What drives stablecoin issuance?
One of the main arguments of the stablecoins paper that Iñaki Aldasoro, Perry Mehrling and I put out at the end of last year is that, like other financial instruments, investment in stablecoins is driven by the search for arbitrage profits.
Stablecoin issuance rose through 2021, then peaked and fell during 2022 and 2023. In the paper, we measured the returns to holding stablecoins using lending rates in the Aave DeFi lending protocol. Aave is relatively conservative among DeFi protocols; accordingly it pays less than other protocols, so this spread should a lower bound to DeFi yields. When off-chain interest rates were zero, as they were until early 2022, one could borrow money for free, buy stablecoins, and lend them out at a positive rate using Aave or another protocol.
The profitability of the entire strategy can measured by the spread of Aave lending rates over SOFR, a key off-chain overnight rate. This graph captures the story. It is a version of Graph 3 in the paper, presented here using Soon Parted style:
A simple and compelling story emerges: investment in stablecoins grew while defi protocols offered high returns; when those returns turned negative, investment in stablecoins fell.
We finished the paper at the beginning of November. Since then, Aave lending rates have risen, so that the spread turned positive once again. As the graph shows, stablecoin issuance stopped declining and began to rise. This seems like a very nice out-of-sample confirmation.
Please do check out the paper for the full analysis.
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