Considering the Emergent Use Cases of Stablecoins
With the growing issuance and use of stablecoins, there has been increased attention within the industry on the exact application that such tokens are finding. Smith + Crown has previously commented on the use of Tether (USDT), USD Coin (USDC), and Dai (DAI). In this weekend’s dispatch, we turn to Ethereum-based Tether (USDT) specifically, as well as Paxos (PAX).
Applying their Data Cooperative tool, which applies statistical and behavioral modeling to on-chain data, Flipside discovered that the majority of ERC20 Tether is used for arbitrage purposes between three exchanges; Binance, Huobi, and Bitfinex. Additionally, they found that arbitrageurs, whether they be in-person or automated, are sending the USDT to their own wallets before sending it to a recipient exchange in order to set higher gas fees than exchange defaults, thereby capturing price differentials before others. When considering the significantly greater price volatility of ERC20 USDT relative to other popular stablecoins such as USDC and PAX, one can see the clear profit opportunity. What is less clear, however, is the cause of this discrepancy and whether arbitrage activity is purely responsive and not causal in any way. ERC20 USDT accounts for far more transaction activity by way of transfer counts than any other ERC20 token and, given that arbitrageurs are setting their own fees, the stablecoin is likely counting for a majority of gas consumption on Ethereum.
Separately, J.P Koning, an ex-equity researcher and columnist at CoinDesk, highlights how a large portion of PAX tokens are in the hands of a suspected Ponzi scheme, the MMM Blockchain Smart Contract (MMM BSC). Koning accounts that the scheme has $4 million worth of PAX in its own wallet, equivalent to 1.6% ever issued, making it the ninth-largest PAX holder. The author shows how MMM accounts for an even greater share of on-chain transfers, averaging 20% in per-day transfers over the prior month. In addressing what Paxos could consider doing in light of this activity, Koning raises the possibility of freezing the tokens themselves, while pointing out the difficulties of such action, such as to whom they would return the tokens. Ultimately, the author appears unpersuaded by any particular course of action but does suggest that Paxos could do more to counter fraudulent activity associated with its token.
In Smith + Crown’s view, both of these sources demonstrate the organic emergence of network usage and the utility of open, permissionless blockchain networks. While both case studies certainly indicate activity far from what many in the industry might hope for, they are also both market-driven, rather than mandated in any way, a value that the cryptoasset industry has largely championed. Beyond this, we believe these developments are useful in considering what should be considered ‘valid’ or ‘valuable’ usage. This is particularly true in the case of arbitrage, something which, on the face of it, may seem purely extractive and not contributing to the Ethereum ecosystem, but which theoretically helps induce price stability by deepening market liquidity. In the broadest sense, both of these examples illustrate a broadening and developing stablecoin and crypto ecosystem, where a fuller range of activities are emerging. Where we might have reservations, however, is what this activity means for other Ethereum applications. Whereas arbitrage is likely the domain of well-capitalized entities, whether institutional or retail, and characterized by large transaction volumes, other emergent applications, including those considered part of Web3, are typically characterized by lower-value transactions or contract executions. On a network where block or gas consumption is competitive, such as Ethereum, the continued rise of stablecoin arbitrage could price-out other user groups. While this problem could be solved through sharding on ETH 2.0 in the long-term and possibly second-layer networks in the medium-term, it does raise concerns as to the more immediate sustainability of activity beyond financial applications. The impact this ultimately has on Ethereum and its ecosystem, stablecoins, and perhaps even the range of alternative smart contract platforms that continue to emerge bears careful observation.