Are Stablecoins the Future of DeFi Borrowing and Lending?

POLYTRADE
8 min readFeb 22

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Stablecoins, like unbacked crypto-assets, are part of the larger crypto-asset ecosystem. They exist to solve the large price swings of unbacked crypto-assets like Bitcoin and Ether, and their comparably low price volatility makes them ideal for a variety of functions that require this attribute.

Stablecoins are digital units of value that use stabilisation approaches to keep their value steady in relation to one or more official currencies or other assets. Stabilisation mechanisms include reserve assets that may be redeemed against stablecoin holdings, as used by collateralised stablecoins and algorithms that balance supply and demand to maintain a stable value, as used by algorithmic stablecoins.

Stablecoins have inevitably become a critical part of the crypto-asset ecosystem due to their frequent use in the trading of crypto-assets and as liquidity providers in DeFi. Three stablecoins currently capture over 90% of the stablecoin market, according to DeFiLlama.com. These include Tether USDT, Circle’s USDC, and Binance’s BUSD.

Below is a list of the top stablecoin tokens as per their market capitalization.

Where are Stablecoins Currently Being Used?

Stablecoins are primarily used to allow the trading, lending, and borrowing of other digital assets. For example, stablecoins let market players participate in speculative digital asset trading and freely move across digital asset platforms, removing the need for fiat currency and traditional financial institutions.

Stablecoins also enable users to store and transfer value associated with digital asset trading, lending, and borrowing inside a distributed ledger system, minimising the need for fiat currency and traditional financial institutions. Digital asset trading platforms and other intermediaries are playing an important role in giving access to and facilitating the trade of stablecoins, as well as in stablecoin arrangement stabilising mechanisms.

There are three key characteristics that define a stablecoin: stability, capital efficiency, and decentralization and many varieties of stablecoins on the market, but the three most common types are fiat-backed, crypto collateralized and algorithmic.

Fiat-backed Stablecoins

Fiat-backed stablecoins are digital assets with a fiat currency backed by a regulated entity such as a bank. Its reserves are in a bank vault or with a reputable financial custodian. These reserves are a weighted combination of cash and currency equivalents such as commercial paper.

For example, a $100 billion fiat-backed stablecoin may include $40 billion in cash and the remaining $60 billion in cash equivalents. As mentioned above, Tether and USD Coin (USDC), the two largest stablecoins by market capitalization, fall into this category. These stablecoins, as previously said, are not decentralised however they are stable and capital efficient, allowing for massive scalability.

The Rise of Stablecoins in Lending

Stablecoins are important in DeFi lending protocols because they serve to decrease volatility concerns and make it easier for both lenders and borrowers to better manage their financial operations.

While USDT has been the crypto of choice for traders with its numerous exchange integrations, USDC has remained at the forefront of the DeFi field due to its near-instant settlement speed, high level of security, and emphasis on transparency and regulatory compliance. According to Flipside Crypto, Circle’s stablecoin has minimal deviations from the $1 price point among the major stablecoins, making it a viable alternative for those seeking stability.

Even on Compound, USDC is the most deposited token, accounting for more than 25% of the TVL.

The objective of DeFi is to improve financial services by employing blockchain infrastructures to provide transparency, security, and community governance. They imitate traditional borrowing and lending while depending on decentralised networks and stablecoins play a major role here as they provide lucrative interest rates.

But why are dollar-pegged stablecoin interest rates so much higher than interest rates on paper dollars? A simple explanation for that is the high-interest rates compensate individuals for the possibility that the stablecoin would depreciate. However, premier stablecoins like USDC and Pax (USDP) are entirely backed by high-quality dollar assets, thus the chance of losing your money is low.

(Disclaimer: not to be confused with financial advice.)

Additionally, the demand for stablecoins is always greater than the supply. As a result, stablecoin lenders demand higher interest rates, and crypto platforms looking out for stablecoins offer high-interest rates to entice new stablecoin lenders. That is why the interest rates on stablecoins are so high.

Lastly, stablecoin can earn yield from all over the world with borrowers offering different risks. By removing intermediaries, stablecoins can access these opportunities directly and get greater yields therein.

Borrowers and lenders have more direct control over their finances with DeFi lending since all operations are handled by smart contracts, which are self-executing algorithms that work on blockchain. One distinguishing feature of DeFi lending is that most loans are overcollateralized, meaning borrowers must make a deposit of assets bigger than the loan amount. This occurs because most cryptocurrencies used as collateral are volatile, and there are no credit scores or identification verification to assist lenders in determining counterparty risk.

So, in a way both lenders and borrowers gain from DeFi lending. The latter can easily obtain loans, whilst the former may earn interest rates that are frequently greater than rates in comparable traditional financial investments.

Stablecoins also provide high liquidity for cryptocurrency exchanges. They allow simple and swift move-in and out of cryptocurrencies without incurring losses on off-ramping or bridging. A rising exchange would need increasing amounts of stablecoin liquidity to keep trading. Stablecoins offer crypto investors a “safe haven”. Whenever the markets go down, the demand for stablecoins surges.

The current lending rates vary on Oasis but historically range from 0% to 8.75%. Aave offers different yields and interest rates to lenders, but they typically range between 1% to 3%.

We at Polytrade enable lenders to deposit their stablecoins into a lender pool with an assurance of an unmatched level of transparency and security. From there, the funds are used to finance real-world assets that are secured by receivables and insured by the likes of AIG, Mercury, and Coface. Each receivable is tokenized and transparent for all to see on our website. At the time of writing, our current pool offers an APR of 11.13% which you can leverage to maximize the earning potential of your USDC.

Stablecoins for RWA Lending

Protocols bringing off-chain investments to DeFi, like Goldfinch and Polytrade are insulated from much of crypto’s volatility. This is due in part to connecting dependable stablecoins RWAs. Major real-world asset players like Goldfinch, Polytrade, Maple, Centrifudge, Credix and TrueFi use stablecoins such as USDC, DAI, wETH, TUSD.

According to data by rwz.xyz, USDC is the most commonly used stable coin and leads the race by 62 pool investments. DAI comes second with 22 pool investments and the rest of the pools use base currencies like wETH, USDT, TUSD and BUSD.

Below is data on the principal outstanding of leading RWA protocols vs stablecoins.

Why is Polytrade Using USDC?

USDC is backed by the US dollar. A dollar-backed stablecoin means that for every USDC created, there is $1 in a bank account supporting the stablecoin. USDC holders can transfer their USDC into dollars at any moment on exchanges such as Coinbase for free. While Ethereum is the most prominent blockchain, Circle has also launched USDC on Algorand, Solana, and Stellar.

There are many reasons why USDC stands out from other stablecoins. These are the same reasons why Polytrade has employed USDC in its lender operations.

The first is that Coinbase and Circle are viewed by the market as extremely cautious companies that strictly abide by the law.

Another reason USDC has become the fastest-growing stablecoin is that USDT has recently had trust concerns. Several prefer USDC to USDT due to USDT’s past backing concerns and lack of transparency with its banking partners.

Third, since its inception, the USDC reserve has been audited on an annual basis. The audit evaluates the reserve’s accuracy, completeness, and composition, as well as the internal controls over financial reporting that assure the accuracy of the financial statements.

The fourth reason is that the Circle has raised a total of $1.1B in funding over 12 rounds and its investors are some of the most trusted and biggest names in TradFi which include Alameda Research, BlackRock & Fidelity.

BNY Mellon, one of the oldest American banks and one of the first to embrace digital asset custody, serves as the “primary custodian” for USDC’s reserve assets. Fireblocks, an $8 billion startup that BNY Mellon invested in last March, powers BNY Mellon’s crypto custody technology.

Though some of these reasons makes USDC centralized, we chose to build on USDC first because of the above reasons.

The BUSD FUD

The US Securities and Exchange Commission (SEC) filed a wells notice to Paxos on February 13, stating that BUSD is an unregistered security. The New York Department of Financial Services (NYDFS) ordered Paxos to stop issuing BUSD on the same day. The reason? Well, as per Matrixport’s Markus Thielen $11 billion in BUSD was issued on the Ethereum network, but another $4.8 billion should have been issued on the Binance Smart Chain as well. The New York State Department of Financial Services (NYDFS) is worried that this $4.8 billion may not have been adequately collateralized.

Polytrade is monitoring the situation closely and has always focused on operating primarily with USDC. Though our hope is that the SEC sees stablecoins especially USDC as “stored value” under monetary transmission law instead of as a security.

What Does the Future Look Like?

With more than $113 billion coins already in circulation, the pros and cons of stablecoins may be debatable, but their rise isn’t. The question is what should be done about them, and who should be made responsible. Answers range from claiming that the present system is fine to speeding research into CBDCs to underlining that stablecoins may be a logical progression of the centuries-old blend of public and private money. For now, let regulatory frameworks define if and when the technology can deliver on its potential. One thing we can be sure of is that both CBDCs and stablecoins will be at the forefront of RWA growth.

Originally written on Polytrade’s blog.

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