Stablecoins Top the List of Risk-Free Assets: How to Pick the Right Stablecoins?
With the collapse of UST still overshadowing, the pace of the crypto market slows down. Stablecoins have thus become the best choice in the current bear market for their security, stability, and decent rate of returns. However, not all stablecoins share these three characteristics. Stablecoins fall into the following categories: those pegged to fiat money, those with over-collateralization, and those based on algorithms. At present, fiat-pegged stablecoins are still the overwhelming force in the market, with the other two striving for bigger market shares. Today, Truly is to discuss details and pros and cons of different types of stablecoins to help you choose the ones that best suit your needs.
What Are Stablecoins?
Literally speaking, stablecoins are a type of cryptocurrency with stable value. Pegged to an asset at a fixed ratio, stablecoins are much less prone to price swings within a short timeframe and can therefore keep their prices relatively stable.
Types of Stablecoins and Their Pros and Cons
Stablecoins fall into the following categories: those pegged to fiat money, those with over-collateralization, and those based on algorithms.
Fiat-pegged stablecoin (Truly rating: 4.5 stars)
Examples: USDT, USDC, TUSD
Fiat-pegged stablecoins maintain a 1:1 ratio with their respective fiat currencies. Usually, this requires a certain amount of fiat currency as collateral — a simple and prudent mechanism. However, such a mechanism requires a centralized intermediary as a custodian to ensure the issuance and convertibility of stablecoins. Meanwhile, it requires periodical auditing to ensure that stablecoins are fully collateralized.Traditionally, these stablecoins are pegged to the US dollar. But they can also be pegged to gold, silver, or even crude oil.
Take TUSD as an example. It is the first USD-pegged stablecoin that is verified by an independent institution and provides 24/7 live on-chain attestations by Armanino, one of the largest US-based accounting firms, to ensure the 1:1 ratio of USD reserves to circulating token supply. Users can access the publicly available audit results via the official website at any time.
Pros: With a simple minting process and a stable price, it works as a safe-haven asset when the crypto market falls
Cons: Periodical audits are needed to ensure its transparency; as a centralized stablecoin, it requires a trusted custodian to hold the fiat assets
Over-collateralized stablecoin (Truly rating: 3.5 stars)
Examples: DAI, MIM
An over-collateralized stablecoin valued at $1 is generated from the collateralization of assets worth over $1; it can be backed by unstable tokens such as ETH, platform tokens, and LP tokens. The risk of this type of stablecoin lies in the volatility of the underlying collaterals, which are also hosted on the blockchain. So the liquidation mechanism is crucial to the issuing platforms.
Pros: On-chain collateral is fairer and more transparent, providing fast and low-cost liquidation.
Cons: Such stablecoins are backed by collaterals, a plunge of whose price may trigger an automatic liquidation due to under-collateralization, so their prices are not as stable as those of the fiat-backed stablecoins. Also, the fund utilization rate is relatively low.
Algorithmic stablecoin (Truly rating: 2 stars)
Examples: UST, DAI
Algorithmic stablecoins rely on algorithms to determine their supply. Free from human intervention and by regulating the coin supply, such algorithmic systems encourage the markets to speculate on the tokens using their own protocols to maintain price stability.
Pros: Price stability is maintained through arbitrage, thus resolving the problem of low fund utilization.
Cons: Prices of the underlying collaterals can become highly volatile when the market loses trust in the protocol, resulting in the failure to maintain the coins’ price stability.
Algorithmic stablecoins are subject to de-pegging from time to time due to their inherent mechanisms.For instance, TerraUSD (UST) kept losing its peg to the U.S. dollar, and Luna almost completely collapsed from over $100 to $0.27, plunging 99.66% in a single month. UST has been in similar situations before, but this time its crash caused more people to lose confidence in the algorithmic stablecoin and exacerbated the market turmoil.
In March and April 2022, the Fantom-based derivative protocol DEUS Finance was attacked twice, losing $3 million and $13.4 million worth of tokens, respectively. In mid-May, the hybrid algorithmic stablecoin DEI started to lose value and became severely de-pegged by the end of May, with its price diving to $0.43.
In addition, the Fantom-based DeFi lending protocol Scream incurred a $35 million bad debt due to its failure to adjust the prices of twin de-pegged stablecoins, FUSD and DEI. FUSD has since fallen to $0.69, and DEI to $0.52.
Despite the occasional de-pegging, algorithmic stablecoins are an integral part of the crypto market, and their underlying mechanism should be further optimized. And Truly is looking forward to a crypto market with better-performing algorithmic stablecoins.
Stablecoins are indispensable to DeFi in the sense of a medium of asset exchange, rather than a store of value. As the underlying mechanism improves, stablecoin of all types will undoubtedly create greater value in the crypto market.
Truly hopes that you can choose stablecoins that truly suit you and maximize their value. Don’t forget to leave a comment if you want to know more!