A stablecoin is a utility token built on another coin’s blockchain. The main objective of stablecoins is to provide the cryptocurrency ecosystem with a digital asset that is not volatile and does not fluctuate in value.
Stablecoins offer convenience, security, and privacy of crypto and, at the same time, offer the stability and trust of fiat. Their appearance and utilization eliminate the high fees that crypto fans would ultimately incur when purchasing fungible and volatile digital assets like Bitcoin.
The US dollar fiat backs some stablecoins in the ratio of 1:1. Other stablecoins are backed by Gold and pegged to the real-time prices of Gold.
Stablecoin ecosystems’ functionality exists in two ways.
Fiat or Asset Collateralization
Fiat collateralization means that every stablecoin is backed by either fiat or valuable assets such as Gold. Tether is an example of companies that releases their USDT stablecoins using Fiat collateralization of the US dollar.
Some of the stablecoins minted in this way include;
- USDT- Is an early dominance in the stablecoin space having USD as its collateral.
- USDP- with the same ratio as Gusd, UsdC uses assets in reserve as collateral.
- USDC- Works on the Ethereum Blockchain with USD as its collateral
- GUSD- This is the first stablecoin developed that became sustainable and scalable. It has a ratio of 1:1 against the US dollar and uses funds held in the State Street Bank as collateral.
The stablecoins minted in this form are more stable than the alternative minting method. This method makes these stablecoins suitable for transactions in the Blockchain network.
Since these coins rely on Fiat Collateralization, the minting company needs to acquire collateral such as fiat to make it stable. The fiat used as collateral cannot be invested and is, therefore, subject to inflation. The other risk of Fiat collateralization is that the collateral may be embezzled, decreasing the value of the stablecoin.
The company minting stablecoins could have millions of dollars set aside as collateral susceptible to these harmful factors.
Another negative factor affecting Fiat Collateralized stablecoins is that it is difficult to audit. Auditing such companies could be very tedious and inaccurate.
Smart Contract Stable Coins
An Algorithm controls these types of stablecoins. Due to this reason, they are also known as algorithmically pegged stable coins.
Although these coins maintain the USD peg, their value is controlled by an Algorithm. Algorithmic stablecoins pose a risk as the stablecoin could rise or fall off its standard when the algorithm fails.
The benefit of these stablecoins is that it is effortless to audit transactions achieved in smart contracts. Auditors only need to validate the intelligent contract codes to particular the value of the stablecoin. It is also less prone to theft as there are no physical assets set as collateral by the providing companies.
Smart contract stablecoins are less stable than the alternative, the fiat-collateralized stablecoins. The reason is that the smart contracts responsible for minting these stablecoins must manipulate the supply of coins to fit the desired price.
These algorithm-based tokens are also very risky and prone to manipulation. A good example is the TerraLuna crypto disaster that wiped billions of funds from institutions and retail investors.
Smart contract stable coins work in various types of algorithms which include;
Coin change Algorithm-This Algorithm changes the number of coins in the owner’s address to maintain the value to that of the US dollar.
Money Printer Algorithm– This algorithm uses a money printer and a bond reward system to adjust the price of one stable coin to one dollar.
Benefits of Stable Coins to the Crypto Ecosystem
Fiat-collateralized stable coins are critical elements of the DeFi ecosystem. They are vital elements of the DeFi ecosystem. These stablecoins over-collateralized an existing digital asset to allow the effective maintenance of considerable market prices. The organization provides a buffer against price fluctuations caused by the underlying collateral.
Examples of Stable Coin Ecosystems
Tether Limited is the company that created the Tether Token. The main goal of the creation was to develop a rigid token on the Ethereum blockchain that was pegged to the US dollar. Tether works under the principle of Asset Collateralization, as discussed above. This concept implies that Tether issues 1 USDT for every US dollar issued to the company. The reverse is also true: whenever a user wants to cash out, they would surrender their token to Tether, and in exchange, Tether would issue the token.
In addition, once USDT is issued back to the stablecoin company, it is destroyed to ensure that the amount of collateral the company has in its reserves is the same as the amount of USDT issued.
Can Tether sustain its ecosystem if everyone cashes out and demands their fiat back? The issue of Tether is that no one knows how much actual fiat Tether has in its reserves. This brings the Tether stablecoin to the limelight so that in case of an intense FUD (Fear Uncertainty and Doubt), the digital token might not survive.
The current market cap of Tether currently stands at over $67 billion. Out of this, Tether claims to have only 2.9% of cash in its actual reserves. Tether also claims to have lent out 12.5% in the form of loans, 10% in corporate bonds and precious metals, and 50% in paper loans, which means more loans. Some remaining amounts are fixed on treasury bills and other Fungible digital assets.
The information is, however, a self-audit that cannot be trusted. Tether strategically registered the company in the British Virgin Islands. This way, the United States government cannot force an audit on the company. Could Tether be hiding some of its operations?
Binance Stable Coin BUSD
BUSD is a stablecoin issued by Binance on the BNB Smartchain network. The current market capitalization of BUSD is just above $21 Billion at the time of this publication. For the past 24 hours, the coin has traded a total volume of $5.3 billion. The coin was created as a partnership between Binance and Paxos in 2019. The stablecoin is approved and regulated for consumers by the New York State Department of Financial Services.
The stablecoin is pegged to the US Dollar through asset collateralization, just like USDT. The value of BUSD to USD currently sits at 1:1, the ultimate stablecoin standard. Reserves of BUSD are held in FDIC-insured banks in the United States. Unlike Tether, Binance and Paxos allow auditing firms to frequently scrutinize the project making it one of the most trusted stablecoins in the cryptocurrency markets. All auditing reports conducted on the stablecoin are found on Paxos official web page.
Terra UST Stablecoin (Crash)
The Terra ecosystem was built to entirely focus on mass payment processing as well as the creation of a stablecoin UST. Terra’s stablecoin UST was developed as an algorithm stablecoin. The algorithm controlled the supply and demand of UST to maintain the value of the stablecoin. When the value of UST is disputed with the value of the US dollar, the algorithm would either print or burn more UST to bring its value to equilibrium. If UST’s value hiked over the dollar, the algorithm printed more tokens, and if the value went under the dollar, the algorithm burnt more UST.
However, like other stablecoins, UST crashed, wiping over $45 billion from oblivious investors and institutions such as Three Arrows Capital. Three Arrows Capital’s initial investment in Terra’s ecosystem, over 500 million dollars, is worth less than $600 today.
Stablecoins are digital assets with a value pegged to fiat or assets such as physical Gold. Stablecoins are an enormous growing sector in the crypto world. These coins are leaders in Innovation and Technology. It provides vital fundamentals to the crypto ecosystem, such as being a store of value. Stablecoin technology is bridging the traditional and decentralized financial infrastructure to build the foundation for the next era of money.