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Digital Derivatives WeeklyJune 6, 2020

Digital Derivatives - The Rise of USDT and DeFi

Jitender Tokas
Chief Business Officer
June 6, 2020
What's in this post?

    Digital Derivatives is a weekly newsletter bringing you the latest research, information and analytics from the cryptocurrency derivatives space brought to you by Delta Exchange.

    For last week’s edition, click here.


    Derivatives Insights

    USDT Supply Untethered

    On May 24th 2020, Tether’s USDT overtook XRP as the 3rd most valuable cryptocurrency by market cap. With a network value of $9.2 billion, Tether has grown immensely over the previous 6 months, growing by 474.99% since November 2019. With this move, Tether has cemented its position as the most dominant stablecoin in the digital asset space.

    Stablecoins are blockchain-based digital currencies with their values pegged to fiat currencies, possessing the dual benefits of blockchain digitalisation and fiat stability. These fiat-pegs are maintained in a number of ways; in the case of USDT, with physical dollar backing. In May 2020, the total aggregate supply of stablecoins surpassed $11 billion, from $4 billion in June 2019, as a testament to the growing popularity of these assets.

    In addition to this, Tether (USDT) has recently cemented its position as the 3rd most valuable cryptocurrency by market capitalisation, accounting for 85.60% of the stablecoin market cap.

    USDT Supply Growth 2017-2020

    Stablecoins have risen significantly in prominence over the last two years as the financial infrastructure surrounding Bitcoin has matured. According to data provided by Token Analyst, on-chain activity pertaining to stablecoins has similarly risen by over 800% over the previous 12 months, largely through the growth of USDT.

    There are a number of reasons for this. First of all, USDT seamlessly combines the benefits of blockchain technology with fiat currency, effectively delivering a high-speed crypto dollar. Second of all, it represents a highly flexible and accessible alternative to a USD bank account for traders around the world for whom this may be extremely difficult to obtain. Lastly, USDT functions around the clock, 24/7, unconstrained by geographical borders and bank office hours.

    The growth in stablecoin adoption has wildly overshadowed the growth of its counterparts – Bitcoin and Ethereum – which have yet to reach the highs made in December 2017.

    With stablecoins acting as an integral part of the digital asset trading space for multiple years, this now begs the question – why the sudden explosion in growth?

    Growth in Arbitrage Opportunities

    One explanation is that arbitrage traders are behind the growth in stablecoin adoption. As the market rate of stablecoins, primarily USDT, deviates from its $1 peg, arbitrageurs can capture this premium for profit.

    • When traders turn bearish, they may sell their BTC for USDT.
    • The spike in USDT demand causes it to trade at a slight premium to USD across exchanges.
    • This creates an incentive for arbitrage traders to create/issue USDT and capture the premium. As USDT is issued at a rate of 1 USDT = 1 USD, traders can create USDT at a price of $1, to then sell for $(1+premium) for a risk-free return.

    As traders exit BTC and other digital assets, they are becoming increasingly likely to hedge in USDT, as opposed to USD due to the accessibility and liquidity benefits. As this occurs, the USDT premium rises and arbitrage opportunities grow, leading to a growth in the issuance/supply of USDT.

    USDT 5.66% premium on March 12th

    This argument is further strengthened by the growth in the USDT premium of March 13th following the crash of Bitcoin. As Bitcoin crashed and traders flocked to Tether, the price of USDT rose from $1.0032 to $1.06 – a gain of 5.66%. This premium was arbed away over the course of 12 hours. With a guarantee of 1-to-1 redemption, these arbitrage opportunities become extremely attractive.

    Growth of USDT Derivative Pairs

    The surge in Tether’s supply furthermore comes from the growth in popularity for USDT-denominated derivative trading pairs. Over the course of the past two years, BTC and ETH has increasingly been traded against USDT, as opposed to its fiat counterpart (or BTC). This marks a significant switch in the trading infrastructure surrounding digital assets.

    Bitcoin derivative trading is also now heavily taking place against USDT, with USDT-denominated pairs quickly becoming the industry standard. In these cases, margin and collateral is often kept in Tether, requiring more traders to hold Tether and thus increasing the demand. Across derivatives exchanges including Binance, Delta, Bitfinex and OKEx, the supply of USDT has risen accordingly.

    Growth of DeFi

    DeFi is the nickname given to financial smart contracts and money protocols built on the Ethereum network. These are distributed, transparent and interoperable financial systems largely built around ETH, DAI and USDT. Tether launched USDT on Ethereum in January 2018 and has quickly overtaken its OMNI counterpart to take up 58.43% of the Tether supply.

    A significant use case of this is the growth of USDT-based DeFi lending opportunities allowing traders to earn a positive yield on their USDT. This erases the relative opportunity cost of holding USD versus USDT (interest rates) and further facilitates the adoption of USDT and other Ethereum-based stablecoins. USDt currently averages a 6.37% APY interest rate across DeFi products. In comparison, the standard US bank savings rate currently sits at 0.01%.

    Value of ETH locked in DeFi products (total: 3.44m ETH / 832.48m USD

    DeFi products have grown tremendously over the past 2 years and 3.10% of circulating ETH is currently locked in such products; despite this, it’s still a relatively insignificant driver of USDT issuances.

    Impact on Bitcoin Price – Bullish or Bearish?

    The impact of stablecoin supply on the price of Bitcoin has been heavily contested, with numerous opposing theories populating the space. According to the theory presented above, the growth in USDT supply is a sell-side phenomenon whereby traders liquidate their BTC holdings for Tether, driving up supply of the stablecoin. This is fundamentally bearish as it is the result of BTC liquidations.

    The arbitrage opportunities presented by the Tether premium is similarly bearish on the price of Bitcoin, as USDT arbitrage trading becomes a more attractive use of resources.

    Another perspective is that the supply of USDT leads the Bitcoin price, driving major moves of the previous few years. This is exemplified by the last 3 major price moves of BTC which were preceded by major fluctuations in the supply of USDT. According to this theory, Bitcoin is in for a major move following the recent explosion in supply of Tether.

    USDT issuances versus BTC price

    Richard Lyons and Ganesh Visawanath-Natraj, of UC Berkeley and Warwick Business School, recently released a report titled “Stable Coins Don’t Inflate Crypto Markets” which discredited this theory however, finding no clear trend between the issuance of USDT and the price developments of Bitcoin, Ethereum or associated assets in the weeks following a stablecoin issuance.

    On the contrary, they found that Bitcoin tended to trend lower immediately following the issuance of fresh USDT.

    However, the growth of Tether has been indicative of the growth of the digital asset ecosystem as a whole. A growth in the active supply of USDT represents a net inflow of fiat into the cryptocurrency space – a portion of which goes towards Bitcoin and the ecosystem as a whole – and this is ultimately a positive.

    Bitcoin Breaches $10k Target

    On June 2nd Bitcoin breached $10,000 for the first time since February 12th, 2020, sparking over $120m worth of buy liquidations in the process. Just 8 hours later, Bitcoin fell back down to $9500, erasing its gains of the previous few hours. This led to over $96m worth of liquidations just 12 hours later. In total, over $220m worth of liquidations took place over the 24 hours of June 2nd, marking a hectic start to the new month.

    Whilst an impressive week for Bitcoin, complementary assets have similarly performed very strongly. Ethereum is up +16% in the last 7 days, with Cardano (+53%), Tezos (+12%) and Stellar (23%) performing strongly too. Of the top 50 cryptocurrencies by market capitalisations, only 4 are in the red over the last 7 days. Of the top 100 cryptocurrencies, only 19 are down over the previous 7 days.

    Despite all of this, BTC futures are still trading at a premium to spot prices suggesting bullish sentiment for the underlying asset and surrounding infrastructure.


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