Using the Stablecoin indexes to find investment opportunities.
• Directly speculating using Stablecoins.

Now let’s go through each type of investment.

Discover investment opportunities through Stablecoin indexes

As mentioned above, Stablecoin is not the sector to invest in. The best way to make a profit from Stablecoin is to observe its movement and make decisions based on the cash flow.

Anytime Stablecoins are issued in an ecosystem, the cash flow immediately has the tendency to get into that ecosystem: 

• Terra USD grew ⇒ LUNA, MIR, ANC grew.
• Tether and Circle issued their Stablecoins on Solana ⇒ SOL, SRM, RAY, MNGO, SBR grew.
• Tether issued Stablecoin on Avalanche ⇒ AVAX, XAVA, PNG, JOE,... grew.

So in order to not miss any market trend, you have to observe and track them before they “take off”. Here are some useful questions that can help you find your own insights:

• Which blockchain ecosystem has the most Stablecoins?
• Which blockchain ecosystem are StableCoins being issued on?
• How can Stablecoin’s pace of growth be compared between different ecosystems?
• Which ecosystem is expanding the DeFi space (as expanding DeFi requires more Stablecoins)?

Most recently, multiple ecosystems have announced their DeFi incentive programs, including:

• Celo with $100M.
• Terra with 50M $LUNA.
• Avalanche with $180M.
• Algorand with 150M $ALGO.
• Harmony with $300M.
• Fantom with 370M $FTM.
• …

It is worth following the Stablecoin movement in these ecosystems and see if they are issuing any new Stablecoin or cooperating with any 3rd-party to do so.

Directly investing using Stablecoins

Nevertheless, if you own a large amount of capital and want to earn with zero risk in this market, using Stablecoins can still be the way to go.

Although the Yield is not as high as using Altcoins, using Stablecoins allows you to be flexible regardless of the market condition. Here are some advisable methods:

1. Lending (4 - 8% APR)

You can deposit Stablecoins on CEXs or lending platforms to receive savings. The advantage of using Lending is its simple interactions, transparent interest, and optional deposit period.

Here are some platforms that you can use Stablecoins to earn savings:

CEX: Binance, Huobi, Gate, MXC, OKEx,...

Centralized Lending: NEXO, BlockFi,...

Decentralized Lending: 

• Ethereum: Aave, Compound, MakerDAO, InstaDapp,...
• Binance Smart Chain: Venus, Alpaca Finance, Rabbit Finance,...
• Solana: Port Finance, Solend.
• Terra: Anchor Protocol.

However, the disadvantage of using Lending protocols is that the interest rate is pretty low, ranging from 4-8%/year. If you want to receive higher yields, take a look at Farming.

2. Farming (20 - 40% APR)

Farming is the approach to provide liquidity for decentralized exchanges to receive platform fees and the native token of the platform. To follow this way, you have to know some basic actions in DeFi, like providing liquidity.

The advantage of Farming is a higher yield with up to 20-40% per year, which is a really high interest rate. In Viet Nam, if you deposit USD, you won’t even receive interest. Whereas if you deposit VND, you will earn a 7% interest rate but the annual inflation rate is even higher than USD.

DeFi is really a gateway bringing a vast amount of opportunities to earn yields, and you can totally use Stablecoins to make a profit before actually investing in the market. Here are some Stablecoin AMM platforms that you can use for Farming:

• Ethereum: Curve Finance, mStable, Snowswap.
• Binance Smart Chain: Ellipsis, Belt Finance, MDEX.
• Solana: Saber.

However, Farming on decentralized protocols has some particular risks, especially in the case of the protocol being hacked, which is why you should distribute your Stablecoin into smaller parts and use them on prestigious and high TVL platforms.

Conclusion

Here are some insights that you can use to find investment opportunities with Stablecoins:

• The Stablecoin sector does not possess many investment opportunities, but can be used as a tool to navigate the market trend.
• Observing and following the Market Cap of Stablecoins from the market outlook (macro) to each ecosystem (micro) can help you discover your own investment opportunities.
• Carefully notice the movement of 4 following Stablecoins: USDT, USDC, BUSD, and UST. Here are the 4 most used Stablecoins in both DeFi and CeFi.
• Pay attention to where those Stablecoins are being issued, and in which ecosystem the Stablecoin’s growth pace is the fastest. Answer to yourself why?
• You should spend your Stablecoins on Farming or Lending. This earns you a passive income, at the same time reduces your “tendency” to FOMO when the market grows tremendously. Most importantly, it can help you to be flexible in any market conditions.

I hope it has helped you in gaining more valuable insights into this sector, and how you can make a profit by using Stablecoins.

If you want to know further about this topic, please feel free to leave a comment below for further discussions.

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