What is the scenario for stablecoins when interest rates decrease?
High interest rates from traditional financial markets help create a good yield source for real yield-bearing stablecoins to develop in recent times. So what scenario will happen if interest rates decrease in the near future?
The role of stablecoins in the crypto economy
Considered potential, the crypto market always contains risks in terms of volatility, making barriers to entering the market for investors still limited. Therefore, stablecoins were born to solve the above problem with a guaranteed value equivalent to fiat currencies such as USD or EUR.
Currently, the capitalization of the top 5 stablecoins is more than 150 billion USD, surpassing a record level in 2022 (excluding UST). Among them, fiat-stablecoins such as USDC and USDT are accounting for more than 93% of the market share, followed by DAI (MakerDAO) and USDe (Ethena), respectively.
To achieve the above milestones, there have been many trials won and lost during the development of the stablecoin project team since its early years.
In the section below, let's look back at the history of formation and development of stablecoins with Coin98 Insights, and predict the upcoming directions of this segment.
Period 2014-2018: The birth of fiat-backed stablecoins
Tether with stablecoin USDT (2014) is considered a gateway to help connect outside money flows into the crypto market. With the fiat-backed stablecoin model, each USDT issued will be backed by traditional assets of equivalent value. Along with the growth of the market in 2017, the amount of USDT issued increased from 10 million USD to more than 2 billion USD, creating a premise for stablecoins such as USDC, TUSD, Gemini dollar to enter the market in 2018. .
During this period, stablecoins serve as a means of payment such as "casino chips" that allow investors to conveniently convert between cryptocurrencies and fiat. Besides, stablecoins are also considered as safe havens. Safety helps minimize risks when the market fluctuates strongly.
Period 2019-2021: the birth of crypto-backed stablecoins
Along with the development of the DeFi market, stablecoin design models are also designed to allow users to increase efficiency through leveraging DeFi stack layers. Prominent among them is MakerDAO - a lending protocol that allows users to mint DAI stablecoins by over-collateralizing crypto assets.
DAI's capitalization quickly reached 9% of the stablecoin market share in January 2022 due to its widespread use in the DeFi space with few regulatory barriers. Besides DAI, some prominent crypto-backed stablecoins during that period included MIM (Abracadabra), LUSD (Liquidity) and sUSD (Synthetix).
Later, the Collateral Debt Protocol (CDP) model was also utilized by protocols such as Aave with stablecoin GHO or Curve with stablecoin crvUSD to create network effect as well as increase profit margins. This strategy is also utilized by LSD Protocols such as Lybra (eUSD) or Raft (R) to optimize the amount of ETH staked for the DeFi layer. However, this trend is not really growing strongly due to the risk-on psychology of the market as well as incentives from DeFi cooling down in the bear market context.
2021-2022: The rise and fall of the Algorithmic stablecoin model
Realizing the limitations in optimizing capital resources of the overcollaterized stablecoin model, stablecoin algorithms were quickly developed, bringing a new breeze to the market. Prominent among them is UST - an algorithmic stablecoin designed with a value equivalent to 1 USD through adjusting the supply and demand (mint/burn) of the $LUNA token.
At its peak, UST's circulating supply reached more than 18 billion - becoming the 3rd largest stablecoin in the market after USDT and USDC. The main reason is the ~20% yield source for UST lending on Anchor - a lending protocol built on Terra blockchain.
The collapse of UST and LUNA was swift in May 2022 when a large number of wallets withdrew UST from Anchor and swapped it to other stablecoins on Curve and Binance. This sudden bankrun reduced the liquidity and value of UST across the market, thereby setting the stage for one of the largest collapses in the crypto market.
In just one week from May 8 to May 14, 2022, more than 60 billion USD from the market was evaporated by LUNA-USDT. The above collapse has somewhat reduced user confidence in algorithmic stablecoins as the capitalization of this group has decreased from more than 20 billion USD to just over 1 billion USD at the present time. Market share dropped suddenly from more than 10% to just 1% after the collapse of UST.
Period 2023-2024: Stablecoin with more sustainable development directions
Throughout the period 2021-2023, the crypto market in general and the stablecoin sector in particular have been somewhat affected by collapses from UST (May 2022), FTX (November 2022) to SBV bank ( March 2023).
Looking at the fiat-backed stablecoin segment, Tether and USDT are currently the biggest beneficiaries with capitalization parameters and market share increasing over time. In turn, competitors such as BUSD and USDC gradually lost their positions after two legal-related events in 2023.
Besides, an important factor that makes the capitalization of fiat-backed groups gain the trust of the market is the stability in terms of volatility. Looking at USDC and USDT, exchange rate stability contributes significantly to both accounting for more than 90% of the current stablecoin market share.
Regarding the crypto-backed stablecoin segment, the market share of the algorithmic stablecoin group has almost completely disappeared with only FRAX still operating with a cooled capitalization (From 2.5 billion USD supply to only 350 million). In contrast, MakerDAO with stablecoin DAI still maintains its market share with more than 5 billion DAI in circulation.
It can be seen that events throughout 2021-2023 have somewhat affected stablecoin issuers, causing the wave to shift to more sustainable development trends instead of depending on the crypto market.
Real yield-bearing stablecoin
Since the beginning of 2022, the FED has increased the basic interest rate from 0% to more than 5.3%, leading to yields from other assets such as bonds. Compared to the yield source from the crypto market, the above yield source is currently higher and less risky (risk-free rate) because it is guaranteed by the US Government. This has fueled a new trend with stablecoins enjoying the above yield through holding interest-bearing assets such as T-bills, Bonds, certificates of deposit,...
In that trend, DAI is one of the first stablecoin projects to apply the yield sharing model from the traditional market through Dai Saving Rate (DSR). Currently, stablecoins such as USDY (Ondo Finance) or MUSD (Mountain Protocol) also allow investors to enjoy the above yield by holding stablecoins with low legal barriers. Besides, the sustainable yield source is also utilized by stablecoin USDe (Ethena) through funding fees from the delta-hedging strategy for Ethereum.
Apply stablecoin to payment
Another sustainable development trend that has also emerged in the past period is the application of stablecoins in the Web2 market, especially the Payment segment. In the previous period, stablecoins were mainly applied in the Web2 market in cross-border payments due to the efficiency of blockchain technology (low cost, transparency and 24/7 operation).
At the current stage, as the legal framework gradually improves after the spot Bitcoin ETF was approved, big players are starting to expand the stablecoin pie beyond the Web3 border. H2 2023 witnessed the participation of two giants including First Digital (FDUSD) and Paypal (PYUSD).
In 2024, giant USDC - with the support of Coinbase, teamed up with Stripe and Visa in applying stablecoins to payments. On the contrary, Tether and USDT are shifting market share to countries with high inflation such as Argentina or Turkey, becoming a store-of-value asset as well as a means of payment (medium of exchange). ).
What is the future development direction for stablecoins?
The US Treasury yield-bearing trend has begun to develop since 2023, stemming from the Web3 project's need to own a yield source outside the traditional market. However, in the next 1-2 years when the FED lowers interest rates, will the above trend still continue?
First, the fiat-backed stablecoin project team such as USDC or USDT must always ensure that the released stablecoin is always pegged 1:1 with cash-equivalent assets. Reduced interest rates will partly affect the profit margins of the above stablecoin companies/projects. The next development direction may be to expand market share and increase revenue. For yield-sharing stablecoins such as DAI or USDY, a certain proportion of low-risk assets must always be present to ensure liquidity such as portfolio diversification.
Therefore, the trend and demand for tokenized Treasury products will always remain to reduce risks for projects within the Web3 market.
When interest rates fall, assets with higher risk such as corporate bonds, stocks, real estate, etc. will partly recover. Treasurys in Web3 will see this opportunity with the need for diversification as well as profit growth in a changing macro context.
At that time, tokenization projects like Centrifuge or Goldfinch will have to compete directly for market share with giants like BlackRocks, Vaneck or JPMorgan in distributing products on onchain. As the on-chain tokenization market proves to be more efficient than traditional asset distribution methods, it is entirely feasible for a large portion of ETFs to be posted on-chain.
Stablecoins apply as the foundation for new financial systems
The increasingly crypto-friendly legal trend is opening the door for applications of blockchain technology to come to life, especially stablecoins. When stablecoins are used as fiat currencies, applications built on top such as credit or asset management can be developed to create an on-chain financial system.
This trend will start from within the crypto market - which is considered a sandbox for new ideas. Currently, stablecoin USDY has been applied to the DeFi stack. Then, this trend will take place in developing countries with crypto-friendly legal frameworks such as Singapore or Hong Kong, and finally in the US. However, the stablecoin pie will only go to 1-2 large companies with a clear legal framework.
Conclusion
Initially, stablecoins were seen as “casino chips” that helped convert value in the crypto market. Subsequently, the development of DeFi accelerated the trend of crypto-backed stablecoins with improved capital efficiency. However, when the market enters a difficult period in terms of capital resources, some models show shortcomings.
The market is once again shifting towards more sustainable development strategies with yield-bearing stablecoins and stablecoin adoption beyond the Web3 market. In the future, when escrow mechanisms demonstrate stress testing capabilities as well as improved legal frameworks, stablecoins can serve as a premise for an on-chain financial system.
