There are now a variety of different cryptocurrencies. An important class is the Stablecoins: cryptocurrencies with a stable value. Here, a bridge is created between cryptocurrencies and FIAT currencies. This combines the price stability of FIAT currencies with the advantages of cryptocurrencies, such as unlimited payment transactions or smart contracts.
This bridge is one of the most widely used applications in the crypto scene. Stablecoins have become an integral part of the ecosystem. However, very few people know that there are other Stablecoins in addition to Tether (USDT). In addition, there are also various ways and methods of keeping the value of a Stablecoin stable. We want to give you a small overview of this world in this article. Let’s start again with the basics.
What makes a stablecoin?
Just like money, stablecoins fulfill three fundamental tasks:
Medium of Exchange that can be exchanged for goods and services.
Unit of Account represents the real value of a specific unit and thus enables units to be compared.
Store of Value ensures that purchasing power is maintained over the long term.
Thus, the most important property of a stablecoin is that it represents the price stability of a specific FIAT currency. At this point, however, the inflation of the actual FIAT currency, and the associated long-term loss of purchasing power, also affect the stablecoin. In addition, there is another risk with a stablecoin: security or coverage. Various concepts are used here, such as how a stablecoin can be aligned and which securities are hidden behind it in detail.
There are currently three types of stablecoins known:
- Central stablecoins with deposited collateral
- Decentralized stablecoins with deposited collateral
- Algorithmic stablecoins without deposited collateral.
Central stablecoins with deposited securities
The best-known stablecoin is also the spearhead of this category: Tether (USDT). The company Tether issues the USDT Coin. For every USDT coin created, one US dollar or an equivalent is deposited to guarantee and maintain price stability. Accordingly, a USDT is always worth 1 USD and can be exchanged for US dollars through the company at any time. This is the oldest form of stablecoins. The principle is relatively simple and can also be carried out with other FIAT currencies. It is the digital image of a FIAT currency.
The stablecoin is naturally subject to the price fluctuations of the deposited security. So if one US dollar were to lose purchasing power, then the digital image would also lose purchasing power. In addition, however, the USDT is traded in a different market than the US dollar. Therefore, there may be volatilities within the stablecoin in individual cases.
With this simple concept, Tether (USDT) has already made it to number 3 of all cryptocurrencies and is now one of the most important pillars of the crypto ecosystem. Like it or not, liquidity is important, and Tether (USDT) delivers it up-to-date.
TrueUSD, USD Coin, GUSD, BUSD and more
The stablecoin business is so lucrative that every crypto exchange has its own stablecoin. There are now many stablecoins that follow exactly this concept. In addition to Tether (USDT), these include TrueUSD (TUSD), USD Coin (USDC) and Gemini Dollar (GUSD). Nonetheless, the supremacy of the USDT remains without exception, and a fundamental antithesis has not yet been established against the criticized company Tether. Libra, Facebook’s stablecoin, could stir up this market again.
Gold, stocks and the problems
However, the collateral cannot only be presented in a FIAT currency. Another approach for this is, for example, stocks, securities or precious metals. Accordingly, the price of a stablecoin, using the example of gold, is based on the price of gold. Here a stablecoin could, for example, represent one gram of gold. However, the difficulty arises that there is no suitable infrastructure to deposit or withdraw gold. In addition, gold differs in quality and is not always worth the same. Therefore, this form is only suitable to a limited extent. One of the most famous stablecoins that use gold as security is DigixDao with their Digix Gold Token (DGX) and of course, Tether Gold.
The stablecoins that are issued centrally are 100% under the control of the respective issuer and therefore do not meet the decentralized requirements in the crypto space. There have been repeated allegations and rumors Tether (USDT), for example, would not be covered 1: 1. Another allegation even goes so far that Tether is said to have played a key role in the Bitcoin Bullrun 2017.
Nevertheless, these stablecoins offer a convenient interim solution for the crypto market to exchange cryptocurrencies for a coin with stable prices. Hazards are quickly hidden.
Decentralized stablecoins with deposited securities
The next group of stablecoins is decentralized stablecoins with deposited collateral. The securities at this point are not FIAT currencies or securities but other cryptocurrencies. However, tokenized real estate or the like can also be used as security. In addition, not only one digital asset is often used as security, but several at the same time. This fact varies from project to project.
The goal of these projects is to achieve a stable value of USD 1 in most cases. In the meantime, however, some projects pursue a different strategy. These primarily want to break away from the US dollar and establish other base units as a benchmark.
MakerDAO & DAI – The number 1 of decentralized stablecoins
The best-known example of decentralized stablecoins with deposited collateral is MakerDAO with its stablecoin “DAI”. MakerDAO enables ETH to be held in a smart contract (locked) and thus a certain number of DAIs to be created. The ETH can no longer be moved until the same number of DAI that one borrowed is repaid. The security must have a 3: 2 ratio to DAI.
This means that for the equivalent of USD 300 in ETH we would get USD 200 in DAI at the same time. Hence, it is a question of using a “lever”. In this case, we would temporarily have a purchasing power of USD 500, although we only have USD 300 in ETH. Of course, the USD 200 has to be paid back at a later time to release the ETH from the smart contract. In the meantime, we can use this amount to e.g. Buy cryptocurrencies. If the value of the deposited security, in this case, ETH, should fall, the DAI position is no longer sufficiently covered, and you lose your deposited ETH.
Decentralized Finance (DeFi)
MakerDAO now offers many other cryptocurrencies in addition to Ethereum. For a short time, it has even been possible to deposit Bitcoin. These are tokenized indirectly via so-called wrapped bitcoins (WBTC) on the Ethereum blockchain. You can indirectly earn interest on your BTC with MakerDAO.
But the competition never sleeps. Only recently, Compound caught up enormously and could even overtake MakerDAO, at least in terms of market capitalization. MakerDAO is still in first place in terms of usage. However, it shows that everyone is talking about decentralized finance (DeFi) and that business with decentralization is growing.
Algorithmic stablecoins without deposited collateral
Now we come to the last group of stablecoins: the algorithmic stablecoins without deposited security. These use an algorithm to achieve price stability. You could compare it at this point with a central bank that controls the issuance of a FIAT currency so that purchasing power increases or decreases. Therefore, an algorithmic stablecoin uses the two most important factors – supply and demand. If demand increases, the value should increase and vice versa.
This simple principle is used by algorithmic stablecoins to automatically bring more coins onto the market in the former case and to meet demand. It works the same way in the other direction. If the supply increases, some of the coins will be removed again.
This works, for example, through increased transaction costs, which are then destroyed. In theory, this should make it possible to keep the price stable by making permanent adjustments to supply and demand. Often a price of USD 1 is strived for these stablecoins. Several projects follow this approach, but so far, it has not been very successful.
Stablecoins have become an integral part of the crypto market. While some see Tether & Co. as the Trojan horse, others use the tokenized FIAT currency’s liquidity. It can be demonized or called good. What is certain is that the future lies with these tokenized assets. The usage shows that they fulfill a real use case. Projects like MakerDAO or Compound offer the undreamt-of potential for the middlemen who make up central stablecoins to decentralize and thus completely provide a decentralized financial market space. Whether we want that is another question.
Everything must still be in an experimental phase. The problems and allegations at Tether or the hacks in the DeFi area underline this fact. The risk of using something not yet 100% mature should not be underestimated. In other words: When using these services, you should always keep this risk in mind and act with caution.
This is the end of our short journey into the world of stablecoins. If you have any suggestions or are missing content, please write it in the comments.