Choosing the Right Stablecoin
Stablecoins have ballooned in size over the past few months as Bitcoin and other digital assets experience extreme volatility. According to data compiled by The Block, the total market capitalization of all stablecoins stand at around USD 180 billion, up from USD 38 billion just a year ago. By comparison, the total digital asset universe has largely remained stagnant over the past year.
The growing market share of stablecoins indicate the growing demand and importance. With over 200 stablecoins presently in the stablecoin ecosystem, it can be difficult for investors to choose between the different options.
What factors to consider?
Stablecoins differ in how they are created, their peg mechanics, and their usability. Consequently, these differences result in varying levels in:
- Security
- Transparency
- Stability
- Yields
Let’s take a look at the most common stablecoins…
Tether (USDT):
Originally founded in 2014, USDT sits rightfully atop the list of stablecoins. It has a USD 80 billion market capitalization, which is almost double the next highest stablecoin. Due to the nature of being fiat-backed, USDT is very secured and stable. In other words, USDT is backed by at least 1:1 ratio with assets held in the form of cash or cash equivalents by Tether Operations Ltd. — implying USDT can always be redeemed for an equal dollar value.
However, some community members believe USDT lacks transparency as audit reports are not frequently procured and disclosed. Despite paying a settlement over accusations of a lack of financial transparency from the NY attorney general’s office, a later audit report by Moore Cayman confirmed the number of issued USDT does not exceed the assets held by the company.
As a consequent of being the first mover and largest stablecoin, investors by and large have adopted USDT as their main choice of preference. Both centralized and decentralized exchanges also choose USDT as the main trading pair. This has led to compressed DeFi yields as pools with USDT are likely to have the highest total value locked (“TVL”); thus, diluting rewards for liquidity providers/depositors.
USD Coin (USDC):
Founded along with digital asset exchange Coinbase Global Inc., USDC is pegged to the U.S. dollar by way of being fiat-backed. Both security and stability are undoubtably high by nature of being fiat-backed. Unlike USDT, USDC reserves are attested monthly by Grant Thornton LLP. It is worth noting that attestations are not the same as audits. An attestation means the firm will check the validity of existing data but won’t perform additional audits for data inconsistencies.
USDC is deemed safe by being fiat-backed but also by its association with Coinbase. Recent trends indicate that USDC has been gaining market share against USDT although its total market capitalization is still USD 53 billion, which is materially less than USDT’s market capitalization.
Regarding DeFi yields, certain USDC pools have recently surpassed USDT pools in TVL which reflects the growing preference for USDC. Generally speaking, yields on USDC is slightly higher than USDT. However, USDC tends to have a lower yield on money markets as USDC typically receives a higher collateral factor — making them more attractive to post as collateral.
Binance USD (BUSD):
BUSD is the third largest stablecoin with a USD 18 billion market capitalization. Similar to USDT and USDC, BUSD is fiat-backed and issued by Paxos Trust Co., Binance’s partner behind BUSD. In August 2020, BUSD was “greenlisted” by the NY State Department of Financial Services. Furthermore, the regulators are also responsible for overseeing its reserves and all reserves are required to be held in credible forms such as U.S. Treasury instruments and FDIC insured bank accounts. This makes BUSD one of the most secured and stable option on the market.
However, the biggest downside for BUSD is its concentration on Binance Smart Chain (“BSC”). BUSD is not commonly used on other blockchains outside BSC, making DeFi opportunities for BUSD quite limited. Despite this limitation, certain niche BUSD pools outside BSC can be lucrative if offered by protocols.
TerraUSD (UST):
Unlike the examples above, UST is not backed by any real-world or on-chain asset. It is an algorithmic stablecoin minted/burned against its volatile counterpart, LUNA token. UST’s mechanics is relatively straightforward. The Terra platform allows the minting/burning of UST against LUNA to enable the market to control the supply of UST to secure and maintain the 1 U.S. dollar peg.
Unlike the fiat-backed options, UST is exposed to smart contract risk and requires market participants to maintain its peg. In a market downturn, if there are not sufficient arbitragers, UST can enter a ‘death spiral’ where UST experiences a constant sell-pressure while LUNA is also losing its value simultaneously. This creates an unfavorable environment which may deter arbitragers from trying to secure UST’s peg.
On the other hand, due to the uncertainties of its security and stability, yields on UST are highly attractive for liquidity pools and deposit lending pools. Furthermore, due to its nature of the Terra platform operating on the blockchain, UST is highly transparent.
DAI (DAI):
DAI is a digital asset-backed stablecoin. More specifically, it’s backed by an overcollateralized digital asset debt position. It is issued and maintain on the blockchain by MakerDAO. Users are required to provide collateral to mint the DAI stablecoin and collaterals are liquidated if the proper loan-to-value is not maintained.
In 2017, the ETH token saw over a 30% correction within 24 hours where hundreds of millions of collateral on the protocol were liquidated to protect the integrity of its DAI stablecoin. Following the days of the correction, DAI traded slightly below its pegged value before fully recovering the 1 U.S. dollar value.
Although it could take a few days for the peg to be fully recovered, DAI is considered one of the safest digital asset-backed stablecoin and most transparent due to the project being on the blockchain. However, its stability can be argued to be lower than the fiat-backed stablecoins. In terms of DeFi yields, DAI regularly ranks above the fiat-backed options due to its generally low pool TVL.
Conclusion:
By way of how stablecoins are minted and their peg mechanics, different stablecoins can vary in terms of security, transparency, stability, and usability. Investors who value security and stability should allocate more of its capital in fiat-backed stablecoins. Investors who seek absolute yields should allocate more of its capital in algorithmic stablecoins. And investors who are in between the two absolutes should consider digital asset-backed stablecoins.
At the end of the day, diversification and risk management should remain the top two priorities for both retail and institutional investors. Investors should allocate their capital across the different stablecoin categories with preference towards the category where the unique characteristic is valued by the investor.
Safe and Stable: USDT, USDC, BUSD, TUSD, etc.
DeFi Yields: UST, FRAX, FEI, etc.
Middle Ground: DAI, MAI, ALUSD, MIM, etc.
Compound Capital Partners is an open-ended fund, providing access to the digital asset class through its dual approach in stablecoin and delta-neutral yield farming.
Twitter: https://twitter.com/investcompound
Website: https://www.compound.capital/
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