Why the Most Untrusted USDT Can Dominate Stablecoins

Author: Conor Ryder, CFA

After all the events of 2023, Tether has become the dominant stablecoin despite being the least trusted. In this week's Deep Dive, we explore whether this proves that is not so important for cryptocurrency investors, and people seem to prefer the stability, liquidity and versatility of anchors.

Although USDT is the least trusted, it has become the dominant stablecoin.

USDC and DAI suffered a decoupling during the banking crisis, while BUSD had an expiry date due to regulation.

CEX and DEX volume shares show different stablecoin preferences.

Investors seem to value the stability, liquidity, and versatility of the USDT peg more than its opaque reporting.

The stablecoin market has undergone a sea change in 2023. At the start of the year, BUSD had an expiry date of 2024, the banking crisis in March hit USDC and DAI hard, and Binance chose TUSD as its stablecoin's preferred zero-fee BTC pair. All of these events have had a huge impact on the stablecoin market structure. BUSD is gradually phased out, USDC and DAI are decoupled after the banking crisis, and TUSD is on the rise. Amidst all of this, USDT has emerged as the most trusted stablecoin in the industry. This article will explore how the stablecoin market structure has evolved over the years, and dig deeper into how one of the most opaque companies in the industry was crowned stablecoin king.

Stablecoins have never been more important to the crypto industry than they are in 2023. With the demise of fiat gateways, stablecoins’ volume share has risen from 60% in 2022 to 76% now.

Strict regulation in the United States and the closure of fiat payment channels have made it more efficient to trade stablecoins on cryptocurrency exchanges. As a result, the dominant stablecoin now has more influence over the health of the market than ever before.

Stablecoin Landscape

A snapshot of stablecoin market capitalization helps us gain a more intuitive understanding of the ebb and flow of the stablecoin competitive landscape.

At the beginning of 2021, Tether is by far the largest stablecoin, more than 5 times larger than USDC, with BUSD and TUSD lagging behind. The bull market of 2021 saw a massive increase in stablecoin market capitalization as USDT increased almost 4x, USDC increased 10x, BUSD increased 14x due to the strong performance of Binance, and TUSD crossed the $1 billion mark.

In 2022, as the bear market develops, the stablecoin landscape changes again. Interestingly, USDC and BUSD’s market cap actually grew year-over-year, while Tether’s market cap lost over $12 billion due to the decoupling following the FTX crash. USDC’s peg remained impressively stable through the turbulent end of 2022, boosting its market share and, at the time, considered the safest and most transparent centralized stablecoin among cryptocurrencies.

However, that will all change in 2023, as the banking crisis causes USDC to trade significantly lower. This resulted in massive redemptions from Circle, resulting in a $14 billion loss in USDC market capitalization. BUSD was set an expiration date by Paxos, and its market value has shrunk by more than 66% this year, while TUSD's market value has been boosted by Binance's preferential treatment.

Volume share

Market cap highlights the dominance of stablecoins, but volume share is also worth looking at to see which stablecoins are leading the way in terms of volume. The notable difference between market capitalization and trading volume is TUSD, whose share of trading volume has increased dramatically from 0% two months ago to over 30% now.

The rise in TUSD and the fall in BUSD is a testament to Binance’s influence over the stablecoin market. It’s unclear why Binance crowned TUSD as their favorite stablecoin, but either way, TUSD was propelled to prominence. USDC trading volume on CEX dropped to almost zero, while USDD, another centralized stablecoin, had almost no trading volume on the exchanges covered.

DEX market share highlights a slightly different landscape, with some of the more interesting narratives highlighted:

DAI's fall from grace. DAI has always lacked direction. It's billed as a decentralized stablecoin, but it's in an ambiguous position due to its overreliance on USDC's reserves. Its share of DEX trading volume has thus been affected, dropping from its market leader position of 28% in 2021 to 2% now. DAI is slowly becoming irrelevant, and the market looks ripe for another decentralized stablecoin option. DAI’s USDC and USDT currency pairs also accounted for 11% of total trading volume in 2021, down from 5% today.

USDC's rise as a market leader has seen USDT's share of Defi transactions fall. In an interesting contrast to centralized exchanges, DEX traders tend to choose USDC as their trading stablecoin of choice, opting for more transparent stablecoins over stable-pegged stablecoins like USDT.

The difference in usage of USDC and USDT on CEXs and DEXs highlights two different types of investors. Traders on CEX may be less concerned about centralization risk and prefer to use USDT as their stablecoin of choice. This is despite the opaque reporting of Tether’s reserves backing USDT.

reserve

Tether reserves still include the other category at 3%, and we have no idea what assets are included in this category. What we can confirm is that in the first quarter, Tether achieved a profit of $1.48 billion, which is a staggering figure. Most attribute this return to the high interest rates on their U.S. government bonds. However, Tether's actual risk-free holdings, the profits Tether earns are actually equivalent to an annual interest rate of 7.9%, which is +3.15% higher than the risk-free rate, indicating that Tether's holdings bear an additional 3.15% risk.

Tether announced that it had accumulated $1.5 billion in BTC in the first quarter and promised to spend 15% of its net profits on buying BTC in the future. As of now, this gives BTC a 2% weighting in their holdings, and this number will gradually increase in the future.

Tether defended the move, saying it was simply using excess profits to buy BTC. However, Tether now has $12.5 billion (15% of reserves) invested in risky assets (bitcoin, gold, other and secured loans). This makes me cautious about future decisions to buy more BTC. I'm not sure why Tether can't park their excess profits in a more liquid money market fund that yields closer to 5%. The only explanation is that they wanted to increase the asset base that the US government cannot regulate. We can see that the USDC configuration is more liquid, has government support, and is objectively less risky.

**From a collateral standpoint, USDC has recently been affected by decisions about where to store cash. **USDT rises on the back of BTC purchases and other VCs. However, to be fair, there are 3 other reasons why USDT is currently leading the stablecoin race:

1) Hook Stability

While other stablecoins struggle, USDT and its peg remain strong. The rise of Tether shows that, for most stablecoin holders, peg stability is far more important than issuer transparency. USDT can proudly claim at least 6 months of peg stability, while most other stablecoins struggle to claim even 3 months.

The TUSD and BUSD pegs have come under some pressure lately, while DAI, billed as a more decentralized stablecoin, fell victim to over-reliance on USDC and was de-pegged from USDC in March.

Zooming out to 2023, it's clear why investors are favoring USDT, which is, in fact, trading at a premium as USDC depegged in March.

2) Liquidity

USDT is also by far the most liquid stablecoin on centralized exchanges, with 1% of top crypto tokens having a market depth of over $130 million compared to USDC's $18 million. Stablecoins dominate trading volumes as a result of greater liquidity, and Tether has been a big beneficiary of the exchange’s massive market depth.

3) Versatility

In terms of trading pairs, USDT offers traders the most trading options, mainly due to its large number of trading pairs on centralized exchanges. As of today, USDT is the quoted asset for 3,347 pairs on centralized exchanges, while BUSD accounts for 324 pairs and USDC accounts for 274 pairs. The reality is that holding USDT allows you to have greater flexibility in CEX transactions.

in conclusion

**Tether's defenders seem to be justifying the purchase of BTC as part of its reserves due to its excess profits. **But it ignores the big problem posed by the aforementioned reserves: ambiguity and risk. However, with a stable peg, greater liquidity, and greater flexibility for traders, USDT will continue to dominate the centralized stablecoin race. **The best hope for USDC to improve its competitiveness is to improve the peg stability, or Tether collapses, but the growth of USDC itself in the short term depends entirely on the US regulatory environment. **Regulatory uncertainty makes Tether a big winner in the crypto industry, something that should worry an industry that prides itself on transparency and accountability. By default, the least trusted stablecoin has become the most trusted stablecoin. **

DeFi actually runs on top of these two stablecoins, and it needs a better and more decentralized solution than DAI to protect itself from any potential issues with USDT or USDC. The problem is, after Terra, decentralized stablecoins have been relegated to the dark realm. Hopefully new stablecoins such as crvUSD, GHO, or others that have yet to be launched will provide investors with a decentralized and healthier solution to the murky world of centralized stablecoins.