Reminder : This month we’re sharing the BUIDL newsletter a week later — on November 27 — due to the U.S. Thanksgiving holiday! And, I dive deep into stablecoins: what they are, key metrics for evaluating adoption and target use cases. Here’s a preview of what you can expect.
What Are Stablecoins?
Stablecoins are often thought of as the holy grail of cryptocurrencies because they offer some of the same benefits as cryptocurrencies (BTC, XRP, ETH, etc.) but are not nearly as volatile as cryptocurrencies.
They are typically pegged to a fiat, government-backed currency like the U.S. Dollar (USD). So, in theory if you hold $1 worth of a stablecoin pegged to USD today, it should be worth the same tomorrow. In theory, stablecoins open up more use cases because there is not a strong incentive to invest and hold (HODL) — by design, they do not appreciate in value.
Stablecoins come in a variety of different flavors, each with their own drawbacks and advantages. In this post, I’ll focus on the two most popular types: (1) stablecoins backed by cryptocurrencies and (2) stablecoins backed by fiat currency.
Crypto-backed stablecoins are usually fully collateralized or backed by cryptocurrency reserves. For example, if there is $1 billion worth of a crypto-backed stablecoin issued to the market, there should be at least $1 billion worth of cryptocurrencies on the blockchain associated with the stablecoin. Smart contracts buy and sell the underlying cryptocurrency to maintain the stablecoin’s peg to a fiat currency.
DAI by the Maker Foundation is a popular crypto-backed stablecoin created on the Ethereum platform. If you own a crypto-backed stablecoin like DAI, you are trusting the smart contract’s ability to manage volatility.
On the other hand, fiat-backed stablecoins are collateralized with fiat currency, like USD, that is held in bank accounts in the name of a corporation that is responsible for creating the fiat-backed stablecoin. For example, if there is $1 billion worth of a fiat-backed stablecoin, there should be $1 billion worth of USD in bank accounts accessible by the named corporation responsible for creating the fiat-backed stablecoin.
Tether is the most popular fiat-backed stablecoin and most recently Circle announced USDC, their version of a stablecoin. Coinbase also recently announced plans to enable its users to hold USDC in the Coinbase wallet. If you own a fiat-backed stablecoin, you are trusting a corporation to hold your USD on behalf of you, and of course, that comes with some drawbacks.
Additionally, it is unclear what regulatory, compliance and sanction screening rules apply to the company behind a fiat-backed stablecoin. Many fiat-backed stablecoins require you to apply, pass know your customer (KYC), and then be accepted before holding and transacting using their fiat-backed stablecoin. This could further fragment adoption and create additional financial silos.
Counter-party free cryptocurrencies such as BTC, XRP and Ether still hold a big advantage in being frictionless, open and fully decentralized so that anyone can participate in blockchain enabled financial access.
“Did anyone actually think that the U.S. government would possibly allow an (fiat) asset-backed Stablecoin with no KYC whitelist *and* no blacklist? We need to be realistic about what we can shoot for. If you want full crypto-decentralization, DAI still exists and works great.”
– Vitalik Buterin
Whether you are a believer in stablecoins or not, data clearly shows stablecoins are growing in popularity and volume.
A number of new stablecoin players have most recently come to the market but there is not a clear winner in terms of volume or market share outside of Tether, which still holds about 97 percent of the stablecoin market share. DAI still dominates the crypto-backed stablecoins.
Since October, fiat backed stablecoins (excluding Tether) are growing in volume faster than crypto-backed stablecoins.
Unbanked exchanges — Tether USD is one of the first mainstream blockchain stablecoins. Tether USD solved a few problems. First, some crypto exchanges do not have a USD banking partner. Customers of these exchanges did not have the ability to deposit, hold and withdraw USD on the exchange itself. Tether allowed customers on these exchanges to hold a USD Tether stablecoin as a reserve when customers want to move out of more volatile cryptocurrencies and hold USD Tether instead.
Moving between exchanges — If you want to move money between crypto exchanges, the options are 1) Bank wire (uh, no thank you) 2) Cryptocurrencies (BTC, XRP, ETH) — you could leverage cryptocurrencies but in the case of BTC and ETH that could be slow and expensive. XRP is a good option for this, but XRP has to be offered at both exchanges (your sending one and the one you want to receive at). Similarly, USD Tether is a popular option when it is accepted at both exchanges. It’s cheap, instant and stable, so if you trust Tether, then this can be a good option.
eCommerce transactions — eCommerce payments continue to grow at a fast pace, and according to research by Forrester over 20 percent of eCommerce purchases will be international by 2022. In many emerging markets where credit cards are not prevalent, mobile wallets leveraging stablecoins could be a solution for facilitating cross-border eCommerce purchases.
Domestic peer-to-peer payment alternatives — In the U.S., the fastest way to send another person a payment in dollars is through a platform such as Paypal. Similiarily, Zelle was created by the largest U.S. banks so that you can easily send payments between banks that are members of the Zelle network. Stablecoins could provide an opportunity for Fintechs to create a more open domestic payments network where one Fintech wallet could send to another and compete with networks like Zelle. Coinbase wallet has already announced plans to enable their customers to instantly send the USDC stablecoin to a Circle wallet (and vice versa).
Derivative financial products (loans) — Stablecoins could also be useful for blockchain use cases that extend over longer periods of time, for example loans that need to be paid back over months. Backing a loan with a stablecoin provides the lender and borrower with assurance on the exact terms of the deal. Imagine if the cryptomarkets crashed and a borrower had to pay back a loan that was suddenly 40 percent more than when it was taken out! Additionally, if a loan is in a fiat-based stablecoin, the borrower can use the funds to buy things in the real world (which, for the most part, relies on fiat currencies).
Stablecoins are gaining momentum and popularity and now make up 20 percent of all volume on crypto exchanges. However, customers should know that in the case of fiat-backed stablecoins, the trust is held in the company or consortium issuing the stablecoin. With a crypto-based cryptocurrency, customers are trusting the underlying smart contract to peg the stablecoin to a fiat currency. While it’s still very early in the evolution of stablecoins, right now these fiat-backed stablecoins are gaining the most traction and popularity.
Emerging use cases for stablecoins range from solving a problem for “unbanked” crypto exchanges to enabling future derivative financial products such as loans. Yet, cryptocurrencies such as BTC, ETH and XRP remain more useful for many other use cases — including truly frictionless, open access — because stablecoins reintroduce some of the same concerns, such as relying on a single company, that distributed-ledger technology and cryptocurrencies were trying to solve for in the first place. They are very fragmented, meaning there are already hundreds of stablecoins with many of them requiring their own rules of engagement. In the case of fiat-backed stablecoins they also rely on a single entity and thus introduce counter-party risk. Counter-party free, trustless cryptocurrencies, like BTC, ETH, and XRP, are still the best way to tie together this fragmented stablecoin ecosystem and enable the the Internet of Value.
Happy Thanksgiving! & Please Sign up for BUIDL below!