Traditional fiat currencies, such as the U.S. dollar, don’t experience anything like this kind of volatility. The other and perhaps more popular way that people use stablecoins is to participate in decentralized finance (DeFi) projects, such as crypto lending and borrowing platforms. Minimizing the volatility risk for users could make it easier to understand the cost (or profit) that can come from these transactions. You can deposit and lock other cryptocurrencies to create these stablecoins, and they’re generally over-collateralized to account for volatility. For instance, the stablecoin DAI is pegged to the USD (one DAI equals $1).
Fiat-backed stablecoin: TrueUSD (TUSD)
As the name implies, stablecoins aim to address this problem by promising to hold the value of the cryptocurrency steady in a variety of ways. Early this year, COB warned that Unattended mounting debt concerns could lead to Liz-Truss-style market chaos, characterized by the sharp drop in the U.S. dollar and political uncertainty. Crypto pundits have long echoed a similar sentiment, saying debt concerns and loss of confidence in Treasuries could spur widespread adoption of alternative assets like bitcoin and gold. Overall, the USD-backed stablecoin continues to dominate the bull and bear cryptocurrency market.
What are stablecoins used for?
Another promising example of a crypto-collateralized stablecoin is GC Dollar (GDC), designed to play a key role in GTON Capital’s ecosystem of Ethereum scaling solutions. GCD is a stablecoin that’s uniquely designed to be used to pay ‘gas’ transaction fees within GTON’s ecosystem. It’s also unique in that it can be collateralized in multiple different cryptocurrencies despite sharing the same design principles as DAI.
Pros and cons of stablecoins
- The FRAX supply is not fixed and changes according to the supply and demand for the stablecoin.
- USDC is a stablecoin outlier in disclosing precise data regarding its assets and liabilities.
- Investors should approach stablecoins cautiously because they require independent auditors to verify collateral or reserves.
- DAI is created when users spend a specified amount of ETH to mint new tokens.
- When moving money between multiple volatile cryptocurrencies, holding onto profits can be difficult.
- Asset-backed stablecoins might not actually hold enough assets to fully collateralize their outstanding coin balance.
Rather, they are designed to maintain their peg to an asset through complex algorithms that automatically control the token supply. Commodity-backed stablecoins are quite unique in that, while they’re designed to be stable, they can appreciate over time. It’s similar to someone who buys gold, hoping its value will increase https://www.tokenexus.com/ later. Due to this, such stablecoins provide an incentive for long-term holders and users. They also provide an easier way for some people to invest in the commodities that back them. Rather than buying physical gold, one can simply purchase PAX Gold (PAXG) tokens that are pegged to their real-world price.
Reserve-backed stablecoins
Cryptocurrencies worth $2 million might be held as a reserve to issue $1 million in a crypto-backed stablecoin, insuring against a 50% decline in the price of the reserve cryptocurrency. For example, MakerDAO’s Dai (DAI) stablecoin pegged to the U.S. dollar but is backed by Ethereum (ETH) and other cryptocurrencies worth about 155% of the DAI stablecoin in circulation. That said, they do provide the aforementioned advantage of increasing their value steadily over time, similar to real-world assets like gold, while remaining relatively stable in terms of their price. A somewhat more successful algorithmic stablecoin is Frax (FRAX), which boasts a market cap of around $1.4 billion and has, until now, managed to maintain its peg. FRAX is based on an open-source protocol that lives on the Ethereum blockchain, and it uses a combination of collateral and algorithms.
Decentralized Stablecoin
Stablecoins are generally widely accepted across multiple exchanges, making it easier to move funds across them. “There’s a bit more risk here because major price changes in those assets could threaten the ability of token-holders to cash out,” says Brody. Still, if you’re considering buying stablecoins, a lack of proper reserves is one potential risk to be aware of.
The yield is not paid directly; instead, it accumulates within the staking contract and is reflected in an increase in value of sUSDe. Traders are only able to unlock the accrued yields when they unstake their USDe. Unfortunately, though the model worked for some time, UST ultimately failed to hold its peg. The exact circumstances of the Terra USD crash are still unknown, but in mid-May, it suddenly entered into a “death spiral” as UST lost its peg and its value crashed.
And even if they’re over-collateralized, crypto-backed stablecoins could run into trouble if other cryptos experience major downswings. Instead, it uses automated algorithms to try to create or decrease supply and hold a steady price. However, these algorithmic or “seigniorage-style” stablecoins haven’t caught on.
