Bridging TradFi and DeFi: The opportunities of complaint stablecoins

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As crypto becomes more mainstream, regulatory issues become more significant. The recent update of the Crypto Assets Markets Regulation regarding stablecoins has led to a significant market boom. The new rules impose strict restrictions on the use of dollar-denominated stablecoins, which account for the majority of global trading volumes.

While MiCA primarily targets the intersection of crypto assets and traditional financial services, the implications for decentralized finance are more nuanced. By its nature, DeFi generally operates independently of the traditional financial system. However, people still need to be able to move their money between the two worlds in some way, and I believe that compatible stablecoins are the best gateway for this.

The regulatory shift has affected major players in the crypto space, such as stablecoin issuers Circle and Tether, forcing them to rethink their strategies. So what is the potential of compliant stablecoins in relation to the DeFi market? Let’s break it down.

The role of compatible stablecoins: Bridging TradFi and DeFi

TradFI and DeFi have long existed in parallel, and together they could offer unprecedented financial opportunities. However, bridging the two worlds is a challenging task. In this sense, compatible stablecoins have great potential to act as a bridge between them.

As regulations tighten, compliant stablecoins are expected to become major assets. In the European Union, for example, stablecoin users are already required to switch from unregulated to compliant (at least if they want to use them on centralized finance platforms, where the use of compliant assets is often strictly enforced).

Centralized stablecoins like Tether (USDT) and USD Coin (USDC) are at the forefront of this regulatory evolution. They are typically issued by entities that hold reserves in fiat currency, allowing them to offer stability and act as a gateway between the crypto world and traditional finance. However, because they primarily provide a financial service, they are subject to oversight and stricter transparency and consumer protection standards.

Compliance is critical to ensuring the legitimacy of these stablecoins and ensuring they integrate into the global financial ecosystem. As previously mentioned, Circle made a significant splash as the first global stablecoin issuer to fully comply with the new regulations. And it’s likely that more companies will follow suit in the near future.

Where do decentralized stablecoins stand?

It should be noted that decentralized counterparts of centralized stablecoins still exist that do not have a direct impact on centralized financial services. These stablecoins are usually governed by decentralized protocols and do not rely on a central issuer or fiat reserve.

Since they are not tied to the TradFi system, these stablecoins are not subject to regulations like MiCA. However, this also means they are less likely to integrate with traditional financial services, limiting their role in bridging the gap between TradFi and DeFi. For now, decentralized stablecoins remain a component of the DeFi ecosystem that provides liquidity without the need for centralized oversight.

However, I believe that centralized stablecoins will be the primary way in and out of the blockchain space and will need to be compliant to ensure legitimacy and broader integration into the global financial ecosystem. Eventually, as time goes on, I think all fungible stablecoins could follow this path due to their custodial nature.

Risk of increased stablecoin centralization

There are decentralized stablecoins that are trending towards more centralization. A notable example of this is MakerDAO’s recent announcement that one of the most popular decentralized stablecoins, Dai (DAI), is switching to the new USDS. This move has sparked a lot of discussion among the DeFi community, with many perceiving it as a shift towards a more centralized model.

Increased centralization often brings with it greater regulatory scrutiny and compliance requirements. This could limit the use of such stablecoins in the DeFi environment, as they become less attractive to users who value the decentralized nature of crypto assets. However, they could take over some of the business currently occupied by USDT and USDC.

Compliant stablecoins: The evolution of a controlled financial system

Compliant stablecoins have many advantages that make them the foundation of the future financial system. First and foremost, they can be used directly through banks and other financial institutions. This means that people can reliably bring their money outside of the crypto ecosystem and use it in their daily lives.

In addition, there are also yield opportunities for users. A large number of crypto users are interested in making profits, whether it be interest payments, staking rewards, or capital gains. And yield products based on compliant stablecoins will be regulated and ensure that the ways to make profits are legal and safe. Admittedly, decentralized stablecoins also offer yield sources that tend to be higher than what centralized stablecoins can offer. Whether they want their yields to be protected by human laws or mathematics is something users can choose for themselves based on their individual preferences and risk tolerance.

In addition, the question of whether a stablecoin is fully backed by fiat money will be eliminated. Compliance with transparency and security standards means that users have greater confidence in the stability of the coins. In contrast, fully decentralized stablecoins already offer full transparency on-chain, so users can verify the backing of the coins themselves. Again, the choice depends on which trust mechanisms a user finds more reliable: regulatory frameworks that support compliant stablecoins or the algorithmic transparency of decentralized ones.

Solution

To summarize, evolving regulation will play a major role in shaping the future of stablecoins and their ability to bridge TradFi and DeFi. The existence of compatible centralized stablecoins will help TradFi users interact with digital assets seamlessly and worry-free.

Meanwhile, decentralized stablecoins will remain largely separate from traditional financial systems and regulations, serving different needs in the DeFi ecosystem. However, this could change as the lines between centralization and decentralization blur.

Of course, it is quite difficult to predict the market’s course over the years. However, one thing is certain: compatible stablecoins will enable the combinability of TradFi and DeFi. I am confident that DeFi is the future of the entire financial system and compatible stablecoins will provide a more traditional and controlled way to transform it.

Michael Egorov

Michael Egorov is a physicist, entrepreneur, and crypto maximalist at the origins of DeFi creation. He is the founder of Curve Finance, a decentralized exchange designed for efficient and low-slippage trading of stablecoins. Since the founding of Curve Finance in 2020, Michael has independently developed all of his solutions and products. His extensive scientific experience in physics, software engineering, and cryptography helps him in product creation. Today, Curve Finance is one of the top three DeFi exchanges in terms of total funds locked in smart contracts.