Price volatility continues to be a large barrier to entry for many traditional players in digital asset markets. When it comes to establishing a reliable medium of exchange, stablecoins, or digital assets pegged to a predetermined value, have quickly become a core focal point for cryptocurrency at large.
Most notably highlighted by Facebook’s recent announcement of a stablecoin called Libra, this class of assets allows for the programmatic issuance of transparent, collateralized digital currencies.
Seeing as most stablecoins are currently pegged to the US dollar, it’s logical that 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 reputable financial institutions to hold an equivalent amount of legal tender in reserves.
In short, 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 ($USDT) – A fiat-pegged stablecoin built on top of the Bitcoin blockchain via the Omni Layer Protocol. Each tether issued into circulation is said to be backed by a one-to-one ratio with the equivalent amount of fiat currency held in a custodial account by Hong Kong based Tether Limited.
- USD Coin ($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 ($GUSD) – Created at the time of withdrawal from the Gemini platform. Gemini customers may exchange US dollars for Gemini dollars at a 1:1 exchange rate by initiating a withdrawal of Gemini dollars from their Gemini account to any Ethereum address they specify.
In recent months, US Dollar Coin ($USDC) has quickly gained traction as the most used fiat-collateralized stablecoin. To highlight this point, it was recently announced that USDC passed $1B in issuance in less than a year. While $USDC is currently the second largest stablecoin on the market (Tether or $USDT being the largest), it’s commonly known that Tether has been unable to provide sufficient evidence that their supply is fully collateralized by an equal amount of underlying US legal tender.
Crypto-Collateralized / Decentralized
Rather than being backed by legal tender, crypto-collateralized stablecoins hold digital assets such as ether ($ETH) in escrow for the issuance of new tokens. By 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 incredibly 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 Collateralized Debt Positions (CDPs). Dai utilizes smart contracts and a governance token, $MKR, to monitor price stability.
- Reserve tokens ($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, $RSR, to monitor price stability in a decentralized fashion.
- Synthetix ($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.
In practice, $DAI has garnered the most traction in the market at large. Most notably highlighted by the recent Coinbase Earn campaign, users were able to earn up to $20 of dai for answering a few questions about the project along with opening their very own Collateralized Debt Position (CDP) through Coinbase’s mobile wallet.
Outside of $DAI, few other crypto-collateralized projects have been able to demonstrate the long-term execution and frameworks needed to garner support from the community at large.
Stablecoins in DeFi
When it comes to DeFi, it’s commonly known that lending is currently dominating as the largest sector according to Total Locked Value (TVL). More specifically, the emergence of stablecoins like $DAI and $USDC have been the main drivers of this growth.
For those unfamiliar with the MakerDAO system, the entire project is centered around the governance, growth and expansion of the $DAI ecosystem. While ether ($ETH) is currently the only form of collateral supported to mint dai, many users are very excited for the approaching launch of Multi-Collateral Dai (MCD) in which a variety of Ethereum-based assets can be used to create new $DAI through enhanced Collateralized Debt Positions (CDPs).
In practice, MakerDAO provides an extremely innovate mechanism for users to further leverage their belief in digital assets. Unlike fiat-collateralized stablecoins which use centralized reserves to retain custody of the fiat used to create new tokens, Maker’s system leverages smart contracts to hold the underlying system in escrow.
As such, users can create a CDP by locking their exisiting ether ($ETH) to mint $DAI. This dai can then be used to purchase bitcoin ($BTC), ether ($ETH) or any other digital asset on a second exchange. If the trade is successful, borrowers can take the profits to pay off their CDP, release the underlying collateral to the initial address and benefit from a larger portfolio thanks to the added exposure.
$DAI is quickly emerging as the defacto stablecoin for a number of Ethereum-based applications including Augur, a decentralized prediction market. With Augur V2, platforms like Guesser, a more intuitive interface built from Augur, will allow users to place bets and profit on the outcome of major world events using $DAI as the principal currency. This is a big milestone for crypto markets as these markets generally take long periods of time to settle. By using $DAI rather than $ETH, players can rest assured that their entry position will be the same value today that it will in three months when the market closes.
With gaming being such a crucial sector for the adoption of blockchain technology, it should come as no surprise that projects like Axie Infinity have partnered with MakerDAO to offer $DAI as reward to top trainers. In the future, it goes without saying that users will be able to use $DAI for all ecosystem interactions on the Axie Infinity platform.
Similarly, MakerDAO’s recent partnership with Airtm leverages $DAI as an in-app wallet balance to combat devaluation in third world countries.
“With Dai helping to power the engine of Airtm, users can not only escape weak currencies, but also worry less about how economic and political circumstances beyond their control affect their daily lives, and instead think long-term regarding their money. With access to Dai, people across the globe can design and control their financial futures, and realize possibilities once beyond their reach.”
As new protocols target mainstream adoption, reputable stablecoins such as USDC will play a vital role in instilling consumer confidence.
“Stablecoins like USDC will be absolutely essential in enabling everyday buyers and sellers to easily and instantly transact with each other across homesharing, ridesharing, contractor services, and many other categories without currency volatility risk. Origin is thrilled to partner with Circle to provide a reliable medium of exchange cryptocurrency on our platform and our partner applications as we aim to reduce transaction fees, promote free and open commerce, and redistribute value from corporate monopolies back to individual buyers and sellers.” – Matt Liu, Origin Protocol Co-founder
Other USDC integrations include BlockFi who plan to extend loans backed by crypto-assets as collateral, using USDC to streamline operations and build a better user experience with loans denominated in USD. MoneyToken intends to use USDC as one of the lending options on their platform. Other platforms such as BitPay in the merchants payments space, and FOTA in the over-the-counter derivatives space, are going to be key in weaving USDC into even more mainstream financial services.
Comparing Stablecoin Rates
When it comes to saving in traditional markets, the average individual is commonly subject to rates that only goes as high as 2% per year. Due to the sophisticated nature that stablecoins currently require, lending out $DAI and $USDC has significantly better returns than that of saving USD. In practice, lending $DAI or $USDC via Compound is extremely similar to how savings work in the traditional financial system. However, thanks to the advent of distributed ledgers, stablecoin lending and issuance becomes fully transparent, unlike the current monetary system where it is virtually impossible to track how your saved legal tender is being loaned.
For those curious about lending and borrow rates for $DAI and $USDC on the largest DeFi platforms for August 2019:
|Platform||DAI Supply APR||DAI Borrow APR||USDC Supply APR||USDC Borrow APR|
As we discussed at the start of this article, stablecoins present a new paradigm to navigate the endless opportunities blockchain protocols provide without having to worry about ever changing prices. For the average user, stablecoins provide much needed comfort in terms of a reliable medium of exchange.
With this being said, it’s worth noting that virtually all reputable stablecoins are based on Ethereum. While this may not seem like a huge issue in the short term, interoperability will likely play a huge role in the eventual success of blockchain-based systems at large. To this point, it’s important for existing stablecoin projects to embrace new emerging protocols with open arms.
Furthermore, outside of niche uses cases such as additional leverage and Ethereum-based applications, stablecoins currently suffer from a lack of accessibility. While this is definitely a common problem across digital assets at large, it only seems logical that the stablecoins that integrate with major platforms such as Amazon or local merchants in underdeveloped countries will provide much needed infrastructure to help combat hyperinflation and the lack of traditional banking services for marginalized individuals at large.
As we begin to watch digital assets make their way to the mainstream with the launch of Libra in 2020, it’ll be interesting to watch is stablecoins such as $USDC and $DAI are able to differentiate themselves enough to remain relevant.
Cooper is a long-time blockchain enthusiast currently working as the managing director for Fitzner Blockchain Consulting. Starting his career in the industry as a project and community manager, Cooper has since expanded his skillset as a CFA Level 1 candidate and recent graduate of Draper’s Hero Training in San Mateo, California. His favorite DeFi projects include Set Protocol and Ren Project with a strong interest in The Block Crypto and Messari.