Investors must examine historical data to see how market dynamics may have altered in order to detect signs of fresh growth when the whole cryptocurrency market is down and there isn’t a sector-wide runup to be discovered. Due to their ability to withstand market fluctuations, stablecoins are the newest trend to emerge in the decentralized finance (DeFi) industry.
This is especially true given the fact that protocols that rely on dollar-pegged assets continue to provide token holders with low-risk yield opportunities even in volatile market conditions. This discrepancy between a decrease in the price of Ether (ETH) and the total value of the tokens locked in smart contracts may be evidence of stablecoins’ increasing importance.
Since its peak, the price of Ether has dropped by a factor of 20 percent more than the entire TVL of the DeFi industry combined. When one considers that the majority of the crypto market saw price drops comparable to those experienced by Ether in contrast to the fact that the DeFi TVL fell less in percentage terms than the price of Ether proves the stability provided by stablecoins.
Over the last year, the entire market capitalization of stablecoins has risen from less than $15 billion to more than $113 billion, driven by Tether (USDT) and USD Coin (USDC), delivering more liquidity to DeFi protocols.
In addition to being featured in a large proportion of the liquidity pool (LP) pairings accessible on DeFi platforms, the top stablecoins are each represented by a distinct token that users may deposit on protocols such as Aave to receive a dividend. As a consequence, they have emerged as a critical component of the rapidly evolving DeFi ecosystem.
When it comes to the reality of stablecoins, they have resulted in the creation of a particular subset of DeFi protocols that are focused on yield farming stablecoins and that offer investors with an easier way to generate a return while reducing risk.
Early in the DeFi frenzy, protocols drew new users and deposits by offering large yields, which were often paid out in the protocol’s native token.
But recently DeFi tokens have lost at least 75% of their value since their all-time highs, wiping out much of the profits that users believed they had made by staking and providing liquidity, and leaving nothing to show for the risks taken on these experimental platforms, according to statistics from Messari.
The use of smart contracts allows users to deposit funds into automatic, compounding stablecoin liquidity processes, reducing the stress associated with daily market fluctuations.
Stablecoins and Liquidity Pools
The value of the Decentralized Finance (DeFi) ecosystem has already crossed the $60 billion level. Today, liquidity pools are a critical component of the DeFi ecosystem.Many applications, including as AMMs, borrow-lend protocols, yield farming, synthetic assets, on-chain insurance, blockchain games, and a variety of others, depend on it to be successful. Liquidity pools are a game-changing innovation in the field of Decentralized Finance (DeFi), allowing traders to trade on Decentralized Exchanges (DEX) while also providing liquidity via the pooling of money that are locked in a smart contract.
The most common application of Liquidity Pools has been Automated Market Makers (AMMs). Each asset exchange allowed by the Uniswap smart contract results in a price modification. In essence, a Liquidity Pool is a market established by a single party on a decentralized exchange (for example, ETH/USDC) for a specific pair of assets. Once the Liquidity Pool is established, a liquidity provider determines the pool’s starting pricing and supply for both assets. This principle of equal supply of both assets applies to all additional liquidity providers ready to give liquidity to the pool.
Liquidity providers are compensated based on the quantity of liquidity they offer to the Liquidity Pool. When a deal is facilitated, the transaction fee is dispersed proportionally across all Liquidity Providers.
Liquidity Pools can be used in a variety of ways thanks to smart contracts. For example, the Consistent Market Maker algorithm ensures that a constant amount of liquidity is available at all times. The price of assets is defined by the number of tokens in the Liquidity Pool in relation to the total number of tokens. As an example, when you purchase ETH from the DAI/ETH pool, the quantity of ETH in the pool is decreased, but the supply of DAI is increased in proportion. This will result in an increase in the price of ETH while simultaneously decreasing the price of DAI.
Some smart contracts additionally reward liquidity providers with additional tokens via Liquidity Mining.
Uniswap, a DeFi protocol for exchanging cryptocurrencies, promotes the fundamentals of utilizing Liquidity Pools. Decentralized exchanges that are based on the concept of Liquidity Pools, on the other hand, differentiate themselves from one another based on the practical applications that they serve.
Coherently, the concept of Automated Market Makers (AMMs), for example, does not work well for assets with similar prices, such as stablecoins or wrapped tokens. Curve, an Ethereum-based cryptocurrency exchange and liquidity pool, has managed to offer cheaper costs and lower slippage when exchanging similarly valued assets by implementing a different algorithm.
Due to its emphasis on stablecoins, Curve enables investors to avoid more volatile crypto assets while still earning high interest rates via lending protocols. When compared to other AMM platforms, the Curve model is very secure due to the fact that it reduces volatility and speculation in favour of long-term stability. Liquidity pools on AMMs like Curve are continuously attempting to “buy cheap” and “sell high.”
The Curve asset, in contrast to the Uniswap or Balancer assets, does not make any effort to maintain the values held in distinct assets constantly equal or proportionate to one another (i.e., balanced).Curve may concentrate liquidity around the optimal price for comparable assets (in a 1:1 ratio) and supply liquidity where it is most needed. As a result, Curve can achieve substantially higher liquidity utilization with such assets than would otherwise be achievable.
Curve is an intriguing DEX because it is created for the exchange of stablecoins (DAI and USDC). Users and smart contracts can use this platform to trade stablecoins and earn interest from liquidity providers. Similar liquidity pools are also used in the Compound protocol (or Yearn.finance), where it provides additional incentives to liquidity providers. Because Curve’s liquidity pools are built up of stablecoins, investors can be confident that the exchange ratio will always be 1:1, which is why Curve has been able to provide some of the highest loan rates on the market, owing to its ability to aggregate returns throughout the whole lending ecosystem in order to discover the most profitable rates.
With the success of stablecoin in liquidity pools, we’re now beginning to see stablecoin that has yield-bearing properties baked in at the protocol level.
Stablecoins and the future of DeFi
Cryptocurrencies have long been heralded as the financial industry’s wave of the future, but it wasn’t until 2020 that they were able to fully fulfil an age-old concept: earning money via the use of money. It refers to a wide variety of blockchain-based apps intended to enhance cryptocurrency users’ earnings without depending on middlemen, earning passive yields similar to those earned from a savings account, Treasury bill, or Apple Inc. bond. DeFi may be the next step in the development of blockchain technology, allowing it to become more widely accepted. This is due to the simple concept of DeFi: fix the long-standing inefficiency in crypto finance of capital sitting idle at a nonzero opportunity cost.
The bulk of crypto investors now anticipate the currency’s value to increase in line with Bitcoin’s. In general, such approach has been shown to be successful in the past. As a result of the rapid increase in the value of cryptocurrencies, there was little need to be worried about a few percentage points gains here and there.
However, the current rise of stablecoins has totally transformed the course of DeFi. In 2021, the aggregate market cap of stablecoins like Terra and USDC has more than doubled. DeFi has now awakened a plethora of passive income options.
The allure of a lower-risk approach to cryptocurrency is evident, and it has the potential to broaden the pool of investors. To make digital currencies more useful, it is now possible to be compensated for holding them (even if there is no price appreciation). This gives digital currency real-world use and changes the narrative of an asset class whose main function was to be sold for a profit.
As a result, many DeFi protocols today may have the ability to surge and grow enough to compete with their centralized equivalents while remaining loyal to their decentralized foundations. Furthermore, with volatility removed and the prospect of more steady returns, institutional investors are increasingly considering crypto as part of their alternative investments.
Another trend emerging on new lending platforms is “yield farming,” or the pursuit of passive revenue via cryptocurrency. Users may now borrow and lend any cryptocurrency using an automated algorithm. Stablecoins have accelerated crypto yield farming. By removing risks and providing stability, Stablecoins have undoubtedly transformed DeFi.