Stablecoins - what are they?
Jul 15, 2022
Amidst the chaos and volatility of the free crypto markets, cryptocurrencies have been built to replicate the relative stability of FIAT currencies. The value of such digital currencies are pegged to central government currencies with most major currencies being pegged to the US Dollar.
Stablecoins are intended to act as a safe hedge for investors to limit their exposure during times of heavy volatility. Major stable digital currencies are often also used to structure financial instruments and derivatives for crypto tokens and assets. These stable currencies are designed to maintain their value by backing each token with assets or by virtue of an algorithm that maintains the relative valuation by constantly calibrating the stablecoin supply available for use. Asset-backed stablecoins can be of two types - backed by FIAT or backed by other crypto assets. Algorithmic stablecoins are still conceptual and a mass-adopted version of a decentralized algorithmic stablecoin is yet to be seen.
So what are the top stablecoins right now?
USDT or Tether is the largest stablecoin by market volume with ~USD 60bn of daily volume across exchanges. The project is created by a Hong Kong registered entity that also owns the exchange - BitFinex. The FIAT-backed coin has been alleged to misrepresent their available cash reserves for redemption and has paid heavy fines but continues to be the largest and most trusted stablecoin.
USDC or USD Coin is the subsequent market leader with ~USD 5bn of daily volume across exchanges. The project is managed by Centre - a consortium formed by Circle and Coinbase. The currency is deemed safely backed by FIAT through monthly attestations by Grant Thornton.
BUSD or Binance USD is an FIAT-backed stablecoin released by the leading crypto exchange - Binance in partnership with Paxos, an American fintech company. With average daily volumes of ~USD 5bn, BUSD token is approved and regulated by the New York State Department of Financial Services and audited monthly reports of their reserves are published on their website. BUSD has gained increased exposure from the growth of DeFi and other dApps on the Binance Smart Chain.
DAI is a unique asset-backed stablecoin that is backed by major cryptocurrencies like BTC and ETH and is run in a decentralized manner. The project is created by MakerDAO which is a decentralized organization formed by the Maker Project. The price is maintained by ensuring that minted DAI tokens are backed in excess by basket portfolios of cryptocurrencies. The protocol tends to back each DAI token with 150% of the USD value worth of ETH.
UST or US Terra is the notorious algorithmically backed stablecoin that uses a system of arbitrage between two digital assets to maintain the price of the stablecoin. The volatility of UST is absorbed by the speculative asset Luna, which in turn grows in value as the stablecoin is adopted more. When the pegged value drops, users are incentivized to burn UST and mint Luna which increases the implied scarcity of the stablecoin and causes an increase in UST back to the stable FIAT-peg while reducing the value of Luna tokens. Similarly, if UST value were to increase higher than the pegged value, users would be incentivized by the protocol to mint UST and burn Luna. UST faced explosive growth before having their algorithm broken by malicious market participants and the token completely losing its FIAT-peg, wiping out billions of dollars from the market overnight.
Recent events show us that while stablecoins are considered a safe hedge within the crypto markets, it still has the underlying risks of being a cryptocurrency itself. The relative safety and risk mitigation that stablecoins offer during times of market volatility has caused explosive adoption in the stablecoins despite cloudy asset reserve reporting practices. The trust in algorithmic stablecoins however has been broken irreparably with the collapse of Luna and UST and it is yet to be seen if a unique sustainable algorithm can maintain a stable valuation for a digital asset in practice.