The rise of new stablecoins was a defining story in the second half of 2018, but the reality is that exclusive discounts partly fueled their growth.

Dollar-backed stablecoins are generally supposed to be worth $1, whether it’s Gemini’s GUSD or Paxos’ PAX. But according to four sources with knowledge of these cryptocurrency exchanges, both stablecoin-issuers privately offered over-the-counter (OTC) trading desks up to a 1 percent discount if traders used these tokens in some fashion before redeeming them for USD.

“They were offering that as a sweetener for getting it kick-started with adoption,” an OTC trader, who asked to stay anonymous, told CoinDesk.

This is why GUSD and PAX activity surged in December 2018, both between OTC desks and on exchange platforms like Huobi and Binance, where several traders moved millions of dollars within a matter of days. According to CoinMarketCap, GUSD’s global market cap suddenly surged from roughly $87 million on December 17 to over $103 million the following day.

“A lot of the arbitrage opportunities were manufactured,” the OTC trader added.

Dorothy Chang, VP of Paxos’ marketing and communications department, told CoinDesk this incentive structure was only offered to a “handful of partners” for “less than two months” starting around late September. Perhaps fortuitously for Paxos, the first-ever U.S.-dollar-pegged stablecoin, Tether (USDT), temporarily lost parity in mid-October.

According to a report prepared for CoinDesk by the analytics firm Delphi Digital, USDT lost almost a third of its market share during this period, with GUSD eventually exceeding PAX with more than $140 million in transaction volume in January 2019.

The Delphi Digital report argued that “competitors are all fighting for the spot Tether will most likely eventually lose.”

With regards to PAX, Chang said the discount was “something we did when we were first introducing our product to the market,” adding that Paxos is increasing its redemption windows from once to twice a day and looking for more partnerships with enterprises across the space.

“We’ve been at above $100 million in daily transaction volume for the past three days and holding steady,” Chang said on Monday.

While Paxos has moved on, the markets may still witness ripple effects from these corporate incentive programs for months to come. GUSD, for example, saw a burst of trading activity and market valuation in January.

“The incentives that are issued by these entities often come with a lock-up period. Those may have expired,” said Jesse Proudman, CEO of the algorithmic trading platform Strix Leviathan. Proudman explained to CoinDesk that the discounted stablecoins can now be freely traded.

Game of coins

Once several stablecoins became available for less than or more than a dollar, whether based on incentive strategies or organic market fluctuations, the arbitrage games began.

According to a Paxos blog and reporting by The Block, several Huobi users tried to obfuscate their source of funds by opening dozens of accounts using other names in order to exceed Huobi’s daily USD redemption limit. Paxos told CoinDesk at least 10 accounts were closed in relation to this trend.

The frenzy arose because the PAX discount program coincided with the release of HUSD, which is essentially a pool of stablecoins offered by the Singapore-based exchange Huobi that allows traders to deposit one type and later withdraw another. Besides GUSD and PAX, the pool also supports Circle’s USDC and TrustToken’s TUSD.

According to Kelvy Ko, partner at crypto hedge fund Leotank Digital Trading, Huobi’s HUSD pool has made it much more convenient for traders to swap stablecoins and leverage arbitrage without actually trading them.

Indeed, around the same time that the stablecoin USDT oscillated and Huobi launched HUSD, PAX’s global market cap jumped from roughly $42 million to $79 million in a single day on October 23. Then in early December, Binance saw a plethora of multimillion-dollar PAX trades as traders struggled to find liquidity and arbitrage sources beyond the redeemer itself. (Paxos later told CoinDesk that “traders have never struggled to find liquidity in PAX markets.”) By the first week of 2019, Paxos told CoinDesk the company had redeemed $200 million worth of stablecoins so far.

Even so, there could be a long way to go until the regulator-approved stablecoins like PAX and GUSD catch up to USDT in terms of volume.

“Even though USDT is wash traded, it has the first mover advantage,” Ko said, referring to how some USDT users allegedly buy and sell the same financial instrument to create the artificial appearance of marketplace activity. Plus, this practice is hardly restricted to USDT and might currently be applied by some traders to other stablecoins as well.

“Even if USDT is in a legal grey area, it is hard for others to compete because some people want to avoid the regulators,” Ko added.

Gemini declined to comment on this specific incentive program or transaction volumes across global exchanges. According to the company’s blog and a recent regulation-friendly marketing campaign, Gemini seeks to distinguish itself from the competition by being “a compliance-centric company.”

When asked if incentive programs artificially inflated the respective coin’s market cap, Chang of Paxos said:

“That may have been true for some, but we have not been optimizing for market cap alone; it’s not meaningful by itself. What is meaningful is transaction volume. For us, the point of offering an incentive was to develop market depth.”

Windows of opportunity

One of the anonymous OTC traders CoinDesk spoke with said that stablecoin issuers were inspired to launch this short-lived campaign because there isn’t an organic demand for these assets.

“The banks and the other [crypto] OTC desks we work with are really incredibly flexible,” the trader said. “It’s much easier to do that [work with the bank] than to…get back these tokens that have a bunch of strings attached and also doesn’t pay any interest.”

On the other hand, Proudman of Strix Leviathan told CoinDesk his company uses PAX for large-scale trades on Binance – sans backroom discounts – because he prefers to hold a regulated asset that can be redeemed for dollars.

“We elect to not use the incentive strategies from any of the stablecoin companies,” Proudman said, adding his firm uses stablecoins for arbitrage related to bitcoin, ethereum and other trading pairs. “From a trader’s perspective, we find ourselves electing to use coins we are comfortable with over those that we are less comfortable with.”

However, since stablecoin issuers require a significant amount of know-your-customer information in order to redeem the tokens, the anonymous trader said OTC desks that participated in the rush may have revealed competitive information about their partners and trading volumes to the exchanges, namely Gemini and Paxos – an assessment that Paxos disputed following the publication of this report, arguing that such information is only used for compliance purposes and that it wouldn’t be used competitively by the exchange.

“These smaller desks can’t get banked at the places that allow instant U.S. dollar transfer, so they are willing to give up some of their privacy,” Proudman said.

The second anonymous trader agreed that this opportunity was especially appealing to OTC desks with liquidity challenges, often related to jurisdictional compliance. Because of that, he expects companies to continue issuing stablecoins, perhaps with more promotional discounts, in 2019.

“I think there is no clear winner yet, both in terms of traders and issuers,” he said.

According to Ko, the regulated stablecoin arbitrage opportunity closed after several weeks because “once the short-term interests [were] achieved, they don’t need to keep the aggressive promotional rebates.”

Plus, a Huobi Global representative told CoinDesk that the exchange added the daily withdrawal limits during the timeframe of this incident.

For PAX traders in particular, the limits are now $20,000 for verified accounts and $1,000 for unverified users. The arbitrage rush may have impacted Huobi’s coffers, with three Huobi wallets holding roughly 78 percent of all GUSD in circulation. Gemini declined to comment on why that might be.

Moving forward, the Huobi Global representative said the exchange plans to “dynamically develop HUSD over the course of 2019” in order to improve the user experience and prevent misuse of the system.

Wolfie Zhao contributed reporting

Game of Thrones image via Shutterstock

UPDATE: This report has been corrected to reflect that several Huobi users sought to obfuscate their source of funds to get around Huobi’s daily USD redemption limit, not Paxos’. This article has also been updated with further comment from Paxos.