Résumé
A stablecoin is a cryptoasset backed by another asset, such as a fiat currency or precious metal.
Stablecoins are designed to maintain a relatively stable price so that users can avoid the volatility risks associated with crypto markets.
There are three types of stablecoins: fiat-backed, crypto-backed, and algorithmic.
Due to their convenience and large capitalization, regulators are starting to look more closely at stablecoins.
Introduction
Not all cryptocurrencies are volatile. This is because stablecoins are specifically designed to maintain a fixed price. In an industry where cryptocurrencies and tokens can collapse overnight, there is massive demand for cryptocurrencies that combine the benefits of blockchain with the ability to track a more stable asset. If you haven't yet started using stablecoins for trading or investing, it's helpful to learn more about these cryptocurrencies and their advantages and disadvantages.
What is a cryptocurrency stablecoin?
Stablecoins are digital assets that track the value of fiat currencies or other assets. For example, you can buy tokens pegged to the dollar, the euro, the yen, and even gold and oil. A stablecoin allows its holder to lock in profits and losses and transfer value at a stable price across peer-to-peer blockchain networks.
Bitcoin (BTC), Ethereum (ETH) and other altcoins have always been volatile. While this situation offers many opportunities for speculation, it also has disadvantages. Volatility makes it difficult to use cryptocurrencies for everyday payments. For example, traders may accept $5 in BTC for a coffee one day, but find that their BTC is worth 50% less the next day. This makes it difficult to plan and launch a business that accepts crypto payments.
Previously, crypto investors and traders had no way to lock in a profit or avoid volatility without converting crypto back to fiat currency. The creation of stablecoins provided a simple solution to these two problems. Today, you can easily enter and exit the volatility of cryptocurrencies using stablecoins like TrueUSD (TUSD).
How do stablecoins work?
Creating a cryptocurrency that tracks the price or value of another asset requires a price tracking mechanism. There are several ways to do this, and most of them rely on another asset serving as collateral. Some methods have been shown to be more effective than others, but there is no guarantee that the price will be the same.
Stablecoins backed by fiat assets
A fiat-backed stablecoin keeps a fiat currency, such as USD or GBP, in reserve. For example, each TUSD is backed by a real US dollar held as collateral. Users can then convert fiat currencies into stablecoins and vice versa at the set rate.
Cryptoasset-backed stablecoins
Cryptocurrency-backed stablecoins work similarly to fiat-backed stablecoins. But instead of using dollars or another currency as reserves, cryptocurrencies serve as collateral. Since the cryptocurrency market is very volatile, cryptocurrency-backed stablecoins typically over-collateralize reserves to protect against price fluctuations.
Crypto-backed stablecoins use smart contracts to manage the issuance and burning of tokens. This makes the process more reliable, as users can independently verify contracts. However, some cryptocurrency-backed stablecoins are managed by decentralized autonomous organizations (DAOs), where the community can vote for changes to the project. In this case, you will need to get involved or trust the DAO to make the best decisions.
Let's take an example. To issue $100 of USD-backed DAI, you will need to provide $150 of cryptocurrencies with a value equal to 1.5 times the collateral value. Once you have your DAI, you can use it however you want. You can transfer it, invest it, or just keep it as is. If you want to get your collateral back, you will need to repay the 100 DAI. However, if your collateral falls below a certain collateral ratio or loan value, it will be liquidated.
When the stablecoin is below $1, incentives are created for holders to surrender their stablecoin to get back the collateral. This decreases the supply of the cryptocurrency, causing the price to rise back to $1. When it is above $1, users are incentivized to issue the token, which increases its supply and decreases the price. DAI is just one example, but all crypto-backed stablecoins rely on a mix of game theory and algorithms on the blockchain to incentivize price stability.
Algorithmic stablecoins
Algorithmic stablecoins take a different approach by removing the need for reserves. Instead, algorithms and smart contracts manage the supply of issued tokens. This model is much rarer than stablecoins backed by cryptocurrencies or fiat currencies and is more difficult to operate successfully.
Essentially, an algorithmic stablecoin system will reduce the supply of the token if the price falls below the price of the fiat currency it tracks. This can be done through locked staking, destruction or redemptions. If the price exceeds the value of the fiat currency, new tokens enter circulation to reduce the value of the stablecoin.
What are the advantages of stablecoins?
Stablecoins are versatile and powerful tools for investors, traders and users of cryptocurrencies. Their main strengths are:
1. Stablecoins can be used for everyday payments. Businesses and individuals appreciate their stability. Due to high volatility, cryptocurrencies have not been widely used for payment processing. Large-cap stablecoins have a history of maintaining their value, making them quite trustworthy and suitable for everyday use.
2. Stablecoins have the advantage of being based on the blockchain. You can send a stablecoin to anyone in the world who has a compatible crypto wallet (which can be created for free in seconds). Double spending and fake transactions are also almost impossible to pull off. These qualities make stablecoins incredibly versatile.
3. Traders and investors can use stablecoins to hedge their portfolios. Allocating a certain percentage of a portfolio to stablecoins is an effective way to reduce overall risk. Your portfolio as a whole will be more resilient to market price fluctuations, and you will also have funds available in good times. You can also sell cryptocurrencies for stablecoins during a market decline and buy them back at a lower price (i.e. sell short). Stablecoins allow you to easily enter and exit positions, without having to withdraw money off the blockchain.
What are the disadvantages of stablecoins?
Despite their possible role in widespread adoption of cryptocurrencies, stablecoins remain subject to certain limitations:
1. Stablecoins are not guaranteed to maintain the value of their underlying asset. Although some large projects have good experience, many projects have also failed. When a stablecoin experiences constant problems maintaining its parity, it can lose its value dramatically.
2. Lack of transparency. Not all stablecoins publish full public audits and many only provide regular attestations. Private accountants carry them out on behalf of stablecoin issuers.
3. Stablecoins backed by fiat assets are generally more centralized than other cryptocurrencies. A central entity holds the collateral and may also be subject to external financial regulation. This gives them significant control over the cryptocurrency. You also need to trust that the issuer has the reserves it claims to have.
4. Crypto-collateralized and uncollateralized cryptocurrencies rely heavily on their community to function. It is common to have open governance mechanisms in cryptocurrency projects, meaning that users have a say in the development and operation of each project. As such, you must engage or trust the developers and community to manage the project responsibly.
Examples of stablecoins
Crypto-backed stablecoin: MakerDAO (DAI)
DAI is one of the most famous cryptocurrency-backed stablecoins that tracks USD on Ethereum. The cryptocurrency is managed by the MakerDAO community which holds the MKR governance token. You can use the MKR to create and vote on project change proposals. DAI is over-collateralized to deal with the volatility of cryptocurrencies, and users enter into collateralized debt positions (CDP) which manage their collateral. The entire process is executed via smart contracts.
Fiat-backed stablecoin: TrueUSD (TUSD)
TUSD is a dollar-backed stablecoin. This is independently verifiable. It is the first stablecoin to computationally control issuance, with instant verification on the blockchain of USD reserves held off-blockchain. TUSD reserves are tracked using Chainlink's Proof of Reserve, so holders can independently verify that their TUSD is backed by USD held in reserves.
Are stablecoins regulated?
Stablecoins have attracted the interest of regulators around the world due to their unique blend of fiat currencies and cryptocurrencies. Since these are designed to maintain a stable price, they are useful for reasons other than speculation. They can also facilitate high-speed, low-cost international transactions. Some countries are even experimenting with creating their own stablecoins. As a stablecoin is a type of cryptocurrency, they will likely fall under the same regulations that apply to cryptocurrencies. Issuing stablecoins with fiat currency reserves may also require regulatory approval.
Conclusion
It is difficult to find an investor or trader today who has not held a stablecoin at some point. Stablecoins are often held on cryptocurrency exchanges so that traders can quickly capitalize on new market prospects. As we discussed, they are also very useful for entering and exiting positions without having to go through fiat currencies. Besides trading and investing, stablecoins can be used to make international payments and transfers.
Even though they are an integral part of crypto and enable the creation of a new financial system, you should not underestimate the risks. We have seen stablecoin projects with a broken price tracking system, missing reserves, and issues with lawsuits. So while stablecoins are incredibly versatile tools, remember that they are still cryptocurrencies and present similar risks. You can mitigate risk by diversifying your portfolio, but be sure to do your own research before investing or trading, and don't invest more than you can afford to lose.
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