Many of us have been affected in some way due to this extended bear market. In a time of extreme volatility, Stablecoins have been there to provide some stability to the market. Stablecoins are a type of cryptocurrency that aims to maintain a stable value relative to a specific asset or currency. This is in contrast to most cryptocurrencies, which tend to be highly volatile and prone to fluctuations in value.
History of Stablecoins
The concept of stablecoins was first introduced in 2014 with the launch of Tether (USDT), a cryptocurrency that is pegged to the value of the US dollar. Since then, various other stablecoins have been developed (USDC, DAI, MIM, FRAX, BUSD, etc.)
One common approach to creating a stablecoin is to peg it to a specific asset or currency, such as the US dollar or gold. These types of stablecoins are known as fiat-collateralized stablecoins, as they are backed by a reserve of a specific fiat currency or asset. Tether & USDC are the best examples of a fiat-collateralized stablecoin, as it is pegged to the US dollar.
Another approach to creating stablecoins is to use a basket of assets as collateral. These types of stablecoins are known as commodity-collateralized stablecoins, as they are backed by a diverse mix of assets such as commodities, precious metals, or even other cryptocurrencies. An example of a commodity-collateralized stablecoin is Digix Gold (DGX), which is backed by a reserve of physical gold.
In addition to these approaches, there are also algorithmic stablecoins, which use complex algorithms to maintain stability. These types of stablecoins do not rely on a specific collateral asset or currency, but rather use a combination of smart contracts and other mechanisms to maintain a stable value. An example of an algorithmic stablecoin is Basis, which uses a combination of bond issuance and buyback mechanisms to maintain stability.
Frax is currently the best example of this. These stables tend to carry more inherent risk as many of them have not fared well. For any of us here during the Iron Finance early days of DEFI, Mark Cuban was famously exposed as the protocol and stable coin collapsed overnight.
There are several reasons why they have gained popularity in recent years. One of the main benefits of stablecoins is that they offer the stability and security of traditional currencies, while still being built on blockchain technology. This makes them attractive to investors who are interested in the potential benefits of cryptocurrencies, but who are hesitant to invest in highly volatile assets.
Future of Stablecoins
Stablecoins also have the potential to revolutionize the way that traditional financial transactions are conducted. For example, stablecoins could be used to facilitate cross-border payments in a more efficient and cost-effective manner. They could also be used to provide liquidity in situations where traditional financial systems may not be available or may be too slow or costly.
One potential use case for them is in the context of international trade. Currently, international trade transactions often involve the use of intermediaries, such as banks, to facilitate the exchange of different currencies.
Stablecoins could potentially be used to bypass these intermediaries, enabling more efficient and cost-effective trade transactions. There have also been many DEFI protocols that have provided a much higher yield on stable coin yielding than any bank would ever consider giving out.
Another potential use case for stablecoins is in the context of remittances. Remittances are financial transfers that are sent by migrant workers to their families in their home countries. These transfers are often subject to high fees and long processing times, making them expensive and inconvenient for the individuals sending and receiving the funds.
Stablecoins could potentially be used to facilitate these transfers in a more efficient and cost-effective manner. Despite their potential benefits, stablecoins also have their own set of challenges and risks. One of the main concerns with stablecoins is their reliance on a specific collateral asset or currency or a “Depegging” of the stablecoin. This essentially means that a stable will lose its 1 dollar peg.
LUNA’s UST failure will go down as the biggest stable coin depegging in history. Over a few short weeks UST completely depegged leaving anyone that held the stable with a stablecoin that had no value. It is advised to only use stables with a large market cap such as USDC or USDT but these each have their own systemic risk and should be considered if holding stables long term.
Another risk of larger stables such as USDC is the centralized nature of the token. We saw earlier this year when Tornado Cash (A DEFI application to move user funds privately) was closed, Circle (the entity behind USDC) Blacklisted wallets that used the application essentially rendering their USDC holdings useless. This is an extreme case but should be taken into account.
On the opposite side, decentralized stables such as MIM (Magic Internet Money) do not carry the same systemic risk but do have risk on the protocol side. Surprisingly MIM has held pretty strong and has not depegged from its 1 dollar hold after all the events of this year.
Stablecoins are the lifeblood of crypto and will not be going away any time soon. Regulation and systemic risk are some of the hurdles that stables need to overcome. But the revolutionary nature of this technology is something that should not be ignored.