25. September 2021

Ethereum economy to be dominated by stablecoins

Not ether, but dollars: Dollar tokens are becoming more prevalent in the Ethereum ecosystem. That makes Ethereum easier to grab – and might not be such a bad thing. At least if done right.

Ethereum is living up to its claim to be the home of tokens

EthereumEver since the dominant stablecoin, the infamous Tether Dollar (USDT), migrated from Bitcoin to Ethereum, it has begun to capture more and more value transactions on Ethereum. Meanwhile, there has been “flipping” – more value is being transferred on Ethereum through stablecoins than through native Ether tokens. Every token serves a different purpose, with some of them you can even gamble in online casinos [1].

A few tweets from Ryan Watkins illustrate the changing ratios through two charts. In early 2019, Ether was still absolutely dominant, accounting for a good 90 percent of the roughly $2 billion transferred via Ethereum. This trend began to reverse in mid-2019, when Tether switched to Ethereum, while at the same time the total volume steadily increased and has now reached just under five billion dollars, even rising to more than 10 billion by the end of 2019. In the process, the absolute value of Ether transactions, which now stands at just over one billion, is falling, while stablecoins are accounting for the remaining value.

In addition to the tether dollar – which accounts for about 70-80 percent of stablecoin volume – circle dollars (USDC), pax dollars (PAX) and dai dollars also contribute to the strength of stablecoins. This also highlights the differences between the stablecoins: while the tether dollars are mainly used for transactions between exchanges – and, reportedly, for the gray market between Russia and China – the circle dollars seem to enjoy a high popularity on the now numerous decentralized or DApp exchanges on Ethereum. The Dai dollar, on the other hand, is considered the basis of a burgeoning landscape of DeFis (Decentralized Finance), where it serves primarily as the base currency for decentralized loans. Thus, the Maker-DAO – which is behind the Dai-Dollar – remains by far the leading force in the vibrant DeFis ecosystem, which, with a current capitalization of $900 million, is about to break the $1 billion threshold.

Such “flipping” of stablecoins is delicate and rather worrisome under most circumstances. The security of a blockchain rests on the fact that there are strong economic incentives for miners to invest hashpower, or, as will be the case with Ethereum in the future, to act as stakers depositing the blockchain’s native currency. In both cases, the miner’s or staker’s return is based on the value of the native token, which is distributed to the miner or staker both through new tokens in the form of a block reward and through transaction fees. The higher the value of the native token, the more secure the network, and one may assume that the value of the token (also) depends on the degree to which it is used to transfer value.

A stablecoin in the form of a token

It is only as good as the network is secure – but at the same time sucks network resources without helping the security of the network. This is illustrated by a blockchain-neutral token like the Tether dollar, which lives simultaneously on Bitcoin, Ethereum, Tron, and now the Liquid sidechain: it inhabits the blockchain that serves it best without actually contributing anything to its security. If the blockchain fails – as Bitcoin did by charging too much – tethers can switch to another blockchain. Such stablecoins act a bit like parasites, taking resources from their host, then moving on to a new one once they’ve sucked it dry.

Of course, the entire ecosystem – and thus Bitcoin, Ethereum, and Tron – benefits from a strong and successful stablecoin like Tether. At least indirectly. Stablecoins create liquidity on exchanges, making it easier to move dollars and euros to buy Bitcoin or Ether, for example. Therefore, their impact on the bottom line should continue to be positive.

It is much more gratifying, however, to look at a stablecoin like the Dai dollar [2]. This is not created by a central – and in the case of Tether, moderately transparent – party holding dollars in a bank account, as Tether dollars are, but rather by a decentralized autonomous organization (DAO) maintaining parity with the dollar by freezing enough Ether in a smart contract to maintain value through buying and selling even when exchange rates are tumultuous. Not only is a stablecoin like the Dai dollar much more compatible with the ethos of decentralization that underlies all cryptocurrencies, but it is also completely transparent in its coverage.

Most importantly, the Dai-Dollar helps native Ether tokens retain their value – after all, they must be deposited in order to create Dai-Dollar. For every Dai-Dollar that exists – which is currently about 100 million – about $1.5 in Ether must be frozen into a smart contract. Just as the gold standard of its day, or the Bretton Woods Agreement after it, backed the value of paper money with deposited gold, giving value to gold itself, Dai dollars prop up the value of Ether tokens by taking them out of circulation. This mechanic leads to a scenario where the world pays in dollars, but Ether, as the true digital gold, could reach an astronomical price.

However, the share of Dai dollars in stablecoin value transfers on Ethereum is relatively small. The traditional stablecoins seem to be even more stable at the moment, mapping the dollar 1:1, while the Dai dollars like to oscillate between 96 and 103 cents; and while the liquidity and stability of the Dai dollars depends on hard-to-predict behavior of the participants in the technically non-trivial maker DAO, the other stablecoins have an instance that is central, but where one knows what to expect.

In some circumstances, the zkDai dollars created by the Aztec protocol could help decentralized stablecoins become more popular. As recently as Feb. 1, the Aztec team launched a “private network on Ethereum.” A software development kit (DSK) allows zkDai dollars to be integrated into DApps (decentralized applications). Aztec uses zero-knowledge proofs to bring Confidential Transactions to Ethereum. These types of transactions do not show the amount being sent; instead of it being in plain text on the blockchain, it is encrypted, but still validated through Zero-Knowledge-Proofs. These types of transactions are not possible on Bitcoin, but are also used by Monero and Blockstream’s Liquid sidechain. They significantly increase privacy and, together with mixing methods – such as CoinJoin, ring signatures or tornado.cash for Ethereum – are considered an element to achieve almost complete anonymity.

Further Information
[1] https://www.luckycoiner.com/bitcoin-casinos/
[2] https://www.coinbase.com/price/dai