Stablecoins have always been an important part of decentralised finance. It is arguable that without stablecoins, there would be no decentralised finance, at least in its current form. So it makes sense that future improvements on the core technology of stablecoins like USDC would directly affect the DeFi ecosystem.
What is USDC, and why would it have such a huge impact on the decentralised finance landscape?
What are Stablecoins?
A stablecoin is a type of cryptocurrency designed for price stability. It is immune to the highly volatile nature of the crypto market and stores value by tying its value to a real-world asset like the US Dollar or gold.
There are so many stablecoins that live on different blockchain networks, and many of them use different mechanisms to achieve price stability. Some of the most popular stablecoins are USDC, USDT, BUSD, and DAI.
USDC, short for USD Coin, is a type of stablecoin designed by Circle that pegs the value of each token to a dollar. Each USDC is backed by a dollar from Circle’s reserves.
Whenever a dollar is added to the reserve, a new USDC token is generated. When a USDC token is to be redeemed for fiat, the corresponding USDC token is burned. This way, the price of a USDC token always remains $1, at least in theory.
Although USDC has occasionally suffered from depeg events, it is, more often than not, for a short time frame before it returns to its pegged value.,
Introduction to the concept of DeFi
DeFi stands for Decentralised Finance. It refers to all the various routes taken by Web3 builders to introduce traditional finance services like lending, borrowing, and trading to the blockchain and Web3 ecosystem.
In DeFi, rather than being run by centralised entities like governments and banks, a decentralised, peer-to-peer model governed by open-source smart contracts is used. These smart contracts automatically execute specific functions when preprogrammed conditions are met.
The most popular DeFi platforms are Aave, Compound and Uniswap
The Role of USDC in the DeFi Ecosystem
As a result of its stability, USDC is used in many different aspects of DeFi. Some of these include:
- Collateral: USDC is used as reliable loan collateral in many DeFi lending and borrowing platforms, such as Aave and Compound, because it does not drop in value.
- Liquidity in Decentralised Exchanges: USDC, due to its stable nature, is usually used to provide liquidity for crypto trades in decentralised exchanges.
- Derivative Trading: With about $1 billion of USDC locked in various derivative protocols on the DeFi space, USDC is heavily used in trading derivatives linked to other assets like futures and options.
- Automated Market Makers: AMMs are protocols that let users trade cryptocurrency without traditional intermediaries. USDC brings its stability into AMM trading pairs for easy measure of value and to avoid sudden price fluctuations
Innovations in the DeFi Ecosystem
Web3 developers are constantly pushing the boundaries of what’s possible in DeFi. New solutions to the many problems that existed during the early days of decentralised finance are being solved. Here are some of the newest innovations in the DeFi ecosystem:
1. Cross-chain compatibility: Since the advent of the first blockchain network, Bitcoin, countless other networks have emerged, and interoperability between them has become a problem. This is now being solved with new protocols like Squid, which enables swaps between EVM-compatible chains like Ethereum, Polygon and BSC.
2. Flash Loans: Flash loans let Web3 users take loans without collateral, provided they repay in the same block. They are usually implemented via a smart contract that contains the logic to repay in the same block. The repayment mechanism is made possible largely by stablecoins like USDC.
3. ERC-4337 Account Abstraction: Basically, two types of Ethereum accounts exist; Externally Owned Accounts(EOAs) and Smart Contract Accounts. The ERC-4337 standard takes away the burden of managing private keys by allowing the use of smart contract wallets with custom logic, such as EOAs. This will make it possible to pay transaction fees with tokens other than ETH and enable account recovery without private keys.
4. Tokenised Ownership of Real World Assets: This makes fractional ownership of high-end assets possible. Assets like real estate and artwork are being tokenised to allow ordinary individuals to have virtual ownership of those assets.
Challenges Facing Stablecoins in DeFi
Although stablecoins, which play a major role in decentralised finance, have many advantages, they also face a few challenges:
1. Government Regulation: Unlike most cryptocurrencies, stablecoins like USDC don’t fluctuate in price and are backed by actual fiat currency in a one-to-one ratio. Because of this, some governments impose strict regulations on stablecoins to protect their local currency from devaluation.
2. Risk of Centralisation: While stablecoins are indeed cryptocurrencies and aim to provide a decentralised and transparent alternative to fiat, most of them are issued by centralised entities and can be controlled. This was demonstrated in 2020 when Circle froze $100,000 worth of USDC linked to an account following a request from law enforcement.
3. Unclear Pegging Mechanisms: Stablecoins are usually backed with real-world assets, most commonly the US Dollar or gold. However, the mechanism by which some stablecoins maintain their price stability can be unclear, as seen in the case of UST(TerraUSD). UST maintained its value via a complex mechanism involving its sister token (LUNA). After the LUNA crash, UST lost its peg, and billions of dollars were lost.
Frequently Asked Questions About The Future of USDC in DeFi
Is USDC truly stable?
Although USDC is backed by the dollar, it is still possible that it briefly loses its peg depending on regulatory market forces, as has been seen in past depeg events. However, compared to other cryptocurrency, it is very stable.
Will USDC replace fiat currencies?
While USDC is heavily used in decentralised finance, it is unlikely to replace fiat currencies—at least anytime soon. This is because strict regulations regulate stablecoin use to preserve the integrity of local currency.
How do I convert my USDC to cash?
You can easily convert USDC to cash by using cryptocurrency exchanges that offer payment in your local currency.
For users in Nigeria and Ghana, Breet delivers in Naira and Cedis. The basic steps are:
- Sign up on the Breet website.
- Complete your KYC.
- Note your USDC wallet address and the cryptocurrency network on Breet.
- Send your USDC tokens to your Breet USDC address.
- Request a withdrawal to your local bank account.
Is USDC different from USDT?
Yes. USDC and USDT are both stablecoins. However, they are issued by different entities. USDC by Circle and USDT by Tether.
What DeFi platforms support USDC?
Since stablecoins are an integral part of decentralised finance, USDC is one of the most popular stablecoins on the market. Every DeFi platform supports USDC.
Conclusion
Stablecoins like USDC and USDT hold the DeFi ecosystem together. They provide stability in an otherwise extremely volatile market. Use cases in lending, liquidity provision, and derivative trading demonstrate how important stablecoins have become to decentralised finance. Innovations like ERC-4337 and cross-chain compatibility, paired with the security of well-backed stablecoins like USDC, are pushing the limits of what is possible with DeFi.
While problems like heavy regulatory monitoring and centralisation risks exist, USDC’s resiliency and transparency position it for future expansion. The continued evolution of stablecoins will likely shape the future of DeFi, cementing their importance as the technology matures and advances.
