What are stablecoins and how do they work?|CryptoNewsHerald explains

Main

• Stablecoins are cryptocurrencies with a fixed or stable exchange rate.
• They are a universal unit of calculation, convenient for trading, storing capital and protecting an investment portfolio from the volatility of cryptocurrencies.
• Stablecoins can have a variety of sources, assets as collateral, and value retention mechanisms.
• There is no single classification of stablecoins, however, researchers divide projects based on criteria such as issuer centralization, reserve ratio, asset class in collateral, and others.

What are stablecoins for?

Popular stablecoins are a liquid asset: there are a lot of them on almost any platform.

Also, popular stablecoins are a universal unit of exchange and storage of capital among crypto-investors and traders. They are easier to trade in pairs with other cryptocurrencies than with fiat currencies. Unlike fiat, stablecoins are faster and easier to transfer between accounts and addresses.

In addition, stablecoins are a means of protecting against volatility in a cryptocurrency portfolio and are actively used in DeFi applications.

What are the popular stablecoins?

There are hundreds of stablecoins on the cryptocurrency market. Here is a list of the top 10 stablecoins based on capitalization (CoinMarketCap data as of August 2022):

1. Tether (USDT);
2. USD Coin (USDC);
3. Binance USD (BUSD);
4. Dai (DAI);
5. TrueUSD (TUSD);
6. Pax Dollar (USDP);
7. USDD (USDD);
8. Neutrino USD (USDN);
9. Fei USD (FEI);
10. Gemini Dollar (GUSD).

What assets are stablecoins pegged to?

In the crypto industry, the most common stablecoins are pegged to the price of the dollar. The most famous example of such a coin is Tether (USDT). 1 USDT equals $1 and has minimal deviations from this price. There are stable cryptocurrencies based on other currencies, for example, the euro – Stasis Euro (EURS), or based on the Singapore dollar – XSGD.

Some stablecoins can be pegged to the price of a fiat currency, but are still used to back cryptocurrencies. In this case, the stability of the price of the token can be achieved through redundant reservations or a cunning arbitrage algorithm. The most famous example of a stablecoin with cryptocurrency reserves is DAI from MakerDAO.

You can also buy stablecoins pegged to the price of gold, such as PAX Gold (PAXG) and Tether Gold (XAUT). Unlike traditional gold-based instruments, such as ETFs, stablecoin issuers do not charge a management fee, and settlements in cryptocurrencies are faster and cheaper. However, such coins are not very popular.

How are stablecoins different?

Each stablecoin has its own system that ensures its value. There is no generally accepted classification of stablecoins, but in general they can be distinguished from each other according to several main criteria:

• The asset class in the reserve is fiat or cryptocurrency.

• Reservation rate. Reserves can cover part of the value of all tokens of a particular stablecoin in circulation, but also match or even exceed it;

• The method of holding the price is either only reserves (mainly for centralized projects), or reserves and an algorithm (this approach is used in algorithmic stablecoins).

What are centralized stablecoins and who manages them?

Most popular stablecoins are issued by centralized issuers. Each of them manages a fund that holds reserves of various assets and securities. The fund regularly undergoes an independent audit, designed to confirm that the declared size and composition of the fund correspond to the real one.

Tether, which manages USDT, the largest stablecoin by capitalization, publishes the results of such reports. on your website. According to an August 2022 audit, Tether’s reserves consist of US Treasury bills, cash, commercial paper, and foreign exchange market funds.

Similarly, they check the accounts of the issuer of BUSD, a stablecoin pegged to the US dollar, which is issued by the Binance exchange.

Stablecoin operators are entities registered in a major jurisdiction. The second-largest dollar-denominated stablecoin, USDC, is managed by a consortium of American companies Circle and Coinbase. He controls reserves, primarily cash and short-term US government bonds. The company that manages the reserves of the BUSD coin operates in the state of New York.

What are the advantages and disadvantages of centralized stablecoins?

On the one hand, centralized stablecoins are very stable, as their price is 100% backed by assets with low volatility. In addition, they are liquid, that is, they are available on almost any cryptocurrency trading platform. Also, popular stablecoins are convenient for mutual settlements and capital storage. It is convenient to place them as a base currency in trading pairs on crypto exchanges.

On the other hand, centralization is a weak point of such coins. Any difficulties with the organization that controls the reserves, including claims from regulators and manipulation of reporting, can lead to problems for all holders of a stablecoin. In addition, it is not known exactly how the stablecoin operator can use the reserves.

A prime example is USDT. In early 2019, the New York State Attorney’s Office charged the Bitfinex exchange that it used the capital of its affiliate Tether to compensate for its own losses of user funds. It was about $ 850 million, access to which the platform lost after they were transferred to the Panamanian processing service Crypto Capital.

Bitfinex repaid the main debt to Tether only at the beginning of 2021 and soon settled the conflict with the authorities. At the same time, investors sued Tether, accusing the company of “illegal and deceptive” practices. In April 2022, the Crypto Capital defendant pleaded guilty to all counts, including the “shadow banking” charge.

What are algorithmic stablecoins?

The stability of some stablecoins is provided not by traditional instruments, but by cryptocurrencies.

Since the value of digital assets can fluctuate dramatically, securing 100% value becomes a challenge. One way to solve it is to introduce a decentralized management system, as well as a special computer algorithm that maintains the value of an asset based on certain principles.

What are algorithmic stablecoins?

One way to ensure the stability of an algorithmic stablecoin is to over-reserve, when the amount of collateral exceeds the cost of the entire issue of the token. The most popular such stablecoin is DAI. This is a cryptocurrency that can be issued by any user using the MakerDAO protocol.

How will stablecoins develop?

After the failure of Terra, the cryptocurrency market, with rare exceptions, lost confidence in algorithmic stablecoins. The main successful project in this area can be called DAI from MakerDAO.

Centralized projects such as Tethere and USDC remain the main players in the stablecoin segment. However, a number of states, including the United States and the European Union, are planning to introduce extensive regulation of stable token issuers, which could make them more difficult to use.

Stablecoins are regularly criticized by regulators and government departments. At the end of 2021, the US Treasury issued a report on the risks of stablecoins, in which they noted the opacity of their reserves and assessed them as a threat to investors. The Fed is confident that stablecoins pose a risk due to possible problems with their conversion to fiat.