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Stablecoins are a new breed of cryptocurrencies backed by stable underlying assets such as fiat currency real-world assets or on-chain tokens. The approach allows stablecoins to combine the advantages of bitcoin, such as low fees, instant transactions, and complete anonymity, with price stability.
The global market cap of stablecoins recently surpassed a $100 billion market cap, representing approximately 5% of the overall crypto market capitalization of nearly $2 trillion. Furthermore, as per the latest report from Analytics Insights, the market-leading stablecoin Tether (USDT) recently hit a monthly trading volume of $2.3 trillion, which is about 95% higher than that of bitcoin.
Stablecoins present an escape from the wild volatility of the crypto market, as they are built on the blockchain and base their value on the US dollar or other stable assets. Therefore, these crypto-assets solve the price swing concerns that render BTC impractical for everyday commerce.
Some crypto advocates argue that stablecoins could be the best bet for empowering digital currency to scale into the mainstream financial world.
Types of Stablecoins in the Crypto Market Today
Based on their design and underlying assets, stablecoins can be classified into three major categories. Fiat-collateralized stablecoins are the most common and straightforward version. These stablecoins are issued by a third party and backed by a single fiat currency vault, essentially making them digital representations of legal tender.
Some stablecoins, such as the imminent Facebook-baked Diem, can be collateralized by a basket of several fiat currencies such as the Euro, Yen, and Pound. USDT and USDC are currently the leading fiat-collateralized stablecoins in circulation. Both coins are pegged to the US dollar.
Crypto-collateralized stablecoins are different in that they are backed by cryptocurrencies such as BTC or ETH rather than fiat currency. The market keeps this stablecoins over-collateralized at all times to guard against the volatility of the underlying crypto assets.
The third category is the non-collateralized stablecoin, which relies on algorithms to incentivize the market by increasing or reducing the circulating supply. The software can also burn tokens to maintain the peg. Those mechanisms help maintain the price stability of the stablecoin against the underlying currency, eliminating the need for collateral.
This article shall focus on crypto-collateralized stablecoins backed by a mix of other reserves of digital assets.
How Crypto-backed Stable Coins Work
Issuers of crypto-collateralized stablecoins avoid relying on government-issued tender by backing their coins by a basket of other cryptocurrencies (e.g., Ether). As a result, the stablecoin operators keep the stablecoins in an over-collateralized position, absorbing the extreme rate swings of the underlying digital assets and keeping the price coin stable.
For instance, crypto users must stake $200 worth of Ether into a smart contract to receive $100 worth of stablecoins. That means that the stablecoins are 200% collateralized, guaranteeing that their price will remain stable even if the underlying collateral’s value drops drastically.
Furthermore, issuers reduce the volatility of single collateral by distributing the risk amid multiple cryptocurrencies.
Pros and Cons
One of the pros of crypto-backed stablecoin is its adherence to the core value of decentralization. Unlike fiat-collateralized stablecoins like USDT issued by centralized commercial entities, this subset of stablecoins is free from intermediaries, making censorship-resistant and secure.
Each transaction is recorded on a public distributed ledger, allowing for unmatched accountability. Fiat-backed alternatives lack this quality, as they require trust from a centralized entity which may sometimes break the rules.
For instance, Tether backers linked to crypto exchange Bitfinix have been in legal trouble with US financial watchdogs for lying about the USD reserves backing their USDT offerings.
Another evident benefit of crypto-collateral stablecoins is the efficiency they offer to users due to their quick process of liquidation on-chain. The feature has made this set of coins vital for PayPal and other private sector companies seeking to transform digital payments.
The trustless nature of these coins also creates leverage for trading, which is appealing to decentralized finance (DeFi) users.
On the flip side, over-collateralized stablecoins have some drawbacks. Unlike fiat-backed stablecoins that only require holding 1:1 reserves in fiat currency, crypto-backed coins need to be over-collateralized, leading to inefficient collateral usage.
These stablecoins also have less stability than their fiat-backed counterparts, as the underlying crypto collateral is inherently prone to high volatility. There is also the risk of instant liquidation if the market value of the crypto collateral drops below a certain threshold.
The Most Popular Crypto-collateralized Stablecoins
Let us look at 4 of the most common stablecoins that use other cryptocurrencies to maintain a stable value.
MakerDAO/DAI is an ERC 20 token that uses Ethereum to keep a stable value while offering instant transactions and transparency. The Maker Protocol oversees the development and issuance of Dai.
Dai locks up an excess of the ETH tokens backing it up on smart contracts stored on a public blockchain, ensuring the price remains stable. Smart contracts, as well as the MKR governance token, help monitor the price stability of Dai. This approach also allows Dai to maintain trust among users and dodge the level of regulatory scrutiny that fiat-based cryptocurrencies like Tether face.
Since it launched in 2017, Dai has gained the most traction in the stablecoin world, enabling a wide range of blockchain-powered services such as supply chain, loans, and prediction markets.
Havven is a decentralized payment network that leverages the Ethereum mainnet and a unique pair of tokens. The “Havven” token serves as the fluctuating token that remains locked in a collateral pool, while “Nomin” or USD is the decentralized stablecoin always pegged at $1.
The project maintains user trust by guaranteeing that the amount of Nomin tokens in circulation is constantly backed up by enough Havven tokens locked using the platform’s escrow technology.
Synthetix started as a stablecoin project dubbed “Havven” that offered a native Havven Token (HAV). The project founders initially intended to build a decentralized payments network that leverages a dual token mechanism to issue a stablecoin (nUSD) backed by HAV tokens (now SNX).
The protocol has evolved into a crypto-collateralized network that offers the $sUSD stablecoin and facilitates over-collateralized on-chain synthetic assets representing real-world assets. In addition, Synthetix oracles track the price movement of these assets in the real world.
Reserve tokens ($RSV)
Reserve offers a flexible pool of hybrid-collateralized tokens that allow people in countries with hyperinflation to move their money into a stable currency. The platform’s native $RSV tokens are stable digital currencies backed by both crypto and fiat currencies. These stablecoins have a lot of utility, including cross-border remittances and payments.
Like Dai, the project utilizes a decentralized governance token ($RSR) to monitor and maintain the price stability of $RSV.
Stablecoins Launched on Other Blockchains
In recent years, many blockchain networks have opted to issue their own versions of market-leading stablecoins USDT and USDC.
Tron blockchain, headed by CEO Justin Sun, was the first to issue the dollar-pegged USDT stablecoin as a TRC20-USDT token in 2019. In addition, the Tron Foundation partnered with Tether to launch USDT as a native token on its blockchain, allowing users to easily transact with dApps and protocols based on the Tron network.
Tether reached a milestone this past May by issuing over 30 billion USDT on top of the Tron chain, surpassing the 27 billion USDT currently issued as ERC20 tokens. So far, the Justin Sun-led chain currently has four stablecoins in circulation, including TRC20-USDT, TRC20-USDJ TRC20- USDC, and TRC20-TUSD.
In February of last year, Tether launched USDT on Algorand, offering the PoS blockchain’s users a better transaction scale and fast settlement. A few months later, Algorand expanded support for USDC, a $25 billion stablecoin rapidly eating into Tether’s $63 billion market cap.
In June 2021, USDC administrator CENTRE revealed plans to issue its stablecoin on more networks, including Kava, Polkadot, and Tron, potentially surpassing the eight blockchain networks currently supporting USDT.
Per the latest news from the crypto world, stablecoin USDC will soon launch on Avalanche, a high-performance smart contacts chain.
Stablecoins hope to emerge as the new currency that powers a digital economy allowing anyone to bypass traditional financial firms and transact directly with their peers.
Crypto-collateralized stablecoins, in particular, have a unique advantage over their fiat-backed counterparts, as they offer more transparency and accountability. In addition, crypto-backed stablecoins also fully adhere to the principle of decentralization and are therefore resistant to interference from any centralized authority.