The emergence of crypto assets created an innovative and ingenious way to participate in the global digital economy. However, the price volatility and speculative nature of most tokens and assets have stalled the adoption of crypto as a payment system. A solution to this problem may be Stablecoins.
Stablecoins are a set of cryptocurrencies that’s value is tied to an external asset class like USD, EUR, gold, or even other cryptocurrencies. Most stablecoins are collateralized by an underlying asset that reinforces the coin’s price. Last summer, a wave of DeFi (Decentralized Finance) products and applications flooded the crypto landscape searching for a way to implement an investor and retail-friendly financial experience. Platforms that allow borrowing, saving, lending, and insurance, amongst others, were in high demand as investors looked for opportunities to transfer their finances to decentralized infrastructure fully. DeFi Summer brought massive gains to traders and investors. As the market stabilized, demand for reduced volatility and savings opportunities, as well as more peer-to-peer transactions, has developed. This spurred the growth of stablecoins massively.
Source: CoinGecko
The first established stablecoin was USDT, U.S. Dollar Tether, which was first listed on exchanges in 2015. Since then, growth, acceptance, and understanding of stablecoins have increased, through bear and bull markets, until exploding over last summer, as seen above. Furthermore, the market cap of the stablecoin landscape has increased about 1575% from ~4 Billion in March 2020 to ~63 Billion in March 2021. All of this growth has propelled creators and users to develop more secure and operative stablecoins that may lead to exciting possibilities like stable peer-to-peer transactions for retail consumers.
What You Need To Know
Stablecoins are a unique mix of fiat and cryptocurrencies, and it is vital to know these key takeaways that are included in our guide below:
Stablecoins are stable. Stablecoins are tethered or linked to an external asset’s value, preventing wild fluctuations in price.
There are different types of stablecoins. Stablecoins come in three different shapes and sizes where some require fully collateralized and backed up fiat assets (Fiat-Collateralized), fully and sometimes even 1.5:1 backed up crypto assets (Crypto-Collateralized), and computer monitored and regulated stablecoins (Algorithmic).
Stablecoins provide security and safety for investors. Investors looking to retreat out of volatile positions can use the stability and dependability of stablecoins.
Auditing is important. Some stablecoins rely more heavily on a centralized structure rather than a decentralized one. That requires heavy auditing to ensure investors a company is liquid enough to support the coin’s pegged value.
Creators can leverage stablecoins as reliable payments. Creators looking to sell and participate in the decentralized global marketplace want to be paid for their material with a secure coin so that their work does not become devalued. Stablecoins can be used and mandated as a medium for purchasing and funding.
What are Stablecoins?
Stablecoins are a set of cryptocurrencies that’s value is tied to an external asset class like USD, EUR, gold, or even other cryptocurrencies. Most stablecoins are collateralized by an underlying asset that reinforces the coin’s price. These stablecoins have so much potential across different spaces such as alternative savings, peer-to-peer transactions, national currencies, high-interest investments, and participation in lending and yield farming protocols.
Types of Stablecoins
Fiat-Collateralized
A fiat-collateralized stablecoin is a crypto token created by a company and requires underlying fiat assets (USD, EUR, Gold, etc.) to mint a coin. For example, this means that USDT (U.S. Dollar Tether) must maintain a 1:1 supply ratio of USD in their reserves to support the price of USDT. The benefits of centralizing money this way are that every coin is fully supported in value, the coins’ price is very stable, and funds are safe from cyber risks.
Crypto-Collateralized
A crypto-collateralized stablecoin is a crypto token created by protocols and requires specific underlying crypto-assets (ETH, BTC, etc.) to mint a coin. Like fiat-collateralized stablecoins, maintaining a collateralized reserve is necessary. Still, because crypto assets are much more volatile than fiat assets, higher reserve ratios like 1.5:1 are needed to maintain a stablecoin’s peg. This is a slight disincentive as this requirement creates capital inefficiencies. Using crypto-collateralized stablecoins allows for a public and open view of the protocols funds and makes exchanging for and redeeming the underlying crypto easy.
Algorithmic
An algorithmic stablecoin is a crypto token that requires no collateral and tries to maintain and regulate its price through a coded algorithm. The algorithm works by increasing supply (issues more tokens) if the price increases above its peg and reduces supply (repurchases the tokens) if it decreases below its peg. Algorithmic stablecoins are fully decentralized and capital-efficient while also requiring no capital to use as collateral, all of which are attractive to traders. However, because there is no collateral associated with the coin’s value, widespread acceptance and trust have come slower than collateralized coins.
Why Stablecoins?
Asset Protection
One of the main advantages of using stablecoins is using the coins as a stable store of assets. This allows investors to sell out of their more volatile crypto positions and preserve their savings in relatively stable and similar assets to fiat currencies like the USD. This also allows quick access to the entire crypto infrastructure. It is significantly easier to purchase tokens if one’s portfolio is already in stablecoins rather than banks and USD or EUR. Once traders have their funds in stablecoins, they can also provide liquidity to liquidity pools and receive consistent and stable returns.
Stablecoins not only offer a haven from volatile crypto but also fiat currencies. In countries where hyperinflation is prevalent, preserving funds in reliable stablecoins is a safer and more viable savings method. Using stablecoins could prevent personal savings from devaluing and have a massive societal impact.
Lending and Borrowing
Stablecoin holders can lend and borrow their assets while obtaining a very high yield. Liquidity pool and lending operators like Curve and Compound have a massive stablecoin user base. Stablecoin lending is attractive because they offer a crypto alternative to centralized finance bank lending and offers higher interest rates. Traders can make such high returns because investors and borrowers can acquire more capital without selling their assets, which is an attractive option for active members. This is possible through collateralized loans where traders need to lock up some of their capital, and when the loan is paid off, they receive their collateral plus and profits they made on the loan assets. Stablecoin lending is sought after because the stability of the loaned stablecoins is more attractive to investors due to their lower volatility risk.
Remittance and International Transfers
Stablecoins are incredibly important and impactful in the global money exchange as they offer 24/7 trading and exchanging and reduced fees. In the centralized banking system, transferring money across borders requires forms, banking fees, and days of transaction time which is outdated in a digital world. This problem amplifies when the money sent is in the form of remittance, which is when foreign workers send money back to their families abroad. High fees cost workers hours of salary and long transaction times hinder their family’s abilities to survive. Sending stable crypto around the world takes seconds and is a direct peer-to-peer transaction. Connecting the global financial world through stablecoins allows the enrichment of citizens’ interactions and livelihoods worldwide and will make an immense difference in people’s daily lives.
Challenges and Concerns
The uses and impact of stablecoins on the mainstream acceptance and growth of crypto cannot be understated --- it’s massive. However, crypto is an ever-changing and ever-progressing industry always looking to improve, and there are some areas of concern that must be understood and hopefully addressed in the future.
A significant concern with fiat-collateralized stablecoins such as USDT, USDC, and TUSD is that the coins and collateral are moderated by a centralized company leaving open the possibility of abuse and arbitrage with no public proof of its reserves. USDT has had many problems over the years by not keeping up their 1 USDT: 1 USD backing, which has highlighted trader’s desires to use only decentralized platforms. Recently, USDT has completed a successful attestation of its reserves and has verified it has assets exceeding the amount of USDT in circulation and intends to continue quarterly, which is a significant step in the right direction. Additionally, fiat-collateralized stablecoins are subject to increased regulation and involvement by governments limiting the decentralized community’s growth and benefits.
Crypto-collateralized stablecoins have some prevalent challenges, primarily relating to their underlying crypto assets’ volatility. DAI, one of the most established crypto-collateralized stablecoins, is subject to price volatility when debt positions liquidate during market crashes and dips. The light blue line below plots the hourly prices of major stablecoins throughout the week COVID-19 engulfed the world. The pandemic caused widespread market crashes across holdings in the centralized and decentralized economies.
Source: CoinMetrics
As seen above, the price of DAI diverged massively above 1 USD as the price of ETH plummeted, causing a shortage in DAI. GUSD, another crypto-collateralized stablecoin, diverged below 1 USD, almost to $.90, which is extremely concerning. A drop that low could be understood as investors' assets losing 10% of their value due to pegging errors and market volatility when these stablecoins should offer a haven in times of market turbulence.
Algorithmic stablecoins present solutions to these challenges by 1. being wholly public and open on the blockchain and 2. not being susceptible to crypto volatility. This allows the coins to operate in a fully decentralized way as code is dictating the stability management process. A risk with this type of coin is that in a crash, there would be no collateral to liquidate to recover the price meaning investors would lose their savings. Furthermore, widespread interest can flood a coin’s market and cause some algorithmic coins to lose their peg. For example, Ampleforth rose to almost $3.00 in July 2020 after launching rewards programs on other platforms.
Looking Forward
Banking
As mentioned earlier, stablecoins can provide safety from turbulent and hyper-inflated currencies. Using stablecoins could preserve a family’s savings or provide relief from volatile markets. Securing and saving assets safely is quintessential to anyone’s livelihood. However, a more significant challenge that has held back billions of people’s economic development is basic banking and savings access. According to the G7 Committee on Payments and Market Infrastructures, there are “1.7 billion people globally who are unbanked or underserved with respect to financial services”, all of whom would benefit from a stablecoin wallet and infrastructure (Coeuré). Stablecoin banking requires only the internet, which most underserved can access. With 24/7 trading hours and instant payments and access, this population’s economic growth will explode exponentially. An entire generation will be introduced to the financial system starting with full custody rather than the current custodial centralized structure.
Payroll
Another exciting development to look for in the stablecoin industry is using the coins as payments, specifically as payroll. Using stablecoins for payroll ensures speed, transparency, and currency-of-choice convenience. Stablecoins are transacted the same as every other cryptocurrency and are publicly encrypted on the blockchain allowing employees to verify amounts and other stipulations. Additionally, the speed of transactions allows employees to spend their salaries as soon as possible and have access to their funds in case of emergencies. Additionally, employers could pay their employees through smart contracts that automatically pay employees in the stablecoin currency of their choice. For example, a European employee could be paid in a EUR stablecoin directly from a USD stablecoin with minimal fees and short transaction times. All of this is possible due to the consistent and reliable pegging of all of these stablecoins.
Decentralized Application Payments
A significant resistance in some of the most well-known cryptocurrencies is that purchasing price varies wildly. For example, one day the price of a good could be worth 1 BTC in USD, but the next, it could be worth much less. This has stalled crypto growth as a payment method, but using stablecoins as purchasing tokens could be a solution to this issue. On decentralized applications, it is necessary for the currencies to be stable to ensure purchases are regulated and maintained at the same value. If the market price continues to be too variable, the development of peer-to-peer transactions for real-world and digital items will be stalled. Once stablecoins and DeFi payment infrastructures are more widely accepted and integrated, creators like artists, musicians, and designers can sell their art, music, and material and be confident their work will not become devalued. Incorporating this type of transaction design will be a revolutionary change to the consumer industry and will open up endless opportunities for entrepreneurs and creators.
Conclusion
Stablecoins have massive utility across different industries and mechanisms and the rapid adoption of cryptocurrencies is only going to push the limit of use cases even further. With decentralization and cryptocurrencies, a future of seamless global financial participation and economic enrichment is in reach. A significant step in this overall development is the integration of Stablecoins. As more developers and investors enter the market, stablecoins will be discovered as a solid solution to many of the easy-to-reach problems because of their easily understood nature and various applications. With strong community desire, it seems to be guaranteed that stablecoins will positively impact society.