Stablecoins: The core pillar of Decentralized Finance.
The origin of Decentralized Finance (DeFi) can be traced back to 2015 when Ethereum was launched. Out of the blockchain network came a key development, smart contracts that eliminated intermediaries and birthed DeFi protocols.
Since then, according to DeFiLlama, DeFi’s total value locked stands at $42 billion with Ethereum remaining king of DeFi holding more than 58% of liquidity in the DeFi ecosystem.
The goal of DeFi
DeFi is an alternative financial instrument that leverages blockchain technology and uses cryptocurrency for transactions.
The goal of DeFi is to democratize financial access through peer-to-peer transactions to provide financial services such as lending, saving, investing, and insurance. DeFi does not require third parties to authorize transactions between two parties saving both time and money.
TradFi Vs DeFi
Compared to Traditional Finance (TradFi) where your digital assets are at the mercy of the banking institution, DeFi users have complete autonomy over their digital assets using their non-custodial wallets. DeFi offers its users full transparency and security of all their transactions. Data in the smart contract is immutable and auditable with all transactions occurring in real time.
A big challenge facing TradeFi is its high barriers to accessing financial services i.e opening a bank account, operating an account, and the cost of accessing financial services. DeFi is permissionless and inclusive in that anyone with a blockchain wallet address can access financial services, trade, and move their assets without having to pay banking fees.
DeFi products and services
DeFi products and services are familiar to TradFi as it offers an alternative financial solution for individuals and businesses and it’s powered by Decentralized apps (dapps) and protocols.
Dapps are software programs that allow users to interact with smart contracts making it easier to engage in transactions directly without the need to engage a central authority. Some of the popular dapps in the blockchain ecosystem include Pancakeswap, Uniswap, Opensea, MakerDao, Compound, and Axie Infinity among others.
Protocols are the rules that govern a blockchain network. Some of the major blockchain protocols used include hyperledger, multichain, Enterprise Ethereum, Corda, and Quorum.
From DeFi dapps and protocols, users can access financial services such as (lending, borrowing, saving, investing), Insurance, tokenization, Decentralized exchanges, yield farming, derivatives, liquidity mining, raising funds, and staking
How are stablecoins powering DeFi?
The DeFi ecosystem is sustained by two elements, blockchain protocols that enable access to these DeFi services and stablecoins that provide a stable store of value for users to transact and trade without exposure to cryptocurrency volatility. Here are 5 ways stablecoins are the backbone for DeFi
- Lending and borrowing
Stablecoins lending works when borrowers put up collateral on a lending platform giving them access to funds they desire and in return paying interest to the lender. Depositors of stablecoins on the lending platform can also borrow against their holding without the risk of their collateral losing value.
Stablecoins lending operates like traditional lending where the credit taken is repaid with interest within a specific time. What makes stablecoin lending stand out is mostly due to the low-interest rate, low transaction cost, and low entry barriers. Users can access these financial services based on their ability to produce collateral and no credit history.
An example of stablecoin DeFi is Aave, which offers a lending platform for Ethereum, polygon, Avalanche, and Abritrum among others and it offers stablecoins such as Dai, USDT, and USDC. Smart contracts facilitate lending and borrowing on the platform.
In the DeFi ecosystems, stablecoins provide a liquidity pool for decentralized exchanges(DEXs) and lending protocols. As of 2022, stablecoin made up 45% of liquidity in decentralized exchanges, and about half of this was provided by collateralized stablecoins.
Their demand is in the form of stablecoin to token swap- which helps users redeem the value of stablecoin and stablecoin to stablecoin swap- which helps users access a store of value all giving a distinct transfer of value while providing liquidity. Paired with other cryptocurrencies, these accumulated stablecoins and tokens can be used to swap against and facilitate lending, trading, and borrowing without exposing assets to market volatility.
3. Reliable store of value
With DeFi, price stability is crucial as it provides a predictable and reliable value for assets for transactions and investments. Stablecoins are designed to maintain a stable value making them less volatile than other cryptocurrencies. Stablecoins’ value reflects the actual value of fiat to a 1:1 ratio making them a reliable, consistent, and predictable store of value.
With stablecoins, investors are confident that once they deposit their funds in the platform they earn yields from it. Borrowers are also confident that they can repay their loans without the risk of price fluctuations that will risk the value of their collateral.
4. Offering yield
Stablecoin users can also earn a passive income through DeFi platforms. Users can make yield in the form of stablecoin by either interest-bearing accounts, staking, or liquidity provision.
The interest-bearing accounts operate similarly to bank accounts where users earn interest based on their deposits and the duration of their deposits. Interest gathered in these accounts varies based on the markets but is in the form of stablecoins
Staking is when users lock up their stablecoins for a period to support the operations of a blockchain network and in return, the users are rewarded in the form of more stablecoins or other cryptocurrencies.
Users can also earn from DeFi protocols by providing liquidity for the liquidity pool in exchange for a share of the trading fees made by the platform. This yield is in the form of stablecoins and can be significantly higher than traditional saving accounts.
Stablecoins such as USDC, and USDT has provided a bridge between traditional finance and DeFi. Users can quickly move their money in and out of the DeFi ecosystems with their value still retained.
Kotani Pay’s stablecoin settlement solution offers businesses a reliable bridge to this conversion from fiat to cryptocurrency very easily to access the benefits that come with DeFi. Users can also off-ramp their credit directly to their preferred local payment channel for real-world use.
Another bonus role of stablecoin is they enable cross-border payments.DeFi works by anonymity. This is to say that borrowers and lenders don’t have to know each another or trust one another. Smart contracts enforce this trust while stablecoins facilitate this trust by providing a transparent, secure, and immutable currency for peer-to-peer transactions. Users also save on cross-border transactions and enjoy real-time transactions across borders.
DeFi users are estimated to be at 4.8 million as of 2022. Despite so, this alternative financial service is still in its infancy stage and has a long way to go to achieve mass adoption. In a globalized world where currencies like the dollar are easing payment and transaction, stablecoins are proving to be a reliable and fundamental solution for DeFi access to those who need it most.
Learn more on how you can leverage Kotani Pay’s reliable on-ramp/off-ramp solution for your cross-border needs.