A simple Explanation of Cryptocurrency Stable Coins.


Mass adoption of stablecoins requires consumer protection and sensible regulation.

Stablecoins are a type of cryptocurrency that bridges gaps between the real world and the crypto realm. Regular stablecoins should be pegged one-to-one and hold their value with underlying fiat assets like the US dollar.

With a total market capitalization of over $150 billion, it is no wonder that stablecoins are capturing the attention of consumers and regulators alike. 

There are many different types of stablecoins in line with the respective backing of their underlying assets. The most popular and easiest to grasp are those based on real money like the US dollar and hard physical assets such as gold or silver. 

However, there are also crypto-collateralized, and algorithmic stablecoins like Maker´s DAI. We will cover the use cases of stablecoin and the latter aspects in this simple guide.

Learn about the best stablecoins you can trust here.

First, we must understand the purpose behind using stablecoins and what they can be used for.

Why Stablecoins?

The current financial system is very slow and despite worldwide digitalization, our money still works in analog ways. Slow transactions add to high costs and a series of other frictions affecting consumers and businesses alike. 

Imagine if you could have the speed and flexibility of crypto and combine it with real-world assets minus the high volatility of crypto. This is the main value proposition of stablecoins. 

Let us examine the use cases of stablecoins

Lending in DeFi

The utility of stablecoins is very clear in the case of lending in DeFi platforms. They serve as on-off ramps providing a frictionless flow between fiat (real money) and crypto. The total transacted amount of stablecoins in June amounts to over $590 billion. 

In developing countries, stablecoins are a hedge against hyperinflation. In bear markets, investors park their funds in stablecoins because they are less volatile than other cryptocurrencies.

Remittances

In countries with hyperinflation like Venezuela or Argentina, stablecoins are a great tool for preserving the actual value of the money that you send to your friends and family members. Having a crypto wallet that supports stablecoins gives you the advantage of lower transaction costs. Moreover, you can instantly send money safely and securely. 

Payroll & Invoicing

Stablecoins can significantly reduce fees and transaction costs for businesses. This is especially advantageous for mom and pops shops that do not have enough resources, larger enterprises, and the end consumers. 

What are the different types of stablecoins? 

Not all stablecoins are equal and thus it is essential to understand how they work. In theory, the stablecoin issuer holds the actual collateral on a one-to-one basis – in either a financial institution or a traditional bank. 

Here is a breakdown of the most common types

Fiat-backed

This type of stablecoin is meant to be fully backed and redeemable on a one-to-one ratio with its corresponding fiat asset. Tether USDT and Circle USDC fall into this category. 

For this model to work properly, the stablecoins must be thoroughly backed and transparently audited by trusted third parties. The largest player by market capitalization is Tether USDT, with over $66 billion, followed by Circle USDC with over $55 billion.

The BUSD stablecoin , founded by Paxos and Binance, also falls into this category, backed by the US dollar one to one. Using a stablecoin such as BUSD can help significantly to hedge against periods of market volatility and now BUSD is likely to gain momentum, after announcing that it will no longer support USDC and will convert user´s USDC into its own stablecoin BUSD.

Binance is the largest crypto exchange by volume and this move will certainly impact the landscape for the second largest stablecoin by market cap, USDC, and heat up the competition among the different types of stablecoin issuers.

Commodity-backed/centralized stablecoins

These stablecoins use hard assets such as precious metals like certified physical gold reserves. Issuers like Tether Gold (XAUT) and DigixGlobal (DGX) are among the top-ranking ones.

Decentralized/algorithmic stablecoins

Many advanced crypto users consider these types of stablecoins to be the most trustworthy. If the smart contract behind the stablecoin is self-auditable, savvy consumers can look into it and spot potential flaws. 

They are backed by other cryptocurrencies, and smart contracts on the Ethereum blockchain automatically stabilize their value.

Smart contracts have algorithmic formulas that control supply and demand to stabilize the value.

DAI is arguably the most trusted decentralized stablecoin. It runs on Ethereum and attempts to maintain a value of $1.00. Unlike centralized stablecoins, DAI isn’t backed by US dollars in a bank account.

Instead, it’s backed by collateral on the Oasis DeFi platform, which was conceived by the same people behind the Maker and DAI project.

More recently, Aave is proposing a decentralized yield-generating stablecoin that will be pegged to the US dollar and minted by users generating interest yields.

The proposal was approved by the Aave DAO, heralding a massive impact on the entire ecosystem. Aave is a giant player in DeFi with a TVL of $6.6 billion, according to DeFi Lama at the time of writing. The contract development of GHO is at an advanced stage and we´ll likely see GHO hit the market soon.

Moreover, the Aave V2 on Ethereum will be the first facilitator for GHO

Issues with stablecoins 

The role of stablecoins is to maintain their pegged value and reduce volatility. Ideally, these digital assets must be 100% backed, similar to the same way that money in our bank accounts should be fully backed one-to-one by government assets. 

Unfortunately, there are cases where stablecoins fail to maintain their value resulting in ​​high systemic risk and liquidity issues. According to DappRadar´s May Industry Report 2022, DeFi lost 45% of its value amid the Terra blockchain collapse.

Source: DappRadar

Stablecoins and regulations 

The collapse of Terra wiped off $60 billion in the most dramatic wealth loss in modern history, creating panic across all crypto assets and worsening the bear market.

While the approaches vary from country to country and technology is always one step ahead, there seems to be a consensus regarding stricter regulations imposed on stablecoins.

In the end, stablecoin issuers could potentially face the same stringent regulatory frames that banks must comply with. 

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Dale Calvert

Dale Calvert is a serial entreprenuer. He started his first business at age 14, a direct mail business out of his parents home. Dale has always believed that wealth is created in front of a trend. This business philosophy lead him into the cryptocurrency space in 2017, He made the decision in 2022, that the cryptocurrency space is where he will be spending the majority of his time.

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