Stablecoin Supply Overview

At just $1, day in and day out, stablecoins (“stables”) don’t strike the everyday user as materially important. Neither does the idea that the collective sum of all these stables could be so essential, so foundational to the entire ecosystem in which the user operates.

For the single user, stables are just a way to transact in the familiar dollar. Dollars become the base unit by which all the user’s activity is measured. When a token is bought, it is often bought with dollars or stables. While holding the token, its price is meticulously checked in dollar terms. Yields, the user, are seen in dollar terms. And, when the token is subsequently sold, it is often for stables as the dollar remains the chief unit of account.

To the single user, stables are just stables - vast, plentiful, and largely an afterthought. But, seen from the perspective of all DeFi users, stables take on a different light - one that puts them front and center in terms of importance.

When all users behave and operate with dollar denomination, then the simple total supply of stables serves as a growth constraint for the market value of the crypto ecosystem. Consider for a moment what it means for the ecosystem to grow; it means the market cap of the ecosystem token grows (such as ETH), and consequently, it means TVL in DeFi also grows. Since TVL is largely made up of ETH, Ethereum application tokens, and stables, TVL expansion means the prices of existing tokens are going up and/or new tokens are being launched. As prices go up across the board, AMM pools require more and more stables in order to balance the price curve (in a token-stable pool, when the token price goes up, it is bought and removed from the pool and replaced with the purchasing stables). Unless the stablecoin supply expands in proportion, free-flowing stables become more scarce.

Scarcity of stables, coupled with high demand for leverage during price appreciation periods, leads to high borrowing rates. At which point, with the stablecoin supply constrained relative to the market value of the system (TVL) and the high cost of capital, it becomes too expensive to fund continued price appreciation.

Once this begins to happen, the process unwinds as the risk-reward for providing stablecoin liquidity to safer positions, such as money markets and stable AMM pools, outweighs buying, holding, and LP-ing of market-valued tokens. Without cheap stables to balance AMM pools, purchase demand dries up, and profit-taking ensues. Of course, this usually results in sharp price corrections, as both the relative stablecoin liquidity is low and many holders are in large profit positions.

To illustrate this relationship played out at a high level, let’s look at Ethereum price and TVL compared to the on-chain stablecoin supply.