Using Curve Pools to Gauge Stablecoin Sentiment

By Conor Ryder, CFA and Riyad Carey

When it comes to stablecoin swaps, Curve Finance dominates. Launching a few months before DeFi summer, it has consistently been the arena in which stablecoins compete. As the crypto industry considers the fallout of sanctions on Tornado Cash — namely Circle (issuer of USDC) blacklisting Ethereum addresses — this role is more important than ever.

Can DeFi achieve its lofty goals while relying on two centralized stablecoins: USDT and USDC? And, if not, are there any decentralized stablecoins that can take their place? As we’ll demonstrate below, decentralized stablecoins took a hit in May 2022 with the collapse of UST, and it remains to be seen whether they will recover. Curve pools can be used as a gauge for investor sentiment towards stables and we will go through some of the most popular Curve pools to get a sense of which stablecoins are most popular among investors and which could potentially be the next weak spot for crypto.

The Current State of Stables

Year to date, over 75% of volume on Uniswap V2 and V3 and over 60% of volume on Curve V1 has involved a centralized stablecoin. USDC-USDT volume alone was over 22% of volume on Curve V1. The core value proposition of decentralized finance is to disintermediate the control that centralized institutions have on financial services. But that becomes complicated when centralized stablecoin issuers have the ability to blacklist users and the reliance on centralized stables is something DeFi will have to address to create a truly new financial system.

Looking closer at potentially the most systemically important liquidity pool in DeFi, the 3pool, we observed a trend that was mirrored in almost every Curve pool we examined — a sharp fall in Total Value Locked (TVL) within the pool in the last few months. TVL in the 3pool dropped from as high as $3.3bn on May 1, before the Terra collapse and the contagion crisis of the summer, to as low as $1bn earlier this week.

As one of Curve’s largest and most important pools, the 3pool can be used as a proxy for the rest of Curve’s liquidity pools. However, when looking at the asset balance within the pool, the 3pool breaks a trend we’re seeing across other pools on Curve. The 3pool is actually becoming more balanced, with an asset breakdown of 38% USDT, 31% USDC and 31% DAI as of late August. That weighting has moved from 24% USDT, 37% USDC and 39% DAI on the 1st of May.

The fear around stablecoin depegging led the pool to become significantly overweight Tether in July as USDT made up around 63% of the pool. Investors flocked to DAI and USDC due to their perceived safety relative to USDT. That fear has since come and gone as the pool is more evenly weighted now, which is a good sign for the health of the 3pool and the assets within. However, unlike TVL, this isn’t a trend we’ve observed across the majority of Curve pools, some of which have become more unbalanced as of late as we’re seeing some interesting dynamics play out when it comes to stablecoin pools.

FRAX

FRAX has one of the largest Curve pools by TVL; the only pools larger are stETH+ETH and the 3pool. This is despite a significant decrease in TVL since May 1, 2022. Around that time, FRAX was also added to the short-lived 4pool, composed of USDC, USDT, UST, and FRAX. Since May, the percentage makeup of the pool has remained relatively stable, with FRAX making up about 60% of the pool in May and about 58% now.

FRAX is unique in that its goal is to move from a fully collateralized stablecoin to an increasingly algorithmic stablecoin. However, ever since October 2021, and especially since UST’s crash in May 2022, the collateral ratio has increased. Additionally, using FRAX’s own decentralization ratio metric, the stablecoin’s backing has consistently become more centralized since October 2021.

At this point in time FRAX can essentially be thought of as DAI with some added complexity. It is simply too reliant on centralized stablecoins at the moment to provide a robust alternative. However, it has proven to be resilient relative to other DeFi-native stablecoins in terms of keeping its peg.

sUSD

sUSD is the stablecoin designed for use in the Synthetix ecosystem. Users can stake SNX to mint sUSD and must burn sUSD to receive their staked SNX. Its Curve pool is the only pool we examined that did not experience a sustained and significant drop in TVL following the UST collapse. The pool has come closer to balance too, moving from sUSD making up about 50% in May to about 33% now.

The pool’s composition and market cap, which has remained relatively stable at the $100mn range all year, suggest that this stablecoin has consistent demand. However, it appears that Synthetix’ ambitions for sUSD do not extend far beyond use on its various trading venues and thus it cannot be considered as a possible USDC/USDT replacement.

LUSD

Liquidity USD has the simplest mechanism and can fairly be called the most decentralized of the stablecoins covered here. Users borrow LUSD by depositing Ether on a variety of front ends (there is no official front end); it has no governance. This simplicity makes it nearly impossible to censor or sanction, which makes it an appealing option in the face of a variety of options that have some reliance on USDC or USDT. The low weight of LUSD in its pool since this summer suggests that there has been sustained demand for the stablecoin on Curve.

LUSD’s simplicity has also been reflected in limited uptake and a shaky peg. Unlike some other stablecoins on this list, there is no associated governance token that gives holders a financial incentive to support and spread the word about the project. Additionally, it has consistently traded at a premium to $1 since mid-June. However, the pool facilitates much more volume relative to its size than other pools, which is reflected in APY. According to Curve, the average liquidity provider APY in the past year for the LUSD pool was 1.16% while FRAX was 0.58%. This also reflects perceived stability and safety, as liquidity providers are more willing to have exposure to FRAX despite its pool’s lower yield.

MIM

MIM has probably the most interesting story of any of the stablecoins covered in this article, which has been well documented here. To borrow MIM on Abracadabra, users can deposit a wide variety of tokens, including xSUSHI, ALCX, SHIB, FTT, USDT, USDC, and wBTC. This would appear to allow for greater decentralization, though many of the collateral assets are tied to centralized tokens such as FTT (37%) and centralized stablecoins such as USDC (14%).

However, while MIM’s mechanism seems to work relatively well, it has not regained the trust that it lost in January 2022 when the revelations covered in the article above emerged. This is reflected in its Curve pool, which was heavily imbalanced in the days leading up to Terra’s collapse and has since shrunk significantly while remaining imbalanced.

USDN

USDN is the dollar-pegged stablecoin on the Waves blockchain that maintains its peg via an algorithmic mechanism that is backed by the Waves token. You’d be forgiven for thinking this sounds very similar to the mechanisms underlying the Terra ecosystem which infamously collapsed in May. USDN has “similar mechanics” to Terra according to the Waves founder, “but is different,” he said, citing restrictions on how many redemptions users can get in one day. Whether or not those restrictions are effective enough to prevent a death spiral remains to be seen. The stablecoin has depegged several times this year, moving as low as $0.74 during May.

The lack of confidence in USDN’s peg is mirrored in the Curve pool for the stablecoin, of which 68% of the $24mn of TVL is in USDN. This has in fact become less imbalanced than it was in July when the imbalance was 84% USDN, as investors were still assessing the fallout from the Terra collapse and contemplating the future of algorithmic stablecoins. Since July, USDN has mostly managed to maintain its peg in what has been its most stable few months yet. However, we saw the Terra collapse begin with a heavily imbalanced Curve pool for the stablecoin UST and the 68% weighting for USDN certainly raises some valid concerns.

Conclusion

Curve’s role in DeFi and the wider crypto ecosystem was made apparent this summer as many of the biggest stories, such as Terra collapsing and stETH depegging, were related to Curve. DeFi’s reliance on centralized stablecoins has been laid bare, and the Curve pools of decentralized competitors suggest that none are ready to dethrone USDC and USDT. Terra and UST’s collapse was a severe setback for the decentralized stablecoin space, and gave many investors a healthy skepticism regarding stablecoins. If and when the time comes that a decentralized stablecoin is up to the task of replacing USDC and USDT, Curve will be one of the first places that this will become clear.