The comeback of USDC, a victory for DeFi and compliance

This article is an original piece by Chain Catcher, authored by Hu Tao.

The battle for stablecoins has entered 2021, presenting a starkly different situation compared to previous years. USDT's position on exchanges remains solid, but its status in the DeFi market has been overtaken by USDC, with various data indicating that USDC has particularly won the favor of DeFi users.

At the same time, stablecoins have become not only tools for crypto users to reduce asset risk but are also emerging as important and compliant mediums for traditional financial market funds to enter the crypto and DeFi sectors.

Stablecoins have always been a focal point in the crypto market, playing a significant role in the decentralized cryptocurrency space with a relatively centralized mechanism, especially in trading and transfer scenarios on centralized exchanges, helping users reduce the volatility risk of their crypto assets and secure fixed returns.

The status of stablecoins has even been recognized by U.S. regulatory authorities. In January of this year, the Office of the Comptroller of the Currency (OCC) announced on its official website that it allows U.S. banks to use dollar stablecoins for payments and settlements. The document stated that banks could use stablecoins to facilitate customer payment transactions on independently verified networks, including the issuance of stablecoins and converting those stablecoins into fiat currency.

In the strong crypto market this year, the demand for stablecoins as primary settlement assets has surged, leading major stablecoin issuers to frequently increase their issuance. The total market capitalization of stablecoins has grown from $28 billion at the beginning of the year to $108.1 billion today.

In recent years, due to the high opacity of USDT's reserves, the market has been anticipating the emergence of new stablecoins to replace USDT's leading position and reduce potential market risks. Although compliant stablecoins like USDC, BUSD, PAX, and GUSD have challenged USDT in recent years, USDT still holds an absolute leading position on centralized exchanges due to user habits.

In May of this year, under regulatory pressure, USDT's issuer disclosed detailed reserve data for the first time since 2014. As of March 31, 2021, nearly 76% of Tether's reserves were in cash or cash equivalents, including commercial paper, trust deposits, and cash, while the remainder consisted of secured loans, bonds, and other investments, including Bitcoin.

The safety of USDT has been preliminarily ensured, but its position in the overall crypto market has changed. According to Messari data, the current total issuance of USDT is $64.3 billion, nearly tripling from the beginning of the year, accounting for about 58% of the total issuance of stablecoins. However, at the beginning of the year, this ratio was still as high as 75%, indicating that USDT's overall dominance in the stablecoin industry is declining, largely due to the explosive growth of the DeFi market.

Since the beginning of this year, an increasing number of emerging DeFi projects have appeared, especially in yield farming, DEX, and lending categories. To maintain high liquidity, they often launch liquidity mining activities for stablecoins, with annualized yields exceeding 50% frequently occurring. However, with the increase in hacking incidents and market downturns, these yields have mostly dropped to around 10%.

In the DeFi market, due to compliance and security considerations, most projects prefer to use ETH and USDC to establish trading pair liquidity pools. USDT no longer possesses the trading depth and liquidity similar to that of centralized exchanges, and users, due to the characteristics of the AMM mechanism, have greater choices. As a result, the more compliant USDC has become the preferred stablecoin for most DeFi users and project parties.

As of July 1, 18:30, the locked amount of USDC in the Uniswap liquidity pool was $3.34 billion, while the locked amount of USDT was $1.66 billion, with the former being more than twice the latter. In terms of trading volume, the trading volume of USDC trading pairs reached $6.02 billion, while the trading volume of USDT trading pairs was $1.85 billion, with the former being more than three times the latter, reflecting a more pronounced tendency for Uniswap users to trade with USDC.

In the Aave liquidity pool, which has the highest TVL, the deposit amount of USDC was $3.89 billion, and the borrowing amount was $2.77 billion, both being the highest assets on the platform, while the deposit amount of USDT was $0.95 billion, and the borrowing amount was $0.82 billion, indicating that USDC far outpaces USDT in both deposit and borrowing amounts.

These two data points reflect that USDC has become the most favored stablecoin asset among DeFi users and plays an irreplaceable role in DeFi ecosystem trading and lending activities.

From recent actions, USDC is no longer satisfied with its existing mediating role in the DeFi ecosystem but hopes to become the main channel for traditional financial market funds to enter the crypto and DeFi markets, challenging USDT from a higher dimension.

USDC has always emphasized compliance as its main concept, with its issuers Circle and Coinbase being highly regarded companies in the industry. Circle was the first company to obtain a BitLicense in New York, subsequently acquiring payment licenses in the UK and the EU, while Coinbase is the cryptocurrency exchange with the most regulatory licenses globally.

Because of this, along with the change in attitude from U.S. regulatory authorities this year, USDC has gained recognition from many traditional financial institutions, with a noticeable increase in use cases. In March of this year, Visa announced that it would allow the use of the stablecoin USDC to settle transactions on its payment network.

In May of this year, Circle also secured the highest single financing amount in crypto history—$440 million, with most investors being well-known venture capital firms and hedge funds from the traditional financial sector. Subsequently, Circle significantly accelerated its market promotion efforts for USDC towards financial institutions to build "a complete set of native payment and financial infrastructure for digital currencies."

In June of this year, Circle, Compound, and Coinbase successively launched USDC savings yield products, with yields around 4%. Among them, Circle partnered with Genesis, a lending platform under Grayscale, with returns coming from institutions willing to pay interest for additional capital; Compound's savings product yields are composed of lending returns and COMP mining returns; and Coinbase's savings product yields come from verified borrowers on the platform.

At the same time, Circle also launched a DeFi API, allowing institutional users to access various DeFi protocols through the API. "By using the DeFi API, businesses will be able to easily and quickly access DeFi protocols, where they can earn interest, governance tokens, and provide the same access to their customers." Circle stated.

Traditionally, U.S. bank savings account interest rates have long been at low levels, such as Bank of America's annual percentage yield (APY) for small deposits not exceeding 0.05%. Even for banks offering high savings rate accounts, their product APYs are usually around 0.60%.

Moreover, traditional financial users often face high barriers to entering the DeFi market, such as private key management and on-chain interactions, leading to increased management and regulatory costs. These difficulties also limit larger-scale funds from entering the DeFi market. The aforementioned institutions abstract these responsible operational processes, allowing users to simply transfer dollars into their accounts to enjoy an annualized yield of 4%.

It is foreseeable that a large amount of traditional financial market funds will flow into the crypto market, bringing more dollar liquidity into the DeFi market, becoming "the first institutional bridge to DeFi."

"This event will be something we look back on in a few years because it marks the institutionalization of DeFi, just as we reflect on the launch of Compound's COMP, which initiated the liquidity mining craze." said Anthony Sassano, founder of The Daily Gwei.

Driven by the demand in the DeFi market and traditional financial market, the supply of USDC has surged nearly 20 times since the beginning of this year, rising from $1.3 billion to $25.1 billion. In the coming months, USDC will also be issued on ten blockchain networks, including Avalanche, Celo, Flow, Hedera, Kava, Nervos, Polkadot, Stacks, Tezos, and Tron, to further amplify USDC's advantages in the on-chain DeFi market.

Currently, the market landscape for stablecoins in the crypto market has become increasingly clear, with USDT and USDC driving market development as dual cores. USDT, due to its compliance disadvantages, is content with the status quo, primarily serving trading and transfer scenarios on centralized exchanges, while USDC seeks to become the main medium connecting the traditional financial world and the crypto world, enhancing the adoption rate of cryptocurrencies by financial institutions and helping traditional funds enjoy DeFi services in a compliant and convenient manner.

Additionally, DAI and BUSD each have their specific application scenarios and positioning, such as DAI primarily serving the various needs of the DeFi native community, while BUSD maintains a solid position as the main stablecoin settlement asset on Binance exchange and the BSC chain, with other stablecoins existing more as market supplements.

As the crypto market matures, the role of stablecoins within it is becoming increasingly significant. Currently, USDC has emerged as a benchmark in this field, driving development, much like Coinbase, which, despite not having the highest trading volume, has still become the most influential exchange in the market due to its compliance.