Stablecoins: What Are They Used For?

General description

Stablecoins are one of the most practical use cases for blockchain technology. More than $150 billion of these digital dollars are in the hands of millions of people around the world. Proponents tout their use for real-world payments, but is that how they are used? This report examines the use cases for stablecoins, evaluates them using blockchain data, and analyzes the implications for the future of the economy.

Background

Stablecoins are tokens on the blockchain that are pegged 1:1 and can be redeemed for US dollars held by an issuer. The issuer typically holds its reserves in cash or investment grade securities, such as U.S. Treasury bonds. In other words, stablecoins are fully collateralized. Stablecoins are useful because they offer instant transfers, self-custody, and peer-to-peer payments, all powered by blockchain. However, they do not suffer from the volatility of cryptocurrencies like bitcoin.

The stablecoin market has grown to $150 billion from just $15 million in 2017. To put this in context, if all stablecoins were from a single issuer and that issuer bought US Treasuries, it would be among the top 20 sovereign nations by holdings of US Treasuries. The largest stablecoin issuers are Tether (USDT: 108 billion) and Circle (USDC: 31.5 billion), which combined have over 90% market share.

But what are all these stablecoins used for? The three most frequently cited use cases for stablecoins are as a medium of exchange, as a store of value, and as a trading asset.

As a medium of exchange, stablecoins are used for payments. This can range from paying for coffee to cross-border remittances and settling large transactions. People in developed countries like the US may find it difficult to see the problems with existing payment methods given the abundance of services like Apple Pay and Venmo, but in developing countries, people often lack access to Inexpensive payment methods that use the US dollar instead of less reliable currencies. Stablecoins are an attractive option.

As a store of value, stablecoins are often used as US dollar bank accounts in countries where people do not have easy access to US dollars and US dollar banking. The reasons for this lack of access could be capital controls, as in China or South Korea, high inflation as in Venezuela, or limitations of correspondent banks as in Nigeria.

As a trading asset, stablecoins serve several purposes. Within centralized exchanges like Coinbase, they are often used as common listed assets across all trading pairs. Within DeFi, they can be used to generate yield in new decentralized applications. They are often used for interest rate arbitrage between DeFi and the traditional financial system. For example, interest rates on decentralized lending protocols like Compound and Aave are currently approaching 20%. Smart traders can borrow at about 5% from traditional lenders, convert the borrowed USD into Stablecoins, and then lend the stablecoins into Compound or Aave for 20%, pocketing the difference. This can generate large inputs and outputs very quickly.

Key statistics

Data extracted from blockchain allows us to delve deeper into how stablecoins are used. Crypto-native financial advisory firm financial grill publishes a useful dashboard on where stablecoins are kept on the ethereum blockchain.

While it is impossible to know with certainty the intent of each holder, we assume that any asset used to seek yield or held on an exchange is used as a trading asset.

In Ethereum, 42% of stablecoins (25% of USDC and 48% of USDT) are carried out in centralized financial applications such as Coinbase or in smart contracts used for decentralized financial applications such as lending, decentralized exchanges, yield farms or used for MEV robots.

Most of the rest is held in individual wallets, which we then split into wallets that have and have not moved any stablecoins in the last month. We assume that those who have moved assets use stablecoins as a medium of exchange. We assume that those who have not moved assets use stablecoins as a store of value. Of course, there could be other reasons for the transfers or lack thereof, but we assume it because it reflects patterns of traditional economics. For example, money in savings accounts rarely moves, while physical cash in wallets tends to turn over quickly, with high money velocity. More questions reveal that 44% of these stablecoins are in inactive wallets for the last month and 56% are held in active wallets for the last month.

Savings also tend to be larger than coins. Since the year 200, the ratio of the M2 money supply to the M1 money supply implies that there is an average of 4 times more savings than US dollars in circulation.

The result is a simple breakdown of how stablecoins are used:

Perspectives and implications

This data helps approximate the use cases for stablecoins and sheds new light on popular narratives in the cryptocurrency market.

Experts often argue that stablecoins are primarily used as a medium of exchange, pointing to their overall high on-chain speed (1% per day) as evidence. But the data shows that the story is more multifaceted. In fact, one group of users circulates quickly, but there is another group that circulates at a slower pace, probably indicating varied use cases. In fact, 95% of wallets containing stablecoins have not sent any stablecoins in the last month. This implies that many people around the world use stablecoins to save in USD.

Other experts argue that stablecoins are overwhelmingly used for interest rate arbitrage between DeFi and CeFi. They point to the correlation between interest rates and stablecoin balances as evidence.

However, the data show that only 3% of stablecoins They are currently locked in DeFi applications. Although outstanding loans do not appear blocked in these contracts, the data shows 1.3 billion dollars has been borrowed from these applications, indicating that outstanding loans do not significantly change the analysis. Even in March 2022, before interest rates started rising, only $8 billion in stablecoins were locked in DeFi protocols. At the time, this represented only 5% of the total stablecoin supply. There are not enough stablecoins being used to chase yield to justify the conclusion that interest rate arbitrage drove the growth and decline of stablecoin balances during the last bull market.

Instead, it could be that the increase in stablecoin balances during the bull market was due to new blockchain users who were attracted by the bull market. When interest rates rose, the bubble burst, which in turn scared away some newly added users. This, in turn, would reduce stablecoin balances and create the aforementioned correlation. The data seems to support this explanation, because balances increased more through March 2022 than they decreased after CeFi interest rates rose. This is consistent with a large growth in the number of new users, some, but not all, of whom subsequently abandoned. The data may indicate that interest rates drive the capitalization of the cryptocurrency market as a whole, which in turn drives active users, which in turn drives stablecoin balances. Regardless, the evidence certainly does not show that most stablecoins are used for interest rate arbitrage.

Taken together, the data indicates that there are three strong and independent use cases for stablecoins. Only one is linked to the speculative sector of the cryptoeconomy. The other two use cases are "real world". This diversified set of use cases bodes well for the future of stablecoins in the economy.

Decision points

Market participants need to take stablecoins seriously without pigeonholing them into one thing. They have the function of commercial asset, payment method and store of value. Ignoring any of these roles would lead to misunderstanding the nature of stablecoins. For financial institutions, this could result in ignoring a potentially disruptive force and missing out on potentially lucrative opportunities to compete in the crypto economy. Most importantly, policymakers should regulate stablecoins with these multiple use cases in mind. Regulating stablecoin issuers as if they only do one thing would potentially impede the other use cases.