What are they?
Let's break it down simply:
Stable - the digital asset is pegged to another asset.
Coins - the asset is a digital version of physical assets we know so well like gold or dollars.
Stablecoins are a type of cryptocurrency. They are typically run by a centralized entity that maintains the peg of the digital asset to the reserves. As an example, for a stablecoin backed by the U.S. dollar, you give the entity $1, and in turn they give you 1 of the tokens. The dollar and token are pegged 1:1, so they are exchangeable for equal values at any given point.
Read on for use cases, earning yield, and some specific examples.
How are they used?
Stablecoins were the first big use case of Decentralized Finance. The cryptocurrencies have become investing tools serving a variety of purposes including borrowing, lending, and execution in smart contracts.
Bitcoin and Ethereum's volatility make it difficult to use the assets for daily transactions. That's where stabelcoins come in. Stablecoins attempt to provide stability by backing the digital tokens with a reserve asset, such as the U.S. dollar or gold.
The most basic utility of a stablecoin is to provide a digital asset suitable for everyday use that maintains its purchasing power. In addition to reducing volatility, these coins offer instant processing, privacy of payment, and high yield:
No bank account is needed to hold stablecoins, and they can be sent anywhere around the globe for only a small fee compared to bank wires. This is particularly beneficial to countries with volatile currencies.
Stablecoins offer interest rates higher than what most banks offer, allowing investors to earn more yield.
Some examples of stablecoins.
Tether
Tether (USDT) is a fiat-collateralized stablecoin backed by the U.S. dollar founded in October 2014. It currently sits atop the list of stablecoins by market cap. For Tether, the U.S. dollar is held as collateral for each digital token that is issued. Tether has minted more than $60 billion worth of coins, acting as a smooth interface between the dollar and crypto ecosystems. Other stablecoins pegged to USD are Coinbase's USD Coin (USDC) and Binance USD (BUSD). The total market cap of dollar-pegged stablecoins exceeds $100 billion, up 300% YTD.
Controversy has arisen in the last couple months around Tether. The NY Attorney General investigated losses the company sustained as well as the company's claims that every token is 100% backed by dollars. As part of Tether's settlement agreement, they publish an ongoing reserve breakdown of assets. In the most recent report, over 75% of reserves were cash or equivalents, and all assets were accounted for. See resources below for an exhaustive Tether history.
DAI
MakerDAO's DAI token falls into a different category: decentralized, crypto-collateralized stablecoins. DAI is a completely decentralized protocol run on the Ethereum blockchain, so there is no controlling company. As such, DAI is pegged to the U.S. dollar but instead of holding cash reserves, uses collateralized debt denominated in ether. The supply of DAI is maintained using smart contracts designed to make dynamic changes based on the market price of the collateral assets. These types of stablecoins are often over-collateralized to prepare for black swan events. Other decentralized stablecoins include Liquidity USD (LUSD), and Fei Protocol (FEI).
terraUSD
terraUSD falls into a third category of stablecoin: no-collateral or small-collateral. These stablecoins have no reserves. Instead they use a working mechanism to maintain a stable price. The terraUSD coin operates on incentives, offering discounts when there's excess supply. Alternatively, frax employs the incentive structure with a layer of collateral in reserve. There are 315 million frax tokens circulating.
Takeaways
Stablecoins offer opportunities to trade, borrow, or lend digital money without a bank.
Most stablecoins are backed with a reserve asset, which comes with positives and negatives depending on use case.
The stablecoin ecosystem continues to evolve to crypto-backed and unbacked tokens.
Resources:
Market cap of dollar-pegged stablecoins.
Tether's reserve breakdown.
Deep dive into some problems with stablecoins.
➡️ About FirstWatch Crypto ⬅️
FirstWatch Crypto was started by Dan McGlinn (@DigitalDanMcG)and John "Blaize" Hrabrick (@blaizebitcoin) who have been investing in the space for a combined 8 years. FirstWatch Crypto is on a mission to simplify the crypto investment landscape.