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
