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Stablecoins

Stablecoins are normally pegged to fiat money like the U.S dollar. Due to their low volatility, they are frequently used by investors to purchase crypto assets like Bitcoin through virtual transactions that can be settled rapidly.

Tether is the leading stablecoin used by crypto exchanges across the globe, with an estimate market share of 75%. Other popular stablecoins include USD Coin (run and managed by a consortium that include Circle and Coinbase), Paxos Standard (has been approved by the New York State Department of Financial Services.), Gemini Dollar (being offered by the exchange run by the Winklevoss twins).

A class of programmatically issued collateralized digital currencies are emerging, most are either backed by fiat reserves ($USD) or by other digital assets such as ether ($ETH).

Fiat-Collateralized

As most stablecoins are currently pegged to the US dollar, the large majority of projects have decided to use US legal tender as the source of collateral for the issuance of their tokens.

Fiat-collateralized stablecoins retain their 1:1 peg by utilizing trusted third parties to hold an equivalent amount of legal tender in reserves.

New stablecoins are minted when a party deposits USD into the issuer’s reserve. Similarly, when a redemption request is made, the issuer will send the buyer USD and burn the redeemed stablecoin.

The most commonly used fiat-collateralized stablecoins include but are not limited to:

  • Tether ($USDT) – A fiat-pegged stablecoin built on top of Bitcoin via the Omni Layer Protocol. Each Tether issued into circulation is said to be backed by a one-to-one ratio with the equivalent amount of fiat currency held in a custodial account by Hong Kong-based Tether Limited.
  • USD Coin ($USDC) – Fully collateralized US dollar ERC20 tokens founded by CENTRE,  a joint venture founded by Circle and Coinbase. USDC is an open-source project which operates within US money transmission laws. The project uses established banks and auditors while leveraging Ethereum-based smart contracts.
  • Paxos Standard ($PAX) – Backed one-to-one by USD deposits and available through Paxos. PAX is available one-to-one in exchange for USD and redeemable one-to-one for USD. Upon redemption, PAX tokens are immediately removed from the supply; PAX are only in existence when the corresponding dollars are in custody.
  • TrueUSD ($TUSD) – A USD-backed ERC20 stablecoin that is fully collateralized, legally protected, and transparently verified by third-party attestations. TrueUSD uses multiple escrow accounts to reduce counterparty risk and to provide token-holders with legal protections against misappropriation. TrueUSD is the first asset token built on the TrustToken platform.
  • Gemini Dollar ($GUSD) – Created at the time of withdrawal from the Gemini platform. Gemini customers may exchange US dollars for Gemini dollars at a 1:1 exchange rate by initiating a withdrawal of Gemini dollars from their Gemini account to any Ethereum address they specify.

Crypto-Collateralized

Rather than being backed by legal tender, crypto-collateralized stablecoins hold currencies such as ether ($ETH) in escrow for the issuance of new tokens. In doing so, users have the ability to mint and burn tokens without needing to utilize or trust a centralized third party.

While the trustless nature of these stablecoins is quite appealing to the decentralized notion of many cryptocurrency projects, it does come with a drawback. Where fiat-backed stablecoins only need to hold 1:1 reserves in legal tender, this subset of stablecoins often require over-collateralization to account for price volatility. Most commonly, this ratio is set at 150%, meaning that in order to issue $100 worth of $DAI, you will need to post at least $150 worth of $ETH as collateral.

The most commonly known crypto-collateralized stablecoins include but are not limited to:

  • Maker Dai ($DAI) – Dai is a crypto-collateralized ERC20 token backed by an excess amount of digital asset collateral (most commonly $ETH) through Maker Vaults. Dai utilizes smart contracts and a governance token, $MKR, to monitor price stability.
  • Synthetix ($sUSD) – Previously known as Havven, Synethetix is a crypto-collateralized network enabling the creation of on-chain synthetic assets on the Ethereum blockchain. These assets are over-collateralized to provide sufficient liquidity for users to redeem collateral at face value. Beyond $sUSD, Synthetix plans to offer stablecoins for other legal tenders such as the euro, yen, and the Korean won.
  • Reserve tokens ($RSV) – Hybrid-collateralized token backed by both fiat and digital assets. Initially built on Ethereum, Reserve tokens aim to be interoperable across any blockchain in the future. Similar to Maker Dai, Reserve tokens utilize a governance token, $RSR, to monitor price stability in a decentralized fashion.

Non-Collateralized (Algorithmic) Stablecoins / Seigniorage

Seigniorage-style coins utilize algorithms to control the stablecoin’s money supply, similar to a central bank’s approach to printing and destroying currency. Seigniorage-based stablecoins are a less popular form of stablecoin.

Significant features of seigniorage-style stablecoins are:

  • Adjustments are made on-chain,
  • No collateral is needed to mint coins,
  • Value is controlled by supply and demand through algorithms, stabilizing price.

A team of anonymous developers is making what might be called a fork called Basis Cash based on the stablecoin Basis (originally  known as Basecoin) that had $133 million in funding before U.S. securities regulators stepped in and the team behind it returned everything in late 2018.

  • Basis Cash ($BAC) – Like most stablecoins, Basis Cash (BAC) is pegged to the U.S. dollar, so one BAC should be equal to the crypto equivalent of one USD. Basis Cash’s price will be managed by two other crypto assets: Basis Bonds and Basis Shares. Originally 50,000 BAC was distributed over a five-day period to folks that deposit any of these five stablecoins into its smart contract: DAI, yCRV, USDT, SUSD and USDC. If BAC should drop below a dollar, the system will issue Basis Bonds. Those Basis Bonds can be bought for one BAC. They can also be redeemed for one new BAC when the price is above a dollar. For example, if BAC were to drop to $0.97, a user could buy a bunch of BAC at that discounted price and redeem them for the bonds (which burn the BAC). That reduces the supply and should bring it back in line with the peg. Then, when BAC goes over $1.00, new BAC gets issued. The system first lets bondholders redeem them (so if someone bought bonds at $0.97 they should get at least a 3% profit) and the rest of the fresh BAC goes to holders of Basis Cash Shares. Though to get the new BAC (the seignorage), BAS holders have to stake their shares in the Boardroom, another smart contract. From the documents it seems to rely on Uniswap price data.
  • Carbon ($CRBN) – Some projects like Carbon modify the seigniorage shares model. In Carbon, users can elect to freeze portions of their funds to manage contraction and growth cycles. Some projects issue bonds, but simply pay out new stablecoins to all users, pro rata, when all bonds have been paid and supply must increase still. Each approach to the seigniorage shares model has its own set of challenges. Carbon is conceptually similar in design to Basis. However, Carbon uses Hedera Hashgraph which could potentially provide it with significantly higher throughput and speed.

Conclusion

For the average user, stablecoins provide a reliable medium of exchange for now.

Fiat-backed stablecoins can never be censorship resistant, permissionless and trustless. The risk for further regulatory / government interference related to fiat-collateralized stablecoins should not be under estimated. Gemini USD and Paxos Standard (PAX) Stablecoins, are the most highly regulated of all the fiat- backed / asset-backed tokens. They are subject to the terms contained In the source code which include the right of forfeiture or seizure if required by law enforcement.

Over time, as the open financial system grows, DEXs gain market share and dApps gain adoption, crypto-native stablecoins will win on the merits of censorship-resistance and value sharing, with Maker’s Dai currently leading the way.

The biggest benefits dollar-pegged algorithmic systems like Basis have over crypto-backed systems is their capital-efficiency and increased profit potential. Capital-efficiency should make it easier for the system to respond to sudden growth in demand, while the profits can be shared with many stakeholders who should be motivated to support and drive the ecosystem forward.

Most of the key innovations will come from crypto-backed and algorithmic backed / seigniorage based stablecoins

Geir Solem

cryptorevolution, disruptor, guides

Decentralized Exchanges

Created in 2008 by the pseudonymous computer programmer Satoshi Nakamoto, bitcoin is digital money that’s tracked via a public ledger and controlled by no central bank, corporation, or individual.

Image courtesy of Wiki Commons

It’s a peer-to-peer currency based on the blockchain running on the internet that allows its users to transfer value with no central authority or third party involved. Since a network of distributed and mostly anonymous miners are all in charge of processing the transactions, we avoid problems like censorship and fraud.

The automated issuance mechanism of bitcoin through mining also seeks to remove the control of money printing from privately owned banks that lend money to the public at an interest, creating the debt based economy. The primary goal of Bitcoin, to return the control of money to its owners, is in a way lost with third party services.

With cryptocurrencies comes the need for exchanges, and centralized exchanges are easy to use, easy to access, and they provide advanced trading functionalities like margin trading and others.

However, they also represent a security risk for your funds. While some exchanges are better guarded than others, hacks are not an uncommon. There are a number or risks related to centralized exchanges like incompetence, bankruptcy, etc.

We need to exchange our currencies. There are certain items and services that we cannot buy with Bitcoin and in order to acquire Bitcoin or cryptocurrencies, most people have to exchange it for a national currency. Furthermore, some cryptocurrencies like Ether or Bitshares have special features or tools that are not present in Bitcoin. So how can we exchange our coins without entrusting them to a third party service? The answer lies with decentralized exchanges.

Image courtesy Wiki Commons

Decentralized Exchanges

A decentralized exchange is an exchange market that does not rely on a third party service to hold the customer’s funds. Instead, trades occur directly between users (peer to peer) through an automated process. This system can be achieved by creating proxy tokens (crypto assets that represent a certain fiat or crypto currency) or assets (that can represent shares in a company for example) or through a decentralized multi-signature escrow system, among other solutions.

This is an alternative to the current centralized model in which users deposit their funds and the exchange issues an IOU that can be freely traded on the platform. When a user asks to withdraw his funds, these are converted back into the cryptocurrency they represent and sent to their owner.

Advantages

The most important benefit to using a decentralized exchange over a centralized one is their “trustless” nature. You are not required to trust the security or honesty of the exchange since the funds are held by you in your personal wallet and not by a third party.

Another advantage to the decentralized model is the privacy it provides. Users are not required to disclose their personal details to anyone, except if the exchange method involves bank transfers, in which case your identity is revealed only to the person that is selling or buying from you.

In addition, the hosting of decentralized exchanges is distributed through nodes meaning that there is no risk of server downtime. To summarize,

  • No parenting by governments, banks and other institutions
  • Secure, no 3rd party involved
  • Set the unbanked free
  • Open, Transparent
  • Global, fast, efficient, 24/7
  • No identity theft
  • A platform for innovation

Disadvantages

Some decentralized exchanges require users to be online in order for an order to be listed and for the trade to take place, requiring users to perform certain actions like signaling that a payment was received.

Trading features like margin trading, lending and stop loss are currently not available in the decentralized model as they only allow the basic exchange of currency for a predetermined value.

Overview of decentralized exchanges

While there is still a way to go in order to build fully functional and convenient decentralized exchanges, there are several projects that have brought us the basic functions and an alternative way to trade currencies while keeping your funds safe from hacks, inside thefts and faulty business models.

Bitsquare is a decentralized open-source exchange that allows users to buy and sell Bitcoin for cryptocurrencies and national currencies without the need to entrust funds to third-party or middleman, meaning that the transactions occur directly between the buyer and seller. Bitsquare relies on a decentralized multi-signature escrow system to ensure that all trades are carried out honestly.

CounterParty is a meta-coin smart contract layer that embeds data into regular Bitcoin transactions. It allows anyone to issue assets or tokens inside of the Bitcoin blockchain. When trading assets for other assets, the Counterparty protocol acts as a decentralized escrow service that holds the funds until the orders are matched. When trading an asset for Bitcoin, the asset is held in escrow and the other user must make a manual bitcoin payment using the Counterparty wallet.

Waveplatform Waves Asset Exchange is allowing users to trade assets (including asset-to-asset exchange), fiat tokens, and cryptocurrencies.

Bitshares is a crypto platform with its own native currency, Bitshares. Using the Bitshares platform, users can trade BTS, Market Pegged Assets (a crypto asset pegged to another currency or commodity that always has 100% or more of its value backed by the BitShares core currency, to which they can be converted at any time) and User Issued Assets (assets that can be issued by anyone to represent shares, commodities, currencies and so on). Openledger is the Web-based version of Bitshares, running on the same underlying blockchain.

Nxt is a crypto platform (one of the first crypto 2.0 projects) that allows users to issue and trade assets. These assets, however, can only be exchanged for the coin NXT and not for other cryptocurrencies.

Komodo EasyDEX exchange will allow users to trade cryptocurrencies directly without resorting to proxy tokens, while the PAX (Pegged Asset Exchange), both being developed by the SuperNET and Komodo teams, allows users to exchange national currency assets with the privacy that zero-knowledge proofs provide.

Stashcrypto is built on the Open-Transactions financial cryptography platform, an extremely fast and low cost off-blockchain system based on signed receipts. When combined with Bitcoin, OT solves hard problems in crypto finance. Receipts in OT cannot be forged, and a user’s balance cannot be changed without his signature. OT is also able to prove all balances, as well as which instruments are still valid, without storing any history except for the last signed receipt.

Cryptor Trust is working on the CryptorDex, an open decentralized distributed platform for trading securities. Cryptor Trust plan to list their own investment entities on the CryptorDex exchange.

Conclusion

Decentralized exchanges provide global, frictionless value-transfers. Without decentralized exchanges, there will be intermediaries having control over the transfer of value.

Geir Solem