Stablecoins

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A stablecoin is a digital currency backed by an asset reserve (fiat money, exchange-traded commodities, cryptocurrencies) in order to maintain price stability.

The major argument against the wide adoption of cryptocurrencies as a means of payment has been revolving around being too volatile and speculative in this regard. Stablecoins have initially set the goal of leveraging the benefits of blockchain technology to enable fast, unmediated and secure transactions while avoiding high volatility of traditional cryptocurrencies.

Stablecoins are usually pegged to (reflect the price of) traditional currencies like USD or EUR. The price stability of stablecoins is typically ensured by an asset reserve, a basket of assets, or alternative algorithmic mechanisms.

History

The idea of a cryptocurrency pegged to a real-world asset was first described in the documentation of Mastercoin protocol[1] in 2012, three years after the Bitcoin emerged in the financial markets. The first stablecoin pegged to American dollar – USDT – was launched by Tether in 2015. To this day, there are over 50 existing stablecoin projects[2], with new ones appearing every month.

Witnessing the growing popularity of stable method of payment among retail users, corporations and governments, multiple blockchain media pronounced 2020 “the year of stablecoins”[3].

Types of stablecoins

Stablecoins are typically categorized by the asset (or mechanism) backing them. These include:

  • Fiat-Based Collateralized Stablecoins
  • Crypto-Collateralized Stablecoins
  • Commodity-Collateralized Stablecoins
  • Non-Collateralized (Algorithmic) Stablecoins

Fiat-Based Collateralized Stablecoins

The majority of stablecoins on the market are backed by a reserve of a fiat currency, such as USD or EUR. 1 stablecoin of this type is equal to 1 unit of currency, ensuring 1:1 exchange rate at all times. When a holder redeems cash with owned stablecoins, the equivalent amount is destroyed or taken out of circulation, thus ensuring price stability. The simplicity of concept behind fiat-collateralized stablecoins makes this category the most popular and prone to further adoption.

Examples:

USDT (Tether)
USDC (CoinBase)
PAX (Paxos)
TrueUSD (TrustToken)

Crypto-Collateralized Stablecoins

Crypto-collateralized stablecoins have been gaining increasing recognition since 2019. While this kind of stablecoins is typically also pegged to dollars or euro for convenience, the mechanism ensuring their stability is tied to other cryptocurrencies.

While this type of stablecoins is open to a potential risk of higher volatility[4] of the underlying asset, some players introduce additional safety mechanisms, such as Equilibrium’s stability fund for EOSDT. Examples:

DAI (MakerDAO)
EOSDT (Equilibrium)

Commodity-Collateralized Stablecoins

Commodity-collateralized stablecoins are backed by interchangeable assets such as precious metals (most commonly gold), oil, or other. Low volatility of commodities and their potential to appreciate in value provide an additional incentive to use this type of stablecoins. Examples:

Tether Gold (XAUT)
Paxos Gold (PAXG)

Non-Collateralized Stablecoins

The price of non-collateralized, or algorithmic, stablecoins is maintained by an algorithm that changes the supply volume according to the market conditions – selling the tokens if the price falls below the peg. Unlike other categories, this type of stablecoins isn’t backed by fiat or another cryptocurrency. Examples:

Reserve (RSR)

Stablecoins in world’s economy

Since 2019, some of the world’s largest corporations and financial institutions have been paying attention to the benefits offered by stable digital currency units and introducing their own stablecoin projects, which include famous Facebook’s Libra and JPMorgan’s JPCoin. These, however, represent a hybrid model from the technological standpoint, being highly centralized – unlike the peer-to-peer DeFi players. In the case of Libra, it has provoked a lot of ethical arguments[6] and leads to the project shutdown.

At the same time, many governments (including China and the U.S.) are developing stable Central Bank Digital Currencies, and financial experts are attributing[7] a variety of beneficial use cases for these.

References

1. A Brief History of Mastercoin; blog.omni.foundation.
2. Sam, Alyze (2019). Guide to Fiat-Collateralized StableCoins with 2019 Complete Guide. Medium.
3. Forst, Greg (2020). 4 Reasons Why 2020 Will Be The Year of The Stablecoin. Tokenpost.
4. Austin, Sara (2019). Will Stablecoins Solve Entrepreneurs’ Biggest Problem? Entrepreneur.com.
5. Kalim, M. (2019). Is Stablecoins the future of cryptocurrencies and, eventually, money? Cryptocurrencies and Blockchains.
6. Eric Posner (2019). The Trouble Starts If Facebook’s New Currency Succeeds. The Atlantic
7 Catherine Coley (2020). The US Should Use Stablecoins for Emergency Coronavirus Payments. CoinDesk