There are a number of different stablecoins in crypto including fiat-collateralized, gold-backed and algorithmic. Stablecoins are a form of cryptocurrency where their value is pegged to another asset.

Stablecoins have emerged as a crucial component in the world of cryptocurrency, offering both stability and utility in a highly volatile market. Because they are designed to maintain a stable value, their peg is often with assets or values beyond the blockchain such as fiat currency and precious metals.

There are several key types of stablecoins, each with its own set of advantages and disadvantages. Read on in this blog to learn more about stablecoins and the integral role they play in the world of cryptocurrency, decentralized finance and web3.

‍

The Main Types of Stablecoins

‍

Fiat-Collateralized Stablecoins

Advantages: These stablecoins are relatively simple to understand and provide a direct link to real-world assets (fiat currency) like USD or EUR. This transparency can build trust among users.

Disadvantages: The stability of these stablecoins relies on the integrity of the organization or entity holding the fiat reserves. If the issuer faces legal or financial troubles, it can put the stablecoin's value at risk

‍

Crypto-Collateralized Stablecoins

Advantages: These stablecoins are decentralized and do not rely on centralized financial institutions. Users can collateralize their own cryptocurrency, providing a degree of autonomy.

Disadvantages: Price volatility in the collateral cryptocurrency can lead to liquidation risks. If the collateral's value falls below a certain threshold, the stablecoin system may become undercollateralized.

‍

Algorithmic Stablecoins

Advantages: Algorithmic stablecoins are fully decentralized and do not rely on traditional collateral. They can be more resilient against economic and financial crises.

Disadvantages: These stablecoins are highly complex and can be difficult to understand for the average user. Maintaining the algorithm's stability can be a challenge.

‍

Commodity-Collateralized Stablecoins

Advantages: Backed by tangible assets, like gold or other commodities, these stablecoins offer intrinsic value. They can provide a degree of stability.

Disadvantages: The value of the underlying assets can fluctuate, and there may be practical challenges in redeeming the commodity. Regulatory hurdles can also be a concern.

‍

How Stablecoins Work with Blockchain Technology

Stablecoins operate on blockchain technology, which provides transparency, security, and immutability. The blockchain's role in stablecoins varies depending on the type:

‍

Fiat-Collateralized Stablecoins

These stablecoins are typically issued on a blockchain, but the real-world fiat reserves are held in a bank account. The blockchain is used for issuance, transfer, and verification of ownership.

Popular examples include Tether’s USDT and Circle’s USDC. To learn more about fiat-collaterized stablecoins be sure to read further on in our article.

‍

Crypto-Collateralized Stablecoins

These stablecoins utilize smart contracts on blockchain platforms like Ethereum. Users lock up a specific cryptocurrency as collateral, and the smart contract mints stablecoins accordingly. The blockchain tracks collateralization ratios.

Crypto-collateralized stablecoins are a key element of the DeFi ecosystem. They over-collateralize an existing digital asset to allow for the dynamic maintenance of a consistent market price. 

This approach provides a buffer against price fluctuations caused by the underlying collateral. Popular examples include MakerDAO’s DAI stablecoin and the EOSDT token.

‍

Algorithmic Stablecoins

These stablecoins are entirely blockchain-based and rely on smart contracts to maintain their stability. Algorithms manage the supply of stablecoins, and the blockchain ensures transparency.

Algorithmic stablecoins do not use crypto or fiat as collateral to back them. Instead, their price stability is maintained using specialized algorithms and smart contracts that manage the supply of tokens in circulation. 

An algorithmic stablecoin system will reduce the number of tokens in circulation when the market price falls below the price of the fiat currency it tracks. And alternatively, if the price of the token exceeds the price of the fiat currency it’s pegged to, then new tokens enter into circulation to adjust the stablecoin value downward.

Popular examples of algorithmic stablecoins include FRAX and USDX. 

‍

Commodity-Collateralized Stablecoins

Like fiat-collateralized stablecoins, these may be issued on a blockchain, but the underlying commodity is held off-chain. The blockchain records ownership and transactions.

Commodity-backed stablecoins are collateralized using physical assets like precious metals, oil, and real estate. 

The most popular commodity to be collateralized is gold and a couple of top examples include Tether Gold (XAUT) and Paxos Gold (PAXG). 

‍

Role of Stablecoins in Decentralized Finance (DeFi)

Stablecoins play a pivotal role in the DeFi ecosystem, which aims to recreate traditional financial services using blockchain technology, often without intermediaries. Here's how different types of stablecoins contribute to DeFi:

‍

Liquidity Provision

Stablecoins serve as a stable intermediary in DeFi protocols. Users can trade in and out of volatile cryptocurrencies, hedge against price fluctuations, and access liquidity pools.

‍

Lending and Borrowing

In DeFi lending platforms like Compound or Aave, users can supply stablecoins as collateral to borrow other cryptocurrencies. This creates an efficient lending market where users can earn interest on their assets.

‍

Decentralized Exchanges (DEXs)

Stablecoins are commonly used as trading pairs in DEXs like Uniswap, enabling users to trade various tokens without worrying about the price volatility associated with non-stable cryptocurrencies.

‍

Yield Farming

Users can leverage stablecoins in yield farming strategies, earning interest or rewards by providing liquidity to DeFi protocols. Algorithmic stablecoins like DAI are popular for these purposes.

‍

Cross-Border Transactions

Stablecoins facilitate borderless and low-cost transactions. People can send and receive value across borders without the need for traditional banking infrastructure.

‍

Risk Mitigation

Stablecoins provide a safer harbor during market downturns, allowing traders to park their capital in a relatively stable asset when they anticipate cryptocurrency market instability.

However, it's essential to understand that DeFi is not without risks. Smart contract vulnerabilities, price volatility in collateral, and regulatory uncertainties can impact the stability of DeFi systems. Users must exercise caution and perform due diligence when engaging in DeFi activities involving stablecoins.

‍

Most Popular Fiat-Backed Stablecoins 

Fiat-backed stablecoins tend to be the most used because of the utility inherent in the fact that they are pegged to a widely used fiat currency. 

There are also stablecoins pegged to other countries fiat currencies such as the Euro (Circle’s EURC) and Yen (JPY). 

However due to the United States Dollar acting as the world’s reserve currency, stablecoins backed by USD are typically the most popular. 

• Tether (USDT) - Tether is one of the most widely used stablecoins and is issued by Tether Limited. It's backed by a reserve of fiat currency, primarily USD, held in bank accounts. USDT is often used for trading and as a gateway for moving funds in and out of the cryptocurrency market. However, Tether has faced concerns about its reserve transparency and regulatory scrutiny.

• USD Coin (USDC) - USDC is issued by regulated financial institutions and is known for its transparency and regulatory compliance. It has gained popularity as a trusted stablecoin for various use cases, including trading, lending, and as a bridge between the traditional financial system and cryptocurrency.

• Dai (DAI) - DAI is a decentralized, algorithmic stablecoin created by the MakerDAO project. It's collateralized by a variety of cryptocurrencies, including Ether (ETH), and is maintained by smart contracts and an autonomous ecosystem. DAI is popular in the DeFi space, where it is used for lending, borrowing, and trading.

• TrueUSD (TUSD) - TrueUSD is known for its commitment to transparency and legal compliance. It allows users to exchange their tokens for real US dollars through registered banks. It's a reliable option for traders and investors seeking a stable value.

• Paxos Standard (PAX) - Paxos Standard is issued by Paxos Trust Company and is regulated by the New York State Department of Financial Services (NYDFS). It offers transparency and security for users seeking a stable and regulated cryptocurrency.

‍

Biggest stablecoins by market capitalization

With the United States dollar still acting as the world’s reserve currency, dollar-pegged stablecoins are the most used and therefore biggest by market capitalization.

DeFiLlama is a cryptocurrency analytics tool used for monitoring and analyzing the performance of the decentralized finance (DeFi) ecosystem. It provides real-time data and insights on the total value locked (TVL) within a range of different DeFi chains, products and protocols, as well as other important metrics such as trading volumes, user activity, fees and liquidity.

‍

‍

Tether’s USDT

Tether’s USDT still dominates the stablecoin ecosystem with a total market capitalization of $84.5 billion - more than three times that of its closest competitor USDC.

Tether’s USDT is the third largest cryptocurrency by market cap. It provides an important link between the world of traditional finance and digital assets.

‍

Circle USDC

Currently, Circle’s USDC has a total market cap of $24.5 billion and is supported on over 60 different blockchains including Ethereum, NEAR, Avalanche, Arbitrum and Polygon.

As well as a stablecoin, Circle refers to USDC as a digital dollar that is available 24/7 and moves at internet speed. 

‍

TrueUSD

With a current market cap of $3.3 billion TrueUSD is a stablecoin running on Ethereum that attempts to maintain a value of US$1.00.

The supply of TUSD is collateralized by US dollars held in escrow by banks. Users can purchase and redeem TUSD tokens on the TrustToken website.

‍

PayPal’s PYUSD

According to data from DeFiLlama, PayPalUSD is already a top 10 stablecoin by market cap. 

PayPal only launched their stablecoin PYUSD in August 2023 and it doesn't look like they're far away from knocking Gemini Dollar's GUSD out of seventh place. 

PayPal came under some controversy when they released PYUSD to the public, due to concerns around their centralized control and the numerous kill switches written into the stablecoin’s code. 

PYUSD’s code includes a "WipeFrozenAddress" function that gives PayPal the power to clear the balance of a frozen address and burn the tokens, effectively wiping out a user's entire PYUSD funds in just one click. 

It also has a built-in "Pause" function allowing PayPal to stop transfers or trades universally and at any time they want. Despite these concerns, it hasn’t stopped user activity and the TVL of PYUSD from increasing, suggesting that PayPal is such a trusted brand in global payments, and with a well established audience base, that these centralization criticisms haven’t deterred user adoption.

‍

Stablecoins Under Fire

Many in the crypto community argue that stablecoins are the best innovation to come out of decentralized finance, while others outside of crypto see stablecoins as a significant threat to traditional finance.

But even proponents of stablecoins know that they don’t come without risk. Thanks to the volatility of the crypto market, as well as the regulatory war against DeFi, some of the most popular stablecoins have come under fire. 

‍

BUSD Banned

In February 2023 Paxos was ordered to stop minting the Binance-branded stablecoin BUSD. Under direction from the New York State Department of Financial Services, Paxos had to cease issuing any new BUSD tokens. 

This was part of broader efforts from the Securities and Exchanges Commission (SEC) as they started to clamp down on the crypto market in the wake of the controversial crypto exchange FTX collapsing in November 2022. 

‍

USDC Depeg

In March 2023 Circle’s USDC stablecoin lost its peg to the United States Dollar and fell to 87 cents amid fears of the issuer’s exposure to Silicon Valley Bank (SVB). 

When SVB collapsed due to a bank run, Circle disclosed that approximately $3.3 billion worth of the cash reserves that backed USDC remained held at Silicon Valley Bank. 

Following this and thanks to wider panic regarding a systemic banking crisis (Signature and Silvergate banks also collapsed during this time), other stablecoins such as DAI and USDD also lost their peg. Fortunately it was short-lived and all these stablecoins returned to $1 within 24 hours. 

‍

TerraUSD and the Fall of Luna

TerraUSD was the algorithmic stablecoin minted by TerraLabs, the same firm behind LUNA.

When the cryptocurrency market started to crash in Spring 2022, TerraUSD (UST) lost its $1 peg and fell to as low as $0.30 on May 11, 2022.

TerraUSD was part of the Terra ecosystem, which also operated the Terra cryptocurrency (LUNA). And as an algorithmic stablecoin TUSD was not backed by US dollar-denominated assets, but instead, a computer algorithm minted (created) and burned (destroyed) both UST and LUNA to keep the price in equilibrium.

However the dramatic downturn in the value of cryptocurrencies caused a significant fall in UST prices and the algorithm simply could not keep up.

‍

The Darker Side of Stablecoins, CBDCs

CBDC stands for Central Bank Digital Currencies. These are digital versions of a country's national currency that are issued and regulated by the region’s central bank. 

CBDCs have similar functionality to stablecoins. However, unlike stablecoins, which are arguably decentralized and typically operate on blockchain technology, CBDCs are centralized and are issued and controlled by a government's central bank.

The main objectives of CBDCs can vary from one country to another, but they often include:

• Improving payment systems: CBDCs can make transactions faster, more efficient, and cost-effective.
  

• Enhancing financial inclusion: CBDCs can provide access to financial services for people who are underserved or excluded from the traditional banking system.
  

• Reducing the use of physical cash: Governments may seek to reduce the use of paper money and coins for reasons such as cost savings and improved tracking of transactions.
  

• Strengthening monetary policy: CBDCs can provide central banks with more tools to implement monetary policy, including the ability to implement negative interest rates.
  

• Combating illicit activities: CBDCs can be designed with features that make it harder for criminals to use them for money laundering or other illegal activities

The design and implementation of CBDCs can vary greatly from one country to another, and they can be either retail CBDCs, which are directly accessible to the general public, or wholesale CBDCs, which are used for interbank settlements and other financial operations.

Many central banks are exploring the concept of CBDCs, and some have already begun pilot programs or issued CBDCs in limited capacities. 

However there is considerable pushback due to their dystopian nature and the potential for the centralized authorities to have full financial control over people’s money, expenditure and savings. 

‍

Stablecoins Are the Cornerstone of Crypto and the Future of DeFi

Stablecoins have become a cornerstone of the cryptocurrency ecosystem, offering a bridge between the worlds of digital and traditional finance. 

Each type of stablecoin comes with its unique set of advantages and disadvantages, and their role in DeFi continues to evolve as the space matures and innovates. 

Users should always carefully consider their specific needs and risk tolerance when selecting and using stablecoins in their financial activities.

‍