Are Stablecoins the future?
Ivan Silkin
Chain 1: Overview of stablecoins (regulations, types, uses)
The first stablecoin (BitUSD) was created on July 21, 2014. Stablecoins, having grown rapidly in recent years, comprise almost 15% of the Cryptocurrency market.
Stablecoins are a type of cryptocurrency designed to provide an alternative to highly volatile cryptocurrencies. A stablecoin’s value is tied to a commodity, financial instrument, or currency such as the US dollar. For example, the most popular stablecoin is Tether (USDT) which is tied to the US dollar, meaning that, if it is functioning as intended, one tether coin would be worth $1.
The primary purpose of stablecoins is to serve as a medium of exchange since they can keep almost constant purchasing power during transactions. In addition, the stablecoin’s low volatility allows for swift and cheap international transactions.
Some advantages of stablecoins are:
Low volatility
Fast and Cheap international transactions
Safe investments with predictable outcomes
Transparent (decentralized only)
Some disadvantages of stablecoins are:
Low ROI
Problems with laws and regulations
Counterparty risk (mostly centralized
Controversy and non-transparency in some instances (see below)
One of the biggest controversies in the world of stablecoins is with Tether. It has been questioned whether Tether is fully backed by the US dollar and if it has sufficient USD reserves. The exchange behind Tether, Bitfinex, rarely shares legal information, and since the start of their operations in 2014, they were only audited once in 2021. It was revealed in March 2021 that only 2.65% of Tether’s reserves are held in cash, and only 76% of Tether was backed by reserves. Tether has also been accused of market manipulation by crypto asset buyers. It is said that they “printed” billions of dollars worth of Tether and artificially inflated Bitcoin prices in 2017.
Chain 2: Fiat-backed stablecoins
Fiat-backed stablecoins are the most popular type of stablecoin and are backed by a fiat currency, such as the US dollar or the Euro. They are usually tied in a 1:1 ratio meaning that 1 USDT would equal $1. The reserves that the stablecoin is backed by are usually audited regularly to ensure that the stablecoin is fully backed and to avoid problems similar to what happened with Tether. Some of the most popular fiat-backed stablecoins are Tether (USDT) and USD coin (USDC), which are tied in a 1:1 ratio to the US dollar. Fiat-backed stablecoins serve as the fastest and least volatile medium of exchange among stablecoins, but many risks come with centralized stablecoins.
Chain 3: Crypto-backed stablecoins
Crypto-backed stablecoins are a type of stablecoin backed by other cryptocurrencies, such as Bitcoin or Ethereum. The value of crypto-backed stablecoins is determined by the value of the cryptocurrency they are tied to. Some of the popular stablecoins which are solely backed by cryptocurrency are BitUSD, sUSD, and sETH.
Crypto-backed stablecoins can be created through an electronic vault system (a type of secure storage that holds the assets behind the stablecoin). To create them, the user deposits a certain amount of cryptocurrency into the electronic vault relative to the value of the stablecoin and the reserve ratio (the total cryptocurrency assets held in reserve behind the supply of the stablecoin) being used. Once this is done, the stablecoin will be “minted” and issued to the user. Crypto-backed stablecoins are decentralized, which makes the platforms transparent and safe. Additionally, to combat the high volatility of the cryptocurrencies backing stablecoins, some crypto-backed stablecoins use a dynamic reserve system that adjusts the reserve ratio based on the volatility of the backing cryptocurrency.
Chain 4: Commodity-backed stablecoins
Commodity-backed stablecoins are a type of stablecoin backed by the reserves of a commodity like precious metals, oil, or real estate. The value of these stablecoins is tied with a 1:1 ratio with the backing commodity. For example, one of the most popular commodity-backed stablecoins is CACHE gold (CACHE). Each stablecoin is backed by 1g of pure gold. Commodity-backed stablecoins are less susceptible to inflation than fiat-backed stablecoins and help investors with little capital to purchase valuable assets. However, if the backing commodity loses value or is mismanaged, the tied stablecoin would also fall.
Chain 5: Algorithmic stablecoins
Algorithmic stablecoins do not rely on the reserves of a fiat currency or commodity but instead use algorithms to adjust the supply of the stablecoin based on its demand. For example, a popular Algorithmic stablecoin is Dai (DAI), which is tied to the value of the US dollar but is not backed by the reserves of a commodity or fiat currency. Instead, Dai uses a system of collateralized debt positions (CDPs) to maintain its stable price. Algorithmic coins are new, so many new legislations are coming in place, but there is potential for algorithmic coins in the decentralized market. On the other hand, since Algorithmic coins are relatively new, there are many risks in the market. For example, TerraUSD was the biggest algorithmic stablecoin, with a market cap of $18.7 billion at its peak. Its value is tied to the US dollar via the “minting” and “burning” of its sister coin, LUNA. In early May 2022, uncertainty in the crypto market sparked a market-wide sell-off of crypto, including LUNA holdings. As a result, Terra couldn’t reach an equilibrium between supply and demand, and its value fell below $1. As a result, the value of LUNA fell by 96%.
Chain 6: The future of stablecoins
In recent times, stablecoins have grown in popularity and have grown massively to control almost 15% of the market share. Stablecoins are easy to handle, have low volatility, and can facilitate swift transactions. They have many applications: Remittances, International transactions, and peer-to-peer payments. These factors give an overview of how flexible stablecoins are and suggest that there is room for them in the future of the crypto market. However, the success of Stablecoins will depend on how well they can be adapted and developed to meet the needs of future markets.
Conclusion:
There are many types of stablecoins out there, with each one being unique in its own way. I think we can conclude that stablecoins have their own positive and negative sides. I would say that Fiat-backed stablecoins have the most positive factors at the moment, whereas Algorithmic stablecoins have the most drawbacks. However, if tackled, the negative side of stablecoins will pose little of a threat to their development as we have seen that stablecoins are still in wide use after the Tether investigations and Terra crash. As technology evolves, so will the uses of Stablecoins. Additionally, as people strive to move away from traditional banking, we would likely see increased stablecoin transactions. Only time will tell if Stablecoins will be part of the future cryptocurrency market.
