STABLECOINS
Stablecoin is literally “stable money,” a class of cryptocurrency whose rate is tied to real assets, such as fiat money or gold. The stability of real assets is also in question. Since the price of gold is not constant, the value of fiat money depends on inflation. But, nevertheless, stablecoins are accepted by the majority and perform functions to minimize the impact of price volatility on the crypto market. The price volatility of stablecoins is significantly less than that of other cryptocurrencies and is located in a narrow price range. This type of cryptocurrency gives market participants a clear point of reference and acts as a stable means of monetary exchange. For example, having bought a product for bitcoins, the buyer would feel sincere disappointment if he found out that the next day the price of bitcoin went up by 10% and it would be possible to save this 10%.
TERMINOLOGY
• Taking profits in transactions with cryptocurrencies. Stablecoins allow you to lock in the value of other cryptocurrencies at the time you exit a trading position on the exchange.
• A tool for preserving value between transactions on the stock exchange.
• Receiving passive income (staking).
• A tool for preserving value between transactions on the stock exchange.
• Receiving passive income (staking).
Stablecoins are a separate class of currencies that also serve as working capital.
Some options for using stablecoins:
TYPES OF STABLECOINS:
DECENTRALIZED STABLECOINS are those that are issued by decentralized protocols or algorithms. The implementation mechanisms for decentralized stablecoins can work in different ways. The main difference from centralized ones is that the issuer does not have the ability to issue coins at will. The emission of decentralized stablecoins is strictly regulated by algorithms specified in the smart contract.
The most famous centralized stablecoins include: USDT (Tether), USDC (Circle) and BUSD (Binance). They have the largest capitalization and liquidity.
The issuing company has the ability to track any movement of its currency, theoretically determine the owner of the asset, and block the funds.
CENTRALIZED STABLECOINS are issued, managed and regulated by private companies. The activities of such companies are under the control of government financial market regulators. These companies are responsible for both the security of their stablecoin and the asset backing it. Issuers hold fiat money in their accounts at a ratio of 1:1 to the number of stablecoins. It is worth clarifying that parity must be confirmed by a reputable audit. Otherwise, doubts may reasonably arise about the real security of the stablecoin.
CENTRALIZED AND DECENTRALIZED STABLECOINS
• centralization;
• transparent audit is required;
• withdrawing a stablecoin to fiat is relatively expensive and not always fast.
• withdrawing a stablecoin to fiat is relatively expensive and not always fast.
MINUSES
• the most stable price;
• ease of implementation;
• Since the collateral fund is not stored on the blockchain, there is less vulnerability to hacking.
• ease of implementation;
• Since the collateral fund is not stored on the blockchain, there is less vulnerability to hacking.
PROS
BACKED BY FIAT MONEY
The simplest explanation of the mechanism of such a stablecoin: $1 is deposited into the guarantee account and the person who deposited the money is issued an IOU (stablecoin) for the same amount. The owner of the guarantee account is obliged to redeem the promissory note upon presentation for $1. Obviously, this is a centralized scheme, since there is an issuer of stablecoins, who is also the holder of the guarantee fund. It is also clear that the stability of the entire system depends on the honesty of the issuer. He may have a desire to increase his profit, for example, by using fiat in other transactions, including those with increased risk. Or issue stablecoins that are not backed by real money. The solution to this problem is regular audit of the issuer. But, as practice shows, the same Tether for the entire time of its existence has never provided sane confirmation of the presence of collateral in a 1:1 ratio. And we are talking about $80 billion.
Stablecoins are backed by fiat money, less often by precious metals. They have the largest capitalization, since users who are accustomed to fiat money can easily understand the mechanism for forming the price of such a stablecoin.
STABLECOINS BY TYPE OF COLLATERAL
• a stablecoin can be liquidated during severe market turmoil due to a fall in the price of the underlying asset;
• less stable price than in the case of stablecoin support using fiat funds;
• inefficient use of capital to support the stablecoin;
• the great difficulty of implementing such stablecoins.
• less stable price than in the case of stablecoin support using fiat funds;
• inefficient use of capital to support the stablecoin;
• the great difficulty of implementing such stablecoins.
MINUSES
• more decentralized compared to fiat-backed ones;
• exchanging a stablecoin into the base currency is quite simple;
• the degree of collateral of a stablecoin is easily verified.
• exchanging a stablecoin into the base currency is quite simple;
• the degree of collateral of a stablecoin is easily verified.
PROS
BACKED BY CRYPTOCURRENCY
This type of token is more vulnerable due to price volatility, and in case of a critical drop, the stablecoin can be liquidated due to the depleted collateral fund. Therefore, the only way to prevent this threat is to back the stablecoin as much as possible. Which, in turn, saves the situation, but makes the whole scheme very capital-intensive.
Stablecoins backed by other cryptocurrencies. How to implement this if cryptocurrencies have high volatility? The collateral must be such as to absorb possible fluctuations in the supporting asset. For example, an amount of ETH (Ethereum) equivalent to $200 is reserved as collateral. And stablecoins are issued for $100.
• difficulty of use;
• complexity of system analysis;
• strong dependence on the market situation;
• the scheme only works if there is a stable demand for such a stablecoin;
• high degree of vulnerability.
• complexity of system analysis;
• strong dependence on the market situation;
• the scheme only works if there is a stable demand for such a stablecoin;
• high degree of vulnerability.
MINUSES
• no collateral required;
• high degree of decentralization.
• high degree of decentralization.
PROS
The stability of the algorithmic stablecoin system directly depends on the demand for them. If there is no user trust in the stablecoin system, it simply cannot exist. An example of the successful implementation of this type of stablecoin is Terra USD (UST) with a capitalization of $15.9 billion.
The rate of an algorithmic stablecoin is regulated as follows. If its rate increases, then additional stablecoins are issued. If it falls, then stablecoins are bought back from the market using profits from seigniorage. If this profit is not enough to settle the exchange rate, then the Seigniorage Shares mechanism used by Central Banks is used.
Seigniorage is the difference between the cost of producing a monetary unit and its face value. A simplified example to understand how this works in practice. The Federal Reserve issued a $100 note. Let’s say the cost of issuing such a banknote is 20 cents. The issuer’s profit amounted to $99.8.
WITHOUT COLLATERAL (ALGORITHMIC STABLECOINS)
To eliminate the shortcomings of the two previous types of stablecoin collateral, a third method was developed – without collateral. The idea is not new, the US dollar is also not backed by an underlying asset, however, it has maximum distribution throughout the world. The stability of the exchange rate of such a stablecoin is regulated through the use of smart contracts and seigniorage .
POPULAR STABLECOINS:
USDT (TETHER)
Stablecoin USDT (Tether) is centralized, backed by the US dollar in a 1:1 ratio. In fact, it is a whole family of stablecoins, since it includes USDT coins issued for different blockchains. Currently it operates on the following networks: Algorand, Ethereum, EOS, Liquid Network, Omni Protocol, Tron, Solana, Bitcoin Cash.
USDC (CIRCLE)
The USDC stablecoin is centralized and fiat-backed. The issuer is the Center consortium. The founders of the consortium are the cryptocurrency company Circle and the Coinbase exchange.
BUSD (BINANCE)
BUSD is issued on the Ethereum blockchain. Capitalization $17.5 billion. Commissions for transfers on the BEP-2 network are $0.5, on the BEP-20 network — $0, on the Ethereum network — $15 (for transfers to Binance).
DAI
The MakerDAO stablecoin rate is pegged to the US dollar rate in a 1:1 ratio. The collateral is various digital assets. The generation of stablecoin tokens is carried out by the Vaults system . The user deposits a certain amount of collateral tokens into the smart contract, and Vaults generates DAI.
TUSD is a centralized stablecoin backed 1:1 by the US dollar.
• working capital, hedging and secured loans;
• trade payments, cross-border transactions and remittances;
• charitable and non-governmental organizations;
• game industry;
• prediction markets.
• trade payments, cross-border transactions and remittances;
• charitable and non-governmental organizations;
• game industry;
• prediction markets.
The token operates on the following networks: Ethereum, Tron, Binance Smart Chain, Binance Chain, AvaChain. Capitalization $1.36 billion. Staking and token farming are possible on DeFi platforms.
The issuer of USDP is Paxos Standard. The stablecoin is fully backed by the US dollar in a 1:1 ratio. USDP is completely centralized not only because it is issued by a private company, but it is regulated by the New York State Department of Financial Services, USA. The token operates on the Ethereum and Binance Smart Chain networks. USDP capitalization is $0.95 billion.
These are the TOP 7 stablecoins by maximum capitalization according to Coinmarketcap . In total, there are 75 stablecoins according to the same source.
A natural question may arise: why is this necessary? Expanding the market, increasing liquidity by increasing the number of trading pairs – such integration increases the capitalization of the stablecoin and the income of the issuing company.
Why do users need this?
In any of the blockchains in which a stablecoin exists, users get access to an understandable, secured, non-volatile asset in which they can take profits and hold funds between transactions.
In addition, the stablecoin receives all the advantages or disadvantages of the network on which it is issued. This could be the speed of transaction processing or network fees. Compare, a USDT (ERC-20) transaction will cost $10, and a USDT (TRC-20) transaction will cost $1 (for transfers to Binance). In this regard, an important point is that a stablecoin can only be transferred on the network in which it was issued. Otherwise, the funds will be lost.
Circle plans to go public in December 2022; the company’s estimated value has grown to $9 billion. This is largely due to the fact that since July 2021, USDC turnover has doubled. Capitalization of USDC is $52.5 billion. Unlike USDT, USDC undergoes regular accounting audits .
Stablecoin is available on networks: Ethereum, Algorand, Avalanche, Hedera, Solana, Stellar, Tron, Flow.
Commissions average about $1, on the Ethereum network – $10 (for transfers to Binance).
It must be said that although the UST token is considered algorithmic, a security fund of $3 billion is being formed against it, with plans to increase it to $10 billion. In this regard, it should be noted that $1.2 billion of this security was decided by Terra management place in USDT. A further increase in the reserve fund will occur, including through income from seigniorage.
Thus, the DAI token is a debt obligation to Maker DAO, secured by collateral. The system is regulated by the liquidation mechanism. When the value of the collateral is less than the liquidation ratio, the position is liquidated. DAI capitalization $9.68 billion.
HOW DO STABLECOIN ISSUING COMPANIES MAKE MONEY?
• Fees for issuance and redemption of stablecoins. The average is 0.1%.
• Earnings on the spread between supply and demand. The amount of earnings can be measured in tenths or hundredths of a percent.
• Investing collateral in safe assets, such as short-term US government bills.
• Earnings on the spread between supply and demand. The amount of earnings can be measured in tenths or hundredths of a percent.
• Investing collateral in safe assets, such as short-term US government bills.
INCOME ITEMS FOR STABLECOIN ISSUERS
This is not a complete list of income items. Financial mechanisms provide ample opportunities for earning money. If the issuer is an exchange, then it does not necessarily issue stablecoins for direct earnings. The reason may be both convenience for its clients and increased liquidity.
Companies that issue their stablecoins have a financial interest. By gaining access to amounts amounting to billions of dollars and having even a small percentage, you can earn huge money. Earnings depend on the mechanism for issuing the stablecoin and the growth of the network.
PASSIVE INCOME ON STABLECOINS
According to the Staking Rewards service , using staking, you can get the following annual rate:
USDT – 8.81%
USDC – 7.53%
BUSD – 8.12%
DAI – 6.66%
USDC – 7.53%
BUSD – 8.12%
DAI – 6.66%
Another way to generate passive income on stablecoins is by participating in liquidity pools. As you can see in the screenshot above, the Binance exchange in the Liquid Swap section offers to place some stablecoins at an interesting percentage, many times more than in staking. It should be taken into account that the reward is paid in a token, which is indicated in pair with the stablecoin.
CONCLUSIONS
Which ones will be in the portfolio: centralized or decentralized, backed by fiat, cryptocurrencies or algorithmic? In what proportion these stablecoins will be in the portfolio – all this depends on the investment strategy and risk management of the investor.
Obviously, centralized stablecoins are more clear to investors regarding their collateral. Therefore, they can be considered as a haven for your funds during periods of uncertainty.
Stablecoins are a tool that helps protect capital from the volatility of cryptocurrencies. To have a balanced and protected portfolio of assets, it makes sense to diversify the stablecoins themselves.
Among centralized stablecoins, USDT looks a bit risky compared to other tokens. This is due to the opacity of reporting on the security of this token, with repeated claims from financial regulators against Tether. This issuer has been subject to numerous fines . Of course, you shouldn’t completely get rid of this token, but you should be more careful about its share in your investment portfolio.
At the same time, USDC is performing well. As already indicated in this review, since July 2021, the token’s capitalization has doubled. USDC liquidity is growing, it has a strong issuer behind it, transparent reporting, and ensuring confirmed money in accounts. It definitely makes sense to diversify into it. If the size of investment capital allows, then it is worth placing part of it in other centralized stablecoins: BUSD, TUSD, USDP. The same BUSD, if an investor uses the Binance exchange, will, by the way, also be used in trading.
It is worth mentioning once again the possibility of any centralized stablecoin being blocked either at the request of the issuer, or under pressure from financial market regulators. Such cases occur, and this can seriously hit capital.
Decentralized stablecoins, despite their lower liquidity, still have widespread adoption, especially in the DeFi space. Their attractiveness also lies in the absence of influence on them from both financial regulators and the issuer. Since the terms of the issue are clearly encoded in the smart contract and theoretically cannot be changed.
If we consider UST and DAI, their risks are more related to the market, with the popularity among users of both the stablecoin itself and the native token of the network. That is, with the development of the parent protocol.
Regarding UST, the following remark needs to be made. As stated above, for this initially algorithmic protocol, the issuer has already formed a reserve fund of cryptocurrencies. This seems to be to the benefit of the token owners, because they now have material support. On the other hand, isn’t this the beginning of the centralization of UST? Investors who are more inclined to decentralize their assets should take this fact into account.