Dharma Markets Report #1: On the Trade-offs of Stablecoins
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|Jan 11, 2019|
2018 was the year of the stablecoin, or digital dollar. The Ethereum ecosystem now has a wide variety of digital assets that maintain a 1:1 peg with the U.S. dollar, enabling a host of new financial use cases like remittances, payroll, and ecommerce.
Stablecoins solve a pain point that has plagued crypto usability since the industry's inception, volatility. Not only can crypto-asset holders now access a stable medium of exchange in the most common global unit of account, but they can also take advantage of the increased transparency, accessibility, and programmability offered by open networks like Ethereum. Similarly, the fact that users can now get access to the stability of a particular asset without having to open up a bank account is massively overlooked.
The growth in the market capitalization of stablecoins clearly signifies market demand for a blockchain-powered stable currency.
Data includes USDC, TUSD, PAX, GUSD, and DAI
In order to better understand the “digital dollar” market, we divide existing assets into two camps: fiat tokens, which are assets backed 1:1 by fiat currency held in bank accounts, and stablecoins, trust-minimized stable crypto-assets. While both types maintain their value relative to the U.S. dollar, it’s important to understand how each asset is minted, what avenues accept the asset as payment, and who, if anyone, has the ability to change the rules of the system.
The most widely used and audited collateralized digital dollars include USDC, TrueUSD, Paxos, and Gemini Dollar, all of which are fiat tokens. You’ll notice that three of these assets were launched and are currently maintained by some of the largest crypto exchanges, giving them easy access to a liquid marketplace. Each asset is controlled by a regulated institution that holds dollars in reserve for every digital dollar they issue.
The most advantageous feature of fiat tokens is their liquidity. Given the fact that these assets have become linchpins in the business models of crypto financial service providers, exchanges have a strong incentive to create liquidity moats around their specific fiat token. As such, we’ve already seen Coinbase list new assets with the only trading pair being USDC. Similarly, Poloniex has run incentive campaigns for traders who trade against USDC pairs. It’s no surprise that the market cap of USDC in particular has gone parabolic recently.
Another reason fiat tokens can generate this type of liquidity is because they’re regulated. Exchanges have no problem listing assets so long as they’re able to comply with KYC/AML laws. While this regulation is attractive to many crypto funds that want off-chain recourse, this of course comes with a tradeoff: centralization. The institutions issuing fiat tokens have a lot of influence over how these assets are traded and who can send/receive them. For example, Centre reserves the right to blacklist certain ERC20 addresses, ensuring no USDC can be sent to and from an address.
On the other end of the stablecoin spectrum are trust-minimized stable assets, the main working example being DAI. In these systems, users can access a stable and decentralized crypto-asset by posting collateral in a different asset. In the case of DAI today, a user must supply 1.5x the value of their loan in ETH. There’s no central party that maintains this peg, rather the system is operated by a set of smart contracts and network keepers that perform key functions like monitoring collateral positions and voting on interest rates.
DAI, and MakerDAO more broadly, have undergone impressive growth amidst a 90%+ decline in the value of ETH. We can see that over the course of 2018, the total supply of Dai grew over 10x, from ~6m USD to ~70m USD.
The most advantageous features of trust-minimized stablecoins are their trustless design and censorship resistance guarantees. Unlike fiat tokens, there’s no central party that can deny a user service or seize their assets. This makes DAI particularly useful for citizens in developing countries that want access to a more stable store of value or for DeFi applications that leverage regulatory arbitrage like betting markets.
Of course, decentralization comes at a cost, the main trade offs being scalability and liquidity. As has been pointed out by the community, creating a closed loop arbitrage cycle for Dai is extremely difficult given the fact that the only way to access the asset is by posting 1.5 times more collateral. This means that demand for Dai is primarily driven by demand for loans rather than the underlying asset. Decreased demand for loans, as dictated by market volatility or an increased stability fee, will tighten liquidity and make accessing Dai more difficult for those who actually need it to store value.
The main takeaway here is that while stablecoins are proving to be one of the most important primitives in open finance, there won’t be a one-size fits all winner. Different needs beget different features, which always come with trade offs.
At the end of the day, creating a parallel financial system is about optionality, it’s about driving competition so costs come down and users can move between financial services fluidly. Both fiat tokens and trust-minimized stablecoins solve existing problems today. Crypto companies can now easily offer their employees payroll directly in fiat tokens, and financial institutions can seamlessly move in and out of assets without taking on the burden created by today’s financial plumbing. Similarly, anyone in the world can now access a stable store of value without the permission of a centralized party, all they need is an internet connection.
At Dharma, we’re extremely excited to see more stable forms of exchange further proliferate the market. We plan on supporting a variety of stablecoins in Dharma Lever to give investors of all types access to trustless margin lending.
ETH Locked in #DeFi: 1/07/2019 — 1/20/2019
The number of ETH locked in financial contracts has remained stagnant over the last two weeks. As can be seen by the charts below, DeFi protocols experienced weaker inflows except for Uniswap, which saw a mild uptick in the supply of their liquidity pools. Increased social exposure and new asset pairs are likely routing more ETH into Uniswap’s contracts. Also, Uniswap is the only avenue to exchange new asset types like reddit karma.
Looking a bit closer at Maker activity, there was a modest increased in locked up ETH on January 14th, 2018, with a new CDP collateralized by ~24,000 ETH. The most likely explanation was that an investor was looking to add leverage to their position after ETH fell from $125 USD to $116 USD.
The Ethereum community decided to delay the Constantinople Hard Fork after a vulnerability was uncovered by external auditing firm, ChainSecurity. They uncovered new avenues for re-entrancy attacks given the fact that EIP-1283 makes gas costs cheaper for SSTORE operations. A detailed overview of the vulnerability can be found here.
The Ethereum core developers gathered last Friday and decided the hard fork would take place sometime between the 26th and 28th of February.
Crypto-asset derivatives firm LedgerX announced the creation of its Bitcoin Volatility Index (LXVX), which will give investors and traders a new way to hedge their risk exposure. Similar CBOE’s popular volatility index ($VIX), LedgerX hopes its new product will serve as the ‘fear gauge’ for the broader crypto markets.
A South China Morning Post reported that Bitmain’s current co-CEO’s Jihan Wu and Micree Zhan are set to be replaced by Haicho Wang, the firm’s current director of product engineering. The executive change comes after a tumultuous following their attempt to navigate a public offering in the midst of a deep crypto winter.
Over 4,800 Spam CDPs were opened on MakerDAO without little indication as to what the creator was trying to accomplish. They were created soon after users started purchasing vanity CDPs like #420.
New Zealand exchange Cryptopia went offline last Tuesday after announcing publicly on Twitter that they suffered a security breach and loss of funds. While details about the attack remain unknown, it was discovered that over $2 million USD worth of ETH was sent from the Cryptopia wallet to an unknown address.
What Team Dharma is Reading
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