Seeing as stablecoins have become much more prominent as part of the crypto conversation, we recently published a general overview of the stablecoin landscape. While that blog post provides lots of great information, there was so much to write about that we decided to turn it into a two-part series, with this post giving you more essential information.
In this article, we will do a quick recap on what stablecoins are and the benefits they provide, and then go on to look at the different types of stablecoins, and the top stablecoins to watch.
What are stablecoins?
A stablecoin is a cryptocurrency that holds a consistent value relative to an asset. This stablecoin definition is very broad because as we will discover later, the asset doesn’t have to be physical. Presently, the safest stablecoin tends to be considered one that is pegged to the US dollar, although this is not a fail-safe guarantee that the coin will stay at exactly $1 at all times.
To read more about what is a stablecoin and what keeps them stable, check out our blog DeFi in detail: Exploring the stablecoin landscape.
What are the benefits of stablecoins?
Stablecoins are designed as a simple, stable, and scalable store of value to be used for transactions with a focus on security, settlement speed, and transparency. The main benefits are as follows:
Transaction costs cut – When considering the costs involved sending money abroad (which we will speak about more below), stablecoins offer a quicker and cheaper alternative. Sending stablecoins involves lower fees and almost instant settlement as a direct P2P transfer, which makes them ideal for foreign workers and businessmen sending money to different countries. Bitcoin can be used in exactly the same way, but its volatility means the price could drastically change by the time a currency lands in the wallet of the recipient.
Safe haven currency – Whenever the cryptocurrency market is exhibiting greater volatility than usual, traders have the option of temporarily moving their digital currencies into stablecoins to hedge against any sudden drops.
Gaining interest – Especially in the DeFi space, stablecoins are used to help run and expand protocols, which is why attractive rates of interest are offered for people who buy stablecoins and then stake them.
Advantages on exchanges – Despite the increasing instances of fiat to crypto trading pairs on the bigger platforms, stablecoins can move between exchanges much more quickly and often at a better rate than if you were to use fiat currencies. Tied to the point above, using an exchange’s native token confers greater advantages, as it is in the exchange’s interest for you to hold them.
Battling inflation – In countries with currencies that typically see high inflation, stablecoins provide a hedge against fluctuations and the reduced purchasing power of a local currency.
What are the types of stablecoins?
Fiat-collateralized stablecoins are pegged to real-world currencies, such as US Dollars or Euros. Each stablecoin is (or should be) backed up by a real unit of currency locked away in reserve as collateral. Tether (USDT) and USD Coin (USDC), the top stablecoins by market capitalization, are pegged to the US Dollar.
Commodity-collateralized stablecoins are backed by hard assets such as precious metals, real estate, and oil. Gold is a popular commodity, with coins such as PAX Gold (PAXG) boasting a market cap of US$310 million (at the time of writing).
Crypto-collateralized coins are backed by cryptocurrencies and are usually over-collateralized due to market volatility. Dai (DAI), the largest crypto-collateralized stablecoin with a market cap of US$5.5 billion, requires an over-collateralization, so if there is a sudden market drop, the value of the DAI you have bought can still be covered. If the price of the collateralized cryptocurrency drops enough, the DAI stablecoin will be automatically liquidated.
The beauty of crypto-collateralized stablecoins is that they don’t have to just be pegged to one asset. While Dai could originally only be collateralized with Ethereum, now there is the option to use BAT, USDC, wBTC, COMP, and more.
Non-collateralized stablecoins are, as the name suggests, not backed by any asset. Rather, an algorithm is used to balance the supply so that the price remains consistent. Compared to the work of a central bank, these stablecoins are based on an algorithm that mints tokens to increase supply when the asset increases in value, then destroys tokens when the price drops below the desired price. TerraUSD (UST) and sUSD (SUSD) are popular non-collateralized stablecoins and have been quite successful in their endeavor, barring some flash rises and crashes.
According to the McKinsey 2020 Payments Report, it is estimated the financial system is making $2 trillion each year from payment facilitation. With stablecoin growth topping $100 billion, banks and governments can no longer treat this cryptocurrency as a fringe tech movement, and are accelerating studies looking into the feasibility of Central Bank Digital Currencies (CBDCs), which will offer greater regulation and monitoring than their private counterparts.
Overall, this should prove to be a win for average consumers who have never interacted with stablecoins before, as they will more likely see cheaper and quicker transfers, with greater interoperability when sending money beyond borders.
Furthermore, if we look at stablecoins themselves, people are constantly assessing how to improve them, A recent article from CoinDesk points to ideas around algorithmic stablecoins that aim to leave behind the dollar standard to track indexes such as CPI, offering a better account of the true value of money at any given time. By algorithmically linking a stablecoin to more than one index, you could get a cryptocurrency that is rock solid, fortifies holders from the effects of inflation, and is not troubled by things such as a change of government, which can cause instability in a central bank currency.
Top 10 stablecoins
While there are more tokens entering the market by the day, here is our list of stablecoins that we think you should know about. Widely used, up and coming, or offering something groundbreaking, these are firmly on our radar.
- Tether (USDT) – Tether needs to be mentioned here, as its $61 billion market cap gives it a greater valuation than all other stablecoins combined. Although claiming it would be 1:1 backed by US Dollar reserves, there has been a lack of transparency, with recent legal documents showing just 74% of minted tokens are backed by physical dollars. Despite this, stability and wide listing on exchanges mean it is bought and sold without problems by people across the globe every day.
- Dai (DAI) – Dai is one of the tokens that helped fuel DeFi’s rapid expansion in 2020; however, it can also be bought on centralized exchanges. Dai is considered the best stablecoin by some, as it is algorithmic and decentralized, which allays some fears about one company gaining a centralized stablecoin monopoly.
- Binance USD (BUSD) – Approved by the New York State of Financial Services, Binance USD is another stablecoin pegged 1:1 to the US Dollar. Users are incentivized to use BUSD on the Binance platform through lower fees and high staking rewards.
- USD Coin (USDC) – USDC prides itself on the fact that it is highly regulated and transparent, regularly publishing statements showing its cash reserves. Just recently Circle (the company behind USD Coin), merged with Concord Acquisition Corp — a special purpose acquisition vehicle (Spac) — to be listed on the New York stock exchange with a valuation of US$4.5 billion.
- Digix Gold (DGX) – While gold-backed stablecoins have had a high fail rate in the past, Digix Gold incorporates third-party auditing to maintain confidence in its established ERC-20 token. Each DGX represents one gram of gold, which is backed up by reserves located in Singaporean and Canadian vaults.
- Gemini Dollar (GUSD) – Gemini is yet another ERC-20 stablecoin built on the Ethereum network with physical USD reserves. Released in 2018, it was one of the first stablecoins to receive recognition from US regulators. In order to improve the relationship between traditional financial institutions and crypto stablecoins, it takes its auditing very seriously and has implemented KYC and AML screening to improve security.
- Tether Gold (XAUT) – Joining Tether’s US dollar and Euro (EURT) stablecoins is Tether Gold, with each token linked to one ounce of gold. XAUT is available as an ERC-20 token on the Ethereum blockchain and as a TRC20 token on the TRON blockchain, with ownership, like DGX, linked to specific gold bars that can be redeemed either as physical gold, or a dollar equivalent if requested.
- Ampleforth (AMPL) – AMPL is another of the more advanced stablecoins. Algorithmic and uncollateralized, it turns price volatility into supply volatility. If the price goes above $1, a user will get more tokens, if less than $1, fewer tokens, keeping their proportion of the overall supply stable. Unlike stablecoins linked to the US Dollar, AMPL hopes to remain unaffected by inflation.
- Terra (UST) – Nearing the end of our stablecoins list, we turn to UST, the Terra blockchain’s stablecoin that focuses on scalability within the DeFi sector. Terra has also been a feature of the DApp space, as platforms minting fungible synthetic assets and tracking physical assets use UST as a benchmark for pricing.
- Frax (FRAX) – Billing itself as the first fractional-algorithmic stablecoin, Frax is largely backed by USDC and is currently operating on the Ethereum blockchain. Although tracking the US dollar now, Frax is the stablecoin mentioned above that aims to track CPI in the future.
As we can see from all the innovation and investment in the crypto space, stablecoins are positioned to have a bright future as part of the wider global financial system. While much is made of cryptocurrencies and blockchain being “the wild West”, part of stablecoin development involves clearing regulatory hurdles, in order to show users that their tokens are indeed safe to transact with.
While physical asset-backed currencies currently dominate, the algorithmic stablecoin cryptocurrency will continue to be perfected, leading to greater flexibility and rewards for holders, especially when interacting on DeFi protocols.
If you have your own stablecoin project, are building your own blockchain, or looking to kickstart DeFi development, get in contact with one of our INC4 specialists. We have worked with over 90 projects in the blockchain space for over 7 years. Our team has the breadth and depth of skills to create a functional application built on watertight smart contracts, meaning your project will be ready to capture the market.