Cryptocurrencies are notoriously volatile, which makes people hesitant to invest in them. This is why stablecoins were created, to keep investor money safe. Stablecoins are ideal for investors who want to keep their capital in the crypto markets while also protecting their funds against volatility and risk.
A stablecoin is a crypto asset designed to maintain a stable value, even during periods of extreme volatility. This is accomplished by pegging the stablecoin’s value to another, more predictable asset, such as the US Dollar or gold. This ensures that the stablecoin’s value remains relatively stable even when the rest of the market experiences volatility.
What Are The Different Types Of Stablecoins?
Fiat-pegged stablecoins are backed by currencies like the Euro, GBP, or the US Dollar. These are the simplest stablecoins with a 1:1 ratio backing. This means that one stablecoin would equal one unit of the fiat currency backing it. Examples of fiat-pegged stablecoins include USDT and USDC.
The price of a fiat-pegged stablecoin remains steady relative to the fiat currency. However, this relies on the trusted, centralized issuing party being regulated appropriately.
Commodity-pegged stablecoins are backed by valuable physical assets like precious metals, real estate, oil, and other commodities. This essentially makes them blockchain-based representations of these physical assets, with all the security and accessibility of a digital asset.
The most common commodity used as collateral for this kind of stablecoin is gold. However, it’s important to note that these commodity-pegged stablecoins are only as stable as the asset that backs them.
The leading utility of these tokens is making commodity investments far more accessible. A single hardware wallet can hold billions of dollars worth of gold-backed stablecoins, but physically storing the same amount of gold is a much more involved task.
Algorithmic stablecoins use complex instruction sets to maintain their value and aren’t backed by commodities or fiat currencies. Instead, these tokens are backed by other cryptocurrencies, and making adjustments to their algorithms based on demand and supply. These tokens also often require over-collateralization to mint tokens.
If the stablecoin’s price rises, the algorithm will adjust itself to issue and sell more coins, and when the price falls, the algorithm adjusts itself to buy back tokens to keep prices afloat. These stablecoins are pretty reliable at defending their peg, but unexpected or black swan events can cause irreversible damage to its tokenomics and collateral reserves.
Seigniorage or Non-Collateralized Stablecoins
Like algorithmic stablecoins, these tokens use smart contracts to follow precise instruction sets that maintain the token’s peg. However, seigniorage stablecoins do not have any reserves, instead relying on complex processes that adjust its circulating supply. This includes minting and selling, or buying and burning tokens according to supply and demand levels.
Top 5 Stablecoin Projects
TrueUSD is a USD-backed ERC-20 stablecoin that’s entirely collateralized, secured, and verified by a third party. TUSD is part of the TrustToken ecosystem, which includes other fiat-backed stablecoins, and uses escrow accounts to reduce counterparty risk and provide token holders with legal protections against fund misappropriation. The platform has also partnered with registered fiduciaries and banks to store the TrueUSD tokens’ funds.
Pax Dollar (USDP)
The Pax Dollar is another stablecoin pegged to the US Dollar and was built to improve the broader financial ecosystem by creating a frictionless global network. The firm behind USDP, Paxos, is also responsible for collateral-backed PAXG token, the most popular stablecoin pegged to the value of gold.
DAI is a stablecoin offered by MakerDAO, a decentralized independent organization that employs a system of smart contracts to allow holders to generate or purchase collateralized debt positions (CDPs) in DAI tokens using ETH. Since all operations are run by smart contracts on the Ethereum network, DAI is seen as a more transparent and fair alternative to centralized stablecoins. It leverages margin trading in response to changing market conditions, preserving its value against major world currencies.
PAX Gold (PAXG) is a commodity-backed gold stablecoin issued by Paxos. Each token is physically backed by one fine troy ounce of gold. The PAXG token is centrally minted and burned on Ethereum by Paxos. PAXG allows for exposure to gold markets without using an ETF, futures contract, or other derivative product, but as mentioned above, collateral-backed tokens aren’t necessarily stable.
FEI is an ERC-20 decentralized stablecoin that uses various mechanisms to sustain an efficient and fair capital distribution. It aims to create a technological solution that occupies a sweet spot between decentralized overcollateralized stablecoins and centralized stablecoins. Governed by minter and burner contracts, the platform controls token releases through bonding curves and trade incentives. Additionally, the protocol maintains liquid secondary markets to earn yield using the value under its control.
There is a strange dichotomy between the decentralized ideal of blockchain networks and the fact that centralized stablecoins are the most widely used cryptocurrencies in the world. Moreover, there are serious concerns about whether these organizations have sufficient financial reserves to maintain 1:1 collateral of their issued fiat stablecoins, especially in a crisis.
These ratios require providers to hold reserves of financial assets equivalent to the value of stablecoins in circulation, which varies based on investor demand. However, these risks may reduce as more stablecoins arrive on the market and better regulation is constructed to handle them.
Stablecoin development is one of the next big things in the crypto space. With businesses entering this domain for extensive rewards and profits, stablecoins are predicted to become one of the most potent driving forces of the future digital economy.