Stablecoins: A Tipping Point of DeFi’s Mass Adoption

Stablecoins: A Tipping Point of DeFi’s Mass Adoption

Since the summer of 2020, the DeFi landscape has seen tremendous growth, with pundits terming it as a pivotal moment in the history of finance.

Indeed, the growth was unlike any other in the world of finance as the sector speedily grew 10 times larger, with a total value locked across the entire sector moving from a value under $1 billion to a peak of nearly $250 billion.

Most of the growth was fuelled by the lucrative yields that can be accrued from lending, staking, and liquidity mining protocols that now flood the entire sector. Another tailwind contributing to the growth of DeFi is the growth of DeFi’s derivatives market and the settling of futures contracts in stablecoins. Stablecoins provide investors a cushion against the volatile price swings of crypto assets. This has led to increasing demand albeit impending risks of using stablecoin.

How DeFi Protocols Operate

While several DeFi ready blockchains exist, Ethereum is still the leading platform for the development of decentralized applications and boasts of settling over $11.6 trillion in transaction volume throughout 2021. This presents a challenge to the DeFi sector given Ethereum’s struggles with volatility and lack of scalability.

As the pioneer of programable blockchains, Ethereum facilitates smart contracts which are irreversible, self-executing contracts written in computer code on a decentralized blockchain network.
Ethereum’s smart contracts are at the heart of the entire DeFi revolution and their open-source and permissionless nature enables decentralized applications to remove intermediaries and third parties from financial processes.

For instance, yield farming protocols which are the hottest trend in DeFi, are built to mimic traditional savings accounts where crypto holders can lock their assets in a smart contract that generates the highest yields possible.

Other DeFi applications that heavily rely on smart contracts include decentralized exchanges built with automated market makers such as Uniswap. Others include borrowing and lending protocols, trustless prediction markets, decentralized insurance policies, and yield farming aggregators. .

Stablecoin and Their Role in DeFi

With the growth of DeFi, stablecoins have increasingly played a pivotal role in the sector’s mass adoption. Given the volatility of cryptocurrencies, stablecoins have offered investors a means of generating yields on their crypto assets on various DeFi protocols without incurring the risks of a volatile market.

For example, an investor placing their ETH into a liquidity mining protocol has to face the risk of impermanent loss and price slippage should be the price of ETH drop. This can offset most, if not all, of the yields earned, thus leaving the investor in losses. With a stablecoin, however, the same investor can be cushioned from ETH’s volatility as they can lock a stablecoin such as USDT or USDC whose value is pegged to the US dollar.

By simply digitizing their fiat money into stablecoins, investors and crypto enthusiasts can access above-average yields on DeFi markets with minimal risks.

The utility of stablecoins on DeFi platforms has brought about mass adoption to an extent where reports have shown stablecoin’s monetary base across DeFi surpassing $65 billion in the first quarter of 2021 alone. What’s more, the accelerating pace of stablecoin adoption has led to a whopping $1 trillion in transaction volume being facilitated by stablecoins leading to one of the biggest growth rates of stablecoins so far.

Stablecoin Challenges

However, it is not all rainbow and sunshine in the DeFi industry. The growth of adoption in DeFi protocols and the increasing demand for US-based stablecoin have sparked the attention of regulators, who now highlight the risks stablecoins might pose to the global financial market.

A report from U.S President Joe Biden’s Working Group on Financial Market in conjunction with other US government agencies, highlighted the need to introduce new legislation for stablecoin issuers to be regulated in the same way as traditional banks.

While these developments could lead to regulatory clarity over cryptocurrencies and the DeFi space in general, it is also likely that hash regulatory measures could be introduced, leading to the stifling of innovation across the entire DeFi sector.