Stablecoin is a type of cryptocurrency whose value is tied to one or several other relatively stable assets such as US dollars, euros, gold or other digital assets to avoid market fluctuations. crypto.
1. What is Stablecoin?
Stablecoin is a type of cryptocurrency developed on blockchain technology, born with the purpose of ensuring stability, pegged and guaranteed by a number of assets such as traditional currencies (US dollars, euros ,…), gold, bonds or other digital assets.
Currently, there are a number of popular stablecoins in the market including: USDT, USDC, DAI, BUSD, TUSD,...
2. What is the role of Stablecoins in crypto?
A bridge to make web2 users more accessible to web3: A beginner investor approaches investing and buying cryptocurrencies, stablecoins act as a medium of exchange, helping users transact easier. For example, if a user wants to buy ETH, trading the ETH/USDT pair always helps users visualize the value of ETH more easily than ETH/BTC.
Store of value: Thanks to its stable properties, stablecoins are also used to store value without having to worry about the volatility of cryptocurrencies. For example, when A buys a coin and makes a profit, if A takes the profit into another token, in case that token drops in price, A will lose all of his profit and may even lose money. But if you take profits into stablecoin, that value will be preserved.
Means of value exchange: Stablecoins in crypto are considered to have features quite equivalent to fiat currencies, they were born as a means of exchanging value or valuing assets and services. in crypto. One use case for stablecoins is to easily liquidate more volatile crypto assets into a more stable cryptocurrency to avoid cryptocurrency corrections or crashes. Instead of converting those cryptocurrencies into fiat currencies, you can liquidate your digital assets into stablecoins and hold them to easily buy back other cryptocurrencies when desired.
Based on the above factors, we can see that stablecoins play an extremely important role in the crypto world.
3. Classification of Stablecoins
There are 4 main types of stablecoins:
Fiat-backed stablecoins
Commodity-backed stablecoins
Crypto-backed stablecoins
Algorithmic stablecoins
Stablecoin classification according to Binance Research
Fiat-backed stablecoins
This is the most popular type of stablecoin to date - its value is backed by fiat currency reserves such as US dollars, euros, etc. managed by financial institutions, such as banks. Unlike other cryptocurrencies, the value of this stablecoin is tied to the price of the underlying asset, not supply and demand.
For example: USDT (Tether), USDC, BUSD (Binance USD), GUSD (Gemini Dollar), CUSD (Coin98),…
Based on Coingecko data, we can see that most of the leading stablecoins in terms of capitalization are fiat-backed stablecoins. Because their value is guaranteed by a corresponding amount of real assets, it will ensure the highest stability.
Tether (USDT)
Currently Tether token (USDT) is the coin with the largest capitalization value. Launched in 2014, this is also considered the pioneering stablecoin in this field and is used by most crypto players. Currently USDT has a capitalization of up to 83 billion USD, which means that the value of their reserve assets must be equivalent to this level.
Reserve value table for Tether's stablecoin
USD Coin (USDC)
As the name suggests, these are stablecoins issued by Circle and their stored value is managed by leading US financial institutions such as BlackRock and BNY Mellon. This is the 2nd largest stablecoin by capitalization, just behind Tether (USDT) with 26 billion US dollars.
However, last March USDC lost its peg due to a large amount of USDC's assets being deposited in Silicon Valley Bank (SVB) and this bank was on the brink of bankruptcy. This has caused a large number of users to continuously sell off USDC to USDT out of fear that USDC may collapse.
However, Circle's CEO later spoke out about being able to guarantee the value of USDC and the SEC's decision to support depositors at SVB caused the value of USDC to quickly return to $1.
USDC stablecoin reserves report
Commodity-backed stablecoins
These stablecoins are backed by values such as precious metals (gold, silver) or commodities such as crude oil and real estate. Among them, gold is the most popular type used as a collateral asset, Tether Gold (XAUT) and Paxos Gold (PAXG) are two of the most liquid gold-backed stablecoins. Besides, we still need to note that these items are still subject to quite high price fluctuations. However, an interesting thing is that holders of these stablecoins, in addition to being able to convert into currency, can also convert to that type of asset, as long as they hold the minimum amount for conversion according to regulations ( For example, hold a minimum of 430 PAXG, which can be exchanged for 1 ounce of gold)
For example: XAUT, PAXG,…
This is the least popular of the stablecoins.
Crypto-backed stablecoins
These are stablecoins created by pledging other cryptocurrencies (ETH, BTC,…). However, holding a reserve in cryptocurrency can lead to extreme volatility of the reserve asset, which is why crypto-backed stablecoins need to be held in reserve beyond the value of the stablecoin that can be minted In addition, ensuring the stability of this type of stablecoin. Overcollateralized means that the assets backing a stablecoin are worth more than the value of the stablecoins in circulation.
For example: DAI (MakerDAO), USDS (Sperax)
Currently, DAI is the largest and most popular stablecoin in this type of stablecoin with a capitalization ranking in the top 3 on the market, reaching more than 4 billion US dollars. This is because DAI is used in MakerDAO's ecosystem with dozens of different projects and is supported and integrated on many other platforms to increase profit generation (For example: Binance , OKX, Kucoin,…)
Algorithmic stablecoins
Algorithmic stablecoins use algorithms and smart contract mechanisms to regulate their stability. If demand is high, the price of each stablecoin exceeds the expected anchor and the software increases the supply. Additionally, if demand is low, supply will decrease.
These stablecoins are currently considered the most risky today, and crypto history has also seen cases where their value went to zero, destroying billions of dollars in value.
For example, in the case of UST (Stablecoin on Terra), when UST was sold off massively and lost its peg, the mechanism automatically minted LUNA (the platform's coin) to compensate for the value of UST. However, the total supply of LUNA is not limited, leading to a domino effect, causing Terra's ecosystem, which is ranked 4th in the market in terms of capitalization, to completely collapse after just a few days. It is also one of the most prominent examples of algorithmic stablecoins.
For example: UST, FRAX, USDD,….
4. Risks of stablecoins
Transparency: While stablecoins are claimed to have reserves equivalent to their circulating value. However, if these reserves are stored and managed by several banks and other third parties, what will happen if these parties run into problems? (Similar to the case where USDC lost its peg for part of the reserves managed by SVB and SVB was on the brink of bankruptcy). In addition, another big question arises: "Are these reserve funds holding the amount of collateral assets as declared?". No one can verify this.
Going against the inherently decentralized nature of crypto: Most stablecoins are controlled by centralized companies, with full decision-making power in their hands. For example, USDC has publicly stated that it can be suspended if funds are used illegally. And this also happened in 2020, Circle (the company behind USDC) froze $100,000 USDC at the behest of law enforcement.
Depeg Risk: Stablecoins that are not explicitly backed by reserve assets are likely to lose their peg, especially algorithmic stablecoins. In general, undercollateralized stablecoins will always be at higher risk than overcollateralized or equivalently backed stablecoins.
5. Conclusion
Stablecoins are one of the core elements of the decentralized finance market, this has been proven over the nearly 10 years since the first stablecoin was launched. The application of stablecoins in payments is also gradually being accepted and expanded in many different countries. However, users also need to be aware of the potential risks that can occur with stablecoins so as not to store the majority of assets in the form of stablecoins, even though their volatility is currently quite low.
Source: Theblock101.com