Stablecoins provide crucial stability in the volatile crypto market, but their success depends on factors like liquidity, collateralization, and integration and much more.
In this article, we break down the mechanics of stablecoins, offering a framework to evaluate their peg stability, capital efficiency, and transparency. You'll gain insights into assessing a stablecoin’s long-term viability, giving you the tools to make informed decisions in DeFi. Whether you’re an investor or developer, this deep dive will clarify what drives stablecoin resilience and what risks may threaten their stability.
-
The stablecoin trilemma
-
The 3 different types of stablecoins
-
Evaluating a stablecoin
-
Example of well-capitalized but questionable stablecoins
-
The new generation of stablecoins : USD0, USDA, GHO, BUIDL, USDe, crvUSD
-
Resilience and on-chain efficiency criteria ; PYUSD, USDT, GUSD, USDP, USDM, USDC, DAI, LUSD
-
Reflections and conclusions
1. The stablecoin trilemma
Stablecoins must navigate a delicate balance between three core objectives: price stability, capital efficiency, and decentralization.
The primary goal is to maintain a stable value, typically pegged to assets such as fiat currency. However, achieving this often requires trade-offs in either decentralization or capital efficiency. Price stability hinges on market confidence and strong collateral mechanisms, while capital efficiency focuses on minimizing the resources required to issue stablecoins. Decentralization, crucial for mitigating risks and ensuring transparency, often conflicts with these other goals.
No design has fully reconciled all three, as centralized and over-collateralized models prioritize stability but sacrifice decentralization or efficiency. Although algorithmic approaches have temporarily addressed the trilemma until market dynamics reveal their vulnerabilities.
2. The 3 different types of stablecoins
Fiat-Backed Stablecoins
Fiat-backed stablecoins were the first to emerge and remain the most widely used. Each token is backed 1:1 by actual fiat currency, such as USD, offering high stability but compromising decentralization. To support this model, issuers rely on centralized structures and traditional financial institutions, requiring users to undergo KYC and AML processes.
However, the issuance of these stablecoins lacks specific financial regulation, resulting in a lack of transparency and a heavy reliance on investor trust. Audits and attestations are voluntary, creating systemic risks in the crypto market. Despite these concerns, fiat-backed stablecoins account for over 90% of the total supply as of June 2024, largely because they serve as the primary gateway for institutional capital. Their future heavily depends on regulatory developments in major jurisdictions like the US and EU.
Crypto-Backed Stablecoins
Crypto-backed stablecoins address the shortcomings of fiat-backed models by emphasizing decentralization and trustless systems. These decentralized protocols allow users to mint and redeem tokens through smart contracts. Governance is typically managed by a DAO, but decision-making can be slow and inefficient.
Since crypto assets are more volatile than fiat, most crypto-backed stablecoins are over-collateralized to ensure stability. This leads to capital inefficiency, as more value is required to issue the stablecoin. To reduce this collateral ratio without sacrificing stability, some protocols accept highly liquid stablecoins, such as USDC, as collateral. However, this reliance on centralized stablecoins reintroduces the censorship risks they aimed to avoid.
Algorithmic Stablecoins
Algorithmic stablecoins aim to solve the stablecoin trilemma without relying on fiat or over-collateralized crypto. These stablecoins use an algorithm to balance supply and demand, maintaining price stability without traditional collateral. The system often employs a two-token model, where one is a floating-price token used in mint-and-burn mechanisms. Investors are incentivized to redeem the stablecoin when it falls below the peg, stabilizing the price.
Hybrid models, like FRAX, are gaining traction by combining algorithmic mechanisms with on-chain crypto collateral. This approach reduces the risk of catastrophic failure, such as that of UST, while maintaining higher capital efficiency than other types of stablecoins.
3. Evaluating a stablecoin
The third part lays a strong foundation on stablecoin fundamentals and offers a methodical approach for analyzing them.
By now, it should be clear that each stablecoin, depending on its nature, requires a unique approach for analysis. To enhance the sophistication and accuracy of our assessment framework, we rely on three key platforms: Bluechip, RWA.xyz, and S&P Global. These tools are invaluable for swiftly identifying critical or potentially problematic issues.
An independent stablecoin rating agency that follows the SMIDGE framework, evaluating Stability, Management, Implementation, Decentralization, Governance, and External factors. Founded in August 2022, Bluechip plans to update its reports with new evaluation criteria by Q4 2024, making the site useful for quickly assessing projects with a critical perspective.
RWA.xyz provides analytics on tokenize RWA, offering data on-chain and off-chain for stablecoins, U.S. Treasury bills, private credit, and more. They are co-founders of the Tokenized Asset Coalition, alongside Coinbase, Fireblocks, Chainlink, and others, and their data is used by S&P Global, Bloomberg, and Grayscale
S&P Global Ratings assesses stablecoins on a scale from 1 (very good) to 5 (poor), analyzing credit, market risks, governance, jurisdiction, redemption mechanisms, liquidity, and collateralization. This comprehensive evaluation offers a well-rounded view of stablecoin stability.
The combination of these platforms provides a qualitative and sufficient overview to form quick conclusions, though not all stablecoins, especially newer ones, have been fully studied.
So, what should be analyzed based on the type of stablecoin in question? Let’s take a look ;
Fiat-backed Stablecoins
The main weakness lies in centralization, granting the issuing entity significant power and exposing the stablecoin to censorship risks. Evaluation focuses on how well these aspects are managed, with transparency and user protection being key.
Crypto-backed Stablecoins
Decentralized stablecoins often face scalability challenges and require efficient liquidation, redemption, and peg maintenance mechanisms. Stability is best ensured through protocols that can liquidate bad debts and maintain a low-volatility collateral while reducing over-collateralization.
4. Example of well-capitalized but questionable stablecoins
Surprised to see USDY on this list ? I was too, but rest assured, there's a reason. Let's get straight to the point : Ondo Finance's USDY is a stablecoin built on strong fundamentals
The USDY, issued by Ondo Finance, is backed by short-term U.S T-bills and operates on a yield-bearing model. Minting requires KYC and takes 40 to 50 days, although interest begins accruing from day one. Strict accreditation standards apply for minting and redemption, limiting accessibility. Despite solid fundamentals and partnerships with reputable institutions like StoneX and Ankura, USDY’s low DeFi composability, limited on-chain liquidity and time-consuming process make USDY an undesirable stablecoin in DEFi, as we need flexibility to compose strategies.
Take a quick look at this overview before we dive into the details :
FDUSD - First Digital Labs
First Digital is an unregulated issuer with reserves composed of cash deposits and U.S. Treasury bills maturing in less than 3 months, held across Hong Kong, Switzerland, and Australia. Audited monthly by Prescient Assurance LLC, its accounts are segregated, but holders lack the right to redeem underlying assets in the event of First Digital Labs’ bankruptcy. FDUSD’s limited DeFi composability and weak fundamentals make it unsuitable for use in DeFi strategies.
TUSD - TrueUSD
TUSD, issued by Techterxy Ltd, a China-based conglomerate, claims to be backed by cash deposits, treasury bills, and other liquid investments, although its reserves are not publicly disclosed. The complete lack of transparency around its collateral, combined with its negligible utility in the DeFi ecosystem, makes TUSD a highly questionable stablecoin.
FRAX - Frax
Frax is a hybrid stablecoin that can be minted and redeemed via FXS, currently undercollateralized at 99%. Despite its "decentralized" label, more than 80% of its backing comes from centralized stablecoins. The protocol’s core team holds full control over governance, while FRAX is heavily collateralized by FXS, USDC, USDT, DAI, and liquidity pools, increasing its risk profile. Redemption is only possible if FRAX drops below $0.9933, and frequent depegs are caused by poor on-chain liquidity and unbalanced pools.
USDD - Tron DAO
Issued by Tron DAO and Justin Sun, USDD is collateralized by TRX (>99%) & USDT and has a reported collateralization rate of 228%. It is pegged 1:1 to the U.S. dollar through an algorithmic dual-token mint-and-burn system involving TRON’s native token, $TRX. The majority of assets are stored in a multisig wallet, and while USDD features a Peg Stability Module (PSM), it is underutilized due to limited funding. The stablecoin is audited by SlowMist (unregulated and China-based) and unregulated, with significant ties to the Huobi exchange.
These stablecoins are highly capitalized but suffer from weak underlying fundamentals. If a stablecoin has strong fundamentals but weaknesses in secondary markets, is it worth considering ? Conversely, should you include a highly composable asset with uncertain fundamentals in your DeFi strategies ?
5. The new generation of stablecoins : USD0, USDA, GHO, BUIDL, USDe, crvUSD
This section provides an overview of innovative or recently launched stablecoins with significant growth potential in the DeFi ecosystem. It includes their strengths, weaknesses, and the key factors these assets must meet to be considered reliable for DeFi strategies.
Usual - USD0
USD0 is a fiat-backed stablecoin collateralized by short-term U.S T-Bills through overnight repos’. It’s categorized as a yield-bearing stablecoin ; yield generated is redistributed to the holders of governance token $USUAL and USD0++.
Usual chose to partner with Hashnote and its USYC token to ensure compliance and strong fundamentals in terms of custody, account segregation, and protection of user funds from issuer bankruptcy risks. Future partnerships with firms like BlackRock or Mountain Protocol may also be established. USD0 serves as a second layer in the reward-bearing stablecoin ecosystem, enhancing DeFi composability and adding a flywheel effect.
The key innovation lies in the USD0++ token, a locked version of USD0 (from 6 months to 4 years). After the lock-up period, USD0++ earns either the yield generated by the collateral and the 'floating yield' from unlocked USD0, or $USUAL incentives.
On-chain liquidity is inefficient, as the -0,20% slippage to TVL ratio stands at 1,47% (reached for $2.65M via Odos)
-
Strengths: Strong partnerships, composability, and tokenomic innovation
-
Weaknesses: Weak on-chain liquidity and relatively low TVL
Overall, USD0 / USD0++ offer an interesting product that can be integrated into certain DeFi strategies on a small scale. The product is still very new, and its market introduction has been successful. However, it’s essential to improve liquidity in secondary markets and increase integrations within the DeFi ecosystem.
Angle Money - USDA
USDA is a USDC-backed stablecoin with additional features for mitigating depegging risks. Its structure allows staking of USDA to generate stUSD, a yield-bearing token without lock-up periods.
USDA relies on collateral like tokenized T-Bills (through Backed), Morpho vaults, and Angle Money’s interest rates to generate yields. This modularity between the two (or even three) assets also allows for an on-chain exit from USDC, even in the event of Circle's bankruptcy, through the cryptocurrencies that make up the collateral or RWAs (reserve status is available on the website)
The anti-depeg mechanism is supported by the Transmuter (PSM), which has been battle-tested with EURA, ensuring a robust peg through a variable fee system that adjusts based on user actions affecting the collateral. It also provides the ability to redeem USDA against any collateral.
On-chain liquidity is extremely efficient, as swaps to USDC occur without fees or slippage, regardless of the amount.
-
Strengths: Anti-depeg mechanisms, sustainable yield, flexible collateral structure
-
Weaknesses: Reliance on Morpho, low TVL, and limited liquidity on Layer 2s (L2)
The use case for Angle’s USDA is particularly interesting because it takes a different approach from its competitors by relying on USDC and adding an additional layer of DeFi features that make stUSD/USDA resilient, transparent, and attractive.
These use cases deserve further development and exploration.
Aave - GHO
The GHO stablecoin is issued through Aave's CDP/MM system and can be minted after depositing collateral that has been whitelisted by the DAO. This process can be carried out using multi-collateral, isolated markets, or Aave’s e-mode. $AAVE stakers benefit from a discounted borrowing cost when minting GHO.
The Facilitators, managed by the DAO, handle requests for minting and burning GHO by interacting with the Aave pool. Additionally, the flash-minter facilitates arbitrage opportunities.
The hard peg of GHO is maintained solely by market arbitrage opportunities (repaying their debts at a discount) ; a very basic and widespread concept
The strength of GHO lies in the Aave protocol itself, known for its strong risk management, liquidation mechanisms, and TVL (Total Value Locked). While GHO's TVL remains modest, its use cases are solid, particularly through the Stability Module, which is currently incentivized with the Merit Program.
On-chain liquidity is relatively efficient, with a -0,20% slippage to TVL ratio of 9,64% (achieved with $11 million via Odos).
-
Strengths: Good DeFi integrations, linked to the leading borrowing protocol in DeFi.
-
Weaknesses: Less sophisticated peg maintenance mechanism, limited deployment on Layer 2 networks, modest TVL.
GHO initially faced a prolonged depeg due to its simplistic peg mechanisms relying on natural arbitrage incentives, compounded by a lack of DeFi utility. However, the utility has improved in recent months. It will be interesting to see if the TVL grows and composability improves on other networks.
Blackrock - BUIDL
A special mention goes to BUIDL, issued by Blackrock in collaboration with Securitize, BitGo, Coinbase, and others. While there is limited information available on this upcoming stablecoin, which will be backed by T-Bills and/or other liquid assets, it has generated excitement due to its rapid growth and potential to become a more effective entry point for institutional investors. Several protocols, such as Mountains and Ondo, have already integrated it into their derivative products.
We will closely follow this stablecoin and its integration into the DeFi ecosystem
Ethena - USDe
USDe is not really a stablecoin but rather a synthetic representation of the dollar's value, backed by various mechanisms.
Ethena leverages derivatives exchanges and executes a “carry trade” strategy to generate yield. To achieve this, Ethena accumulates capital (in BTC, ETH and ETH’s LSD) and executes short positions on these assets, using the collateral to generate yield through funding rates
The effectiveness of this strategy relies on positive funding rates and optimal trade execution to minimize slippage. To safeguard against periods of low or negative funding rates, Ethena has established a $45 million security fund, though this fund is exposed to 30% of liquidity providers (LPs) holding USDe.
With over $2,6 billion in capitalization, USDe has been widely adopted by major DeFi protocols. It has recently integrated with Solana and includes $SOL as a reserve asset.
On-chain liquidity is relatively efficient, with a -0,20% slippage to TVL ratio of 10,38% (achieved with $32 million via Odos).
-
Strengths: Strong DeFi integrations, widely available on centralized exchanges, and used as collateral for derivatives.
-
Weaknesses: Dependent on funding fees, significant custody risk as assets are primarily managed by platforms like Binance, Bybit, or OKX.
USDe is a new asset meeting the growing demand in DeFi for an inherently profitable stablecoin. While the team emphasizes that it is not a stablecoin, the similarities are evident. Monitoring USDe’s performance during periods of extreme market volatility will be crucial to understanding how its mechanism reacts under such conditions.
Curve Lend - crvUSD
Llama Lend is a CDP protocol with isolated pools, where crvUSD is a stablecoin pegged 1:1 to the dollar, minted from available collateral. Instead of using traditional loan pools, Curve implements a "soft liquidation" mechanism, which allows collateral to be gradually liquidated over a price range rather than through sudden liquidation. Borrowers deposit collateral into a LLAMMA and receive debt in crvUSD. The collateral is divided into specific "bands" for each user, creating the "liquidation range."
To maintain solvency during collateral price drops, LLAMMA pools partially liquidate collateral for crvUSD. The LLAMMA price decreases faster than the oracle price, so Curve's lending pool sells collateral at a lower price than the current market price, incentivizing liquidation. Arbitrageurs can purchase collateral from LLAMMA with crvUSD and sell it on the market, capturing the price difference. When the collateral price rises, LLAMMA reverses the liquidation, incentivizing arbitrageurs to return collateral to the pool. In this system, collateral is "bidirectional," which protects the protocol from bad debt.
Peg stability is ensured by the protocol always being over-collateralized, and loans are managed through banded liquidations and bidirectionality, ensuring the protocol’s solvency.
With these mechanisms, crvUSD's backing remains solid. A lack of liquidators would be needed to create bad debt. Peg Keepers are responsible for balancing Keeper pools by trading for profit. These contracts allow the creation and absorption of crvUSD debt to trade near the peg. Each Peg Keeper targets a specific pool and facilitates trades between crvUSD and a blue-chip stablecoin (USDP, USDC, USDT, TUSD).
On-chain liquidity is highly efficient, with a -0,20% slippage to TVL ratio of 14,60% (reached for $11.3M via Odos).
-
Strengths:
-
High customization in managing loan positions
-
Effective bad debt management
-
Interesting DeFi integrations and yield generation
-
-
Weaknesses:
-
Very low TVL
-
Use cases focused on the Curve ecosystem
-
On-chain liquidity could be improved
-
Isolated pools limiting composability
-
Limited deployment on Layer 2s
-
Overall, crvUSD features an innovative and efficient mechanism designed to favor borrowers. Its main obstacles are its limitation to the Curve ecosystem and the influence of major players on the protocol. Although there are many use cases within Curve, it would be essential to see crvUSD expand into other ecosystems.
This section highlights six promising new stablecoins with notable growth potential. Additionally, deUSD could also be considered, as it shares similarities with USDe
In the next section, we'll take a different approach to studying 8 other stablecoins.
6. Resilience and on-chain efficiency criteria ; PYUSD, USDT, GUSD, USDP, USDM, USDC, DAI, LUSD
The design and management approaches of stablecoins vary significantly, affecting their utility, security, and relevance for different investment strategies. Building on the concepts explored previously, we will deepen our understanding of these stablecoins.
What’s better than a cheatsheet for a quick grasp of a topic ? Here are two for you :
Centralized stablecoins :
Decentralized stablecoin :
Peg Mechanisms and Stability
The primary distinction between stablecoins lies in the nature of their reserves and how they maintain parity with the dollar or another fiat currency.
DAI: A decentralized and complex model
DAI’s uniqueness comes from its backing by a diverse range of assets, which spreads risk but also adds complexity. DAI’s overall collateralization ratio is 134%, which is critical for absorbing the volatility of some of its underlying assets.
DAI Collateralization Breakdown :
-
11% backed by fiat stablecoins via the PSM, primarily USDC.
-
20% backed by volatile crypto assets like ETH/wstETH and wBTC.
-
38% in real-world assets (RWAs), mainly U.S. Treasury Bills, held via partners such as Coinbase, BlockTower, and Clydesdale.
-
31% in other diversified crypto assets (D3M).
DAI’s stability hinges on the Spark protocol’s ability to efficiently handle volatile asset liquidations through Dutch auctions and on the health of the PSM. Part of DAI’s collateral also comes from Spark and Morpho’s D3M modules, tied to USDe, linking DAI’s peg resilience somewhat to USDe’s.
While the PSM is crucial for maintaining DAI’s peg, it raises concerns about true decentralization, as 70% of DAI is backed by centralized assets.
Note: Maker DAO has recently transitioned DAI towards the NST.
LUSD: A peg mechanism that compromises protocol efficiency
Through the Liquity protocol, which is immutable and open-source, users can borrow LUSD using ETH as collateral, with a minimum collateralization ratio of 110%. However, this figure is largely theoretical.
Although Liquity offers one of the lowest collateralization ratios in the ecosystem and does not charge interest, maintaining the hard peg requires sacrificing collateralized ETH to buy LUSD below $1. These ETH come from the least-capitalized Troves, supplied by users.
This mechanism creates a vicious cycle that deteriorates UX and reduces the protocol’s TVL to ensure LUSD’s stability. Without strong demand in the secondary market, LUSD risks further losing collateralization. Is maintaining a 500% collateralization ratio truly attractive in a competitive landscape?
This stability model works but comes at significant costs.
Redemption Access for Centralized Stablecoins
The essential condition for maintaining the peg of a centralized stablecoin is ensuring users and arbitrageurs can access efficient redemption.
This ability depends on several factors:
-
Sufficient collateralization
-
Available liquid assets
-
Redemption conditions (for users)
-
Conditions of banking partners
It is notable that only USDT partially relies on less liquid assets, the details of which are not disclosed.
T-Bills and overnight repos are considered highly liquid assets, particularly by the NYDFS. For money market funds, liquidity depends on the nature of the underlying assets. In the case of USDM, these are T-Bills managed by BlackRock, making them highly liquid as well.
Tether is the only company that limits redemption access. While other issuers allow verified KYC users to redeem their stablecoins within a short timeframe (usually two business days), Tether requires a minimum amount of $100,000 and charges a 0.1% fee. This policy is counterproductive for ordinary arbitrageurs and unattractive to users in general.
Thus, maintaining a stablecoin peg relies on a combination of an efficient redemption process, facilitated by key partnerships, and the trust users place in the asset. A depeg could easily occur if depositors and auditors are unreliable, audits are rare or non-existent, the redemption process is slow, or on-chain liquidity is weak.
Regulation and Transparency
Regulation is a critical factor for institutional investors and users seeking increased security in the often-perceived risky crypto environment.
FinCEN, NYDFS, or BMA ? Among the first criteria mentioned in the summary of fiat-backed stablecoins is the country of incorporation and the license/regulatory framework governing the issuing entity ; this is a key consideration. What’s the difference for a stablecoin issuer ?
-
FinCEN (Financial Crimes Enforcement Network) imposes general compliance requirements at the federal level, but these are primarily focused on monitoring criminal activities rather than solvency or consumer protection.
-
The NYDFS (New York State Department of Financial Services) is far more stringent with its BitLicense, imposing strict standards for reserve management, financial audits, and cybersecurity to ensure the solvency of stablecoin issuers.
-
The BMA (Bermuda Monetary Authority), while perceived as a more flexible jurisdiction, also imposes rigorous reserve management and transparency requirements, but with a regulatory framework more favorable to innovation.
Stablecoin issuers must often choose the jurisdiction that best aligns with their business model and growth strategy, while considering the costs and complexities associated with each regulator.
While FinCEN represents the minimum legal requirement to operate in the U.S., NYDFS is the most difficult to obtain and the most demanding in terms of reserves, security, and consumer protection. The BMA can be categorized as strict but seen as more flexible than the NYDFS.
BVI, Bermuda, or the U.S ? The choice of incorporation depends on various factors, including regulatory requirements, costs, consumer protection, and the legal environment.
The BVI (British Virgin Island) offers a more flexible regulatory framework for stablecoin issuers, with less stringent compliance and transparency requirements compared to jurisdictions like Bermuda or New York. This attractive framework is ideal for minimizing costs at the expense of credibility, transparency, and consumer protection.
In contrast, Bermuda and the U.S. (especially New York) impose stricter regulations, requiring solid guarantees for solvency and consumer protection. This level of regulation is often preferred by companies seeking to establish greater credibility in the global market, despite the high compliance costs.
Choice of Auditors for Transparency
Auditors play a crucial role in the stablecoin ecosystem by ensuring financial transparency, regulatory compliance, and user trust. Among the main auditing firms in this sector, Deloitte stands out as a leader, benefiting from its "Big Four" status with global expertise in financial services.
Beyond Deloitte, other auditing firms like WithumSmith+Brown, BDO Italia, BPM LLP, and The Network Firm also play important roles in the sector. While smaller than Deloitte, these firms provide services tailored to the different sizes and structures of companies operating in the stablecoin space.
Issuers regulated by the NYDFS or BMA are required to conduct regular third-party audits. Companies like Tether and Circle have opted for more frequent disclosures of their reserves, independently, not only to comply with FinCEN requirements but also to add an extra layer of credibility.
Systemic Risks and User Protection
It is crucial that stablecoin issuers maintain segregated accounts to ensure that user funds are separate from company assets, protecting them in the event of financial issues. Additionally, being "bankruptcy remote" ensures that stablecoin-related assets are protected from creditors if the company goes bankrupt, which maintains stability and trust in the stablecoin by preventing the use of these funds to settle company debts. These measures are essential for maintaining user safety and trust.
It is surprising that Tether's USDT continues to dominate the stablecoin market, despite criticisms of its transparency and financial practices. Unlike issuers regulated by authorities like the NYDFS or BMA, which enforce strict requirements for fund segregation and bankruptcy-remote structures to protect users, Tether operates under the lighter FinCEN framework. Its lack of comparable guarantees raises questions about its stability, but its high liquidity and widespread adoption continue to secure its dominant position, despite lingering doubts.
DeFi Integrations and Composability
Integration within the DeFi ecosystem is crucial for investors looking to leverage the yield opportunities offered by various protocols. This includes :
-
The number of ecosystems covered and the number of DeFi protocol integrations for the stablecoin
-
Liquidity efficiency, which is critical from a user experience standpoint
DeFi Composability ;
The integration of a stablecoin across multiple blockchains (ecosystems) makes DeFi more accessible at a lower cost.
While tracking the number of ecosystems is useful, it's essential that the use cases are relevant and the liquidity is sufficiently deep. Additionally, ensuring that blockchains are interconnected through canonical bridges (native) is vital for security, as they are more secure than non-canonical bridges (such as Orbiter, Synapse, etc.), though the latter often offer unmatched speed.
In this regard, USDC has a significant lead thanks to the CCTP developed with Chainlink, currently covering Arbitrum, Avalanche, Base, Ethereum, Noble, OP Mainnet, Polygon PoS, and Solana. Launched in September 2022, it facilitates the transfer of native USDC across networks through a "burn and mint" bridging method, rather than the traditional "lock and mint" approach. To use CCTP, users transfer native USDC on a supported source network for burning, and an equivalent amount of native USDC is minted on a supported destination network and sent to the beneficiary’s specified wallet address.
Thanks to their TVL and longevity, USDC, USDT, and DAI benefit from strong composability within DeFi, which facilitates the creation of creative and scalable strategies. It will be interesting to see which other stablecoins manage to make their assets just as usable.
The growth of a stablecoin must be primarily supported by its on-chain liquidity. The greater the liquidity, the easier it becomes to create lending and borrowing markets while ensuring solvency
With this in mind, let's examine the liquidity efficiency of these assets.
Liquidity Efficiency ;
USDC and USDT are used as benchmarks in these simulations, where swaps into these assets are utilized to calculate the price impact. The "Slippage Limit -0.20%" column indicates the dollar amount for which the swap experiences a slippage of -0.20% (the threshold set for these simulations). To normalize liquidity efficiency, we calculate the ratio of this threshold to the TVL of each stablecoin.
USDM shows significantly higher efficiency compared to its competitors, particularly against PYUSD, which appears to overlook secondary market liquidity. It’s also noteworthy that DAI benefits from a strong ratio, largely due to the variety of DEXs with DAI pools.
While the "Big 3" (USDC, USDT, and DAI) continue to dominate due to their diversity and robustness in DeFi, newer assets like USDM (and others mentioned in the second article on stablecoins) are skillfully positioning themselves to increase adoption.
7. Reflections and conclusions
Creating an attractive stablecoin for DeFi users is a major challenge for new issuers. While the lucrative yields offered by T-Bills allow for a highly profitable business model from the product's launch, success hinges on the ability to attract capital.
The key lies in integrating users into the flywheel : how can issuers entice them to move away from native yields, like those from T-Bills or other underlying products ?
USDC is a perfect example. When a stablecoin is deeply integrated into DeFi, with substantial liquidity and easy redemption, users can easily find yields above 5% in DeFi, lending on Aave for example. As a result, users overlook the native yield of the stablecoin, which goes entirely to the issuer, in exchange for a regulated and robust product with which they can implement profitable strategies. As demonstrated by Pendle, with YT_farmers chasing yield vs PT_fixed_yield seekers, DeFi users (or "degens") forego the native yield in hopes of generating even higher returns, benefiting both parties.
While this is easier for established stablecoins like USDT, USDC, and DAI, it proves more challenging for new entrants. For example, Ethena offers a highly profitable product natively with a more exotic model, while Usual solidifies its stablecoin, collateralized by T-Bills, by incorporating a ve-style-model flywheel.
Does this seem unfair ? We are witnessing the rise of a new class of stablecoins, like USDY and USDM, which directly integrate T-Bill yields into the token held by users, using a rebase and/or reward-bearing model for better DeFi integration. Mountain Protocol is doing remarkable work by first establishing efficient on-chain liquidity, then integrating wUSDM into yield protocols like Beefy and lending/looping platforms like Dolomite. Its fundamentals are among the strongest in the market, so it's only a matter of time before its TVL grows.
PayPal has taken a different, more aggressive approach by deploying on Solana with massive lending incentives on Kamino. While the origins of these $1.2 million weekly incentives remain unclear, it appears they are using part of their reserves or native yields to kickstart the flywheel ; probably a costlier and less sustainable solution
At Redacted Labs, our strategies are based on thorough due diligence of every asset and protocol we use. This series of articles is just a glimpse of our research, providing you with essential information and the steps to take so that you, as a DeFi user, can analyze the risks and opportunities associated with stablecoins. Continuous, diligent monitoring is required, as both fundamentals and on-chain metrics can evolve rapidly.
Feel free to reach out to us to discuss this fascinating topic. See you soon!