Exploring DeFi Stability

Key Insights:

• DeFi ecosystems are generally constrained by the amount of available stables.
• Ethereum TVL hit roughly twice the level of on-chain stables while Polygon and Avalanche saw higher multiples of five and six.
• The stablecoin supply seems to be a constraint factor for DeFi ecosystems.
• Stablecoin balances in DEX pools tend to be overweight stables prior to downside market volatility.

Everything in the world is a system. Whether the system is mechanical, political, or economic, each has certain properties that drive and constrain the system. DeFi is no exception. User counts are constrained by the underlying chain’s transaction throughput. DEX slippage is constrained by the liquidity deposited. Loans are constrained by the available deposits and so on. All systems have their underlying forces which dictate just how far the pendulum can swing in one direction or the other. At the most underlying layer, which forces constrain DeFi?

For many current DeFi protocols, liquidity or the amount of funds available is one of the chief constraints. However, not all liquidity is created equal. For example, a DEX with millions of a rarely traded token is significantly less valuable than a DEX with liquidity of highly traded tokens such as ETH and stablecoins. Stables, in particular, are a universal constraint across various ecosystems. Users overwhelmingly favor loans in stables and DEX pools containing stables. This is because stable assets are more familiar to users and thus have high natural demand in DeFi. Consequently, this high relative demand is what makes stables a constraint variable for DeFi. Without sufficient stable liquidity, DeFi adoption can only go so far.