Bitcoin, the largest cryptocurrency by market cap, is famously volatile. Launched in 2011, it reached a feverish high of almost USD20,000 on 17 December 2017 before crashing to around USD11,000 some 4 days later. The lack of price stability plaguing both Bitcoin and altcoins is holding back cryptocurrencies from displacing fiat currency. The price volatility issue has prompted resulted in a trend towards stablecoins or price-stable currencies.
What are stablecoins?
Stablecoins are are cryptocurrencies which are pegged to a “relatively stable” asset, like USD or gold. This makes them more reliable as a store of value, medium of exchange, and unit of account.
Stablecoins can be put into three main categories:
- Fiat-backed
- Crypto-backed
- Algorithmic
Here’re the key differences TABUL8TED!
On 6 January 2020, Binance, one of the largest cryptocurrency exchanges in the world announced that it obtained NYDFS (New York State Department of Financial Services) approval for its BUSD stablecoin.
Fiat-backed Stablecoins
Fiat-backed stablecoin systems accept fiat currency as collateral, store it with custodians and issue tokenized IOU vouchers (stablecoins) on a 1:1 basis.
Here’re the key details on the three most popular fiat-backed coins (Tether (USDT), USD Coin (USDC) and TrueUSD TABUL8TED!
Commodity-backed Stablecoins
Crypto-backed Stablecoins
Crypto-backed stablecoins maintain reserves of crypto-assets, held in smart contracts.
MakerDAO’s DAI is widely considered the most promising crypto-collateralized stablecoin. Unlike other Stablecoins, DAI is completely decentralized. DAI is created by locking ETH into a decentralized smart contract. The user can deposit any of the acceptable collateral assets in the system and receive a smaller amount of DAI in return. Single Collateral Dai (Sai) only supports one type of collateral — Pooled Ether. Multi-Collateral Dai (Dai) supports any number of Collateralized Debt Positions (CDP) — including Augur (REP), Basic Attention Token (BAT), DigixDAO (DGD), Ether (ETH), Golem (GNT), OmiseGo (OMG), Ox(ZRX).
In a new feature called the Dai Savings Rate (DSR), Dai holders can earn interest on Dai by locking their Dai into a DSR contract.
Algorithmic Stablecoins
Algorithmic stablecoins typically consist of a stablecoin and a token that backs the stablecoin. Algorithmic stablecoins maintain their peg to fiat currency by creating and destroying supply through a swap with another token. The most prominent example of an algorithmic stablecoin is TerraUSD (UST) and the free-floating altcoin LUNA.
When UST’s supply cannot meet demand, its price will exceed USD1. The Terra protocol lets users trade 1 USD of LUNA for 1 UST. This trade burns 1 USD of LUNA and allows the user to sell 1 UST for USD 1.01.
When UST’s supply exceeds demand, its price will fall below USD 1. The Terra protocol lets users buy 1 UST for USD 0.99, and trade 1 UST for 1 LUNA. The trade burns 1 UST and mints 1 USD of LUNA, netting the arbitrage trader a profit of .01 UST.
In May 2022, UST started to depeg from USD. LUNA could not be minted fast enough to prop up UST.
Concluding Thoughts
Despite all the hoo-ha about decentralization that blockchain technology was supposed to bring about, the world seems to be gravitating back to a centralized model. Hot-button developments include Central Bank Digital Currencies (CBDCs) — with China racing to be the first major economy to issue a CBDC.
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- READ MORE:
- Read TABUL8TOR’s beginner’s guide to cryptocurrencies, cryptoccurrency exchanges, cryptocurrency wallets.
- Read TABUL8TOR’s post on The Central Backed Digital Currency Race.
- Read TABUL8TOR’s review of cryptocurrency cards and cryptoback apps.
***Disclaimer: This post is for informational purposes only and does not constitute a recommendation to buy cryptocurrencies. Please do your own due diligence before taking any action.
