Introduction
Since stablecoins are starting to see regulatory warmth, we wanted to share some basics with our community. Read below for an overview on stablecoins.
Let’s get started…
The most common type of stablecoin is one pegged to the US Dollar, setting a stable price in which 1 token equals 1 USD. This is important because it allows exchanges to utilize decentralized representations of fiat-backed currency. So think of a stablecoin like any other token but it’s trusted as a representation of fiat.
The amount of trust put into that coin is really up to the user, and they should do their due diligence. First, just because it has the word “stable” in its name doesn’t mean it’s going to actually be stable and safe. Any token is vulnerable to hacks, bad actors internally, and miscalculations or programming errors.
Another thing to consider with a stablecoin is whether it is accepted by your preferred exchange. Unless you are cashing out amounts upwards of $50,000, you will want to use an exchange like Coinbase, Binance, Bittrex, or others. Not all accept all stablecoins, so keep in mind where you intend to later use it. In terms of DeFi Swap or conversion tools, almost all are usable with a select variety of stablecoins, but liquidity can be a concern.
There are two primary types of stablecoins pegged to the USD. For the purpose of this article, I will refer to them as a hard-peg and soft-peg. A hard-peg stablecoin is one that is backed 1 to 1 with fiat and solid financial derivatives like a short-term bond. Some may also call these fully collateralized, meaning if 100% was withdrawn, it could be processed, although at that percent it may take some time to process. A soft-peg stablecoin is one that is programmatically collateralized generally in a decentralized way. This means that calculating the underlying value and how it adjusts at any point in time, the fund should hold enough assets to match the market cap. These seem to receive more hype and attention lately because it democratizes the creation of stablecoins. Instead of raising hundreds of millions and parking it into a bank account, you can crowdsource funds and use code to maintain the peg. These are generally considered less trustworthy, compared to those with solid accounting and audits. It doesn’t mean they aren’t worthwhile, but they are not what a financial institution or large fund would use for legal protection due to licenses, knowing the issuers and trust for all parties involved.
A full list of all stablecoins can be found here.
Hard-Peg Stablecoins
Note: they claim to be backed 1:1 but the only 100% proof is what is on a secured public blockchain. Here, we presume that large auditors and companies would not ruin their reputation; hence, it’s similar to many other real world assets. Below are some examples of hard-peg stablecoins and the underlying banking they claim.
- Gemini Dollar: Gemini Trust Company, LLC, New York, Audited
- HUSD (stcoins): United States Trust, Audited
- PAX: FDIC U.S. Domiciled Trust, Audited
- TrueUSD: FDIC U.S. Domiciled Trust, Audited
- USDC (Circle): FDIC U.S. Domiciled Trust, Audited
- Tether: Hong Kong Ltd., Bahamas Bank, Not recently Audited
You put your trust into the company’s statements, the licenses, and the auditor’s records. These are trusted on various exchanges, and to be a U.S. based trust, you are under some of the most strict conditions. There has been a lot said about Tether. What I can ascertain according to their site is that, since 2018, they have stopped issuing and redeeming to U.S. customers or entities (https://tether.to/faqs/). In addition, they’re a Hong Kong Corporation and their bank is said to be operated by Deltec out of the Bahamas. What does this really mean? From a practical standpoint, if you’re located within the U.S. or your business is, Tether is probably not going to adhere to your legal requirements or audit needs. If you’re an entity like Binance that wants the ability to have US Dollars but finds it difficult to deal with a U.S. based entity, then Tether can work. This is likely why Tether is so popular internationally and not easily found within the United States. I’m not going to speculate about issues with Tether, but you can do your own research. USDC on the other hand, backed by Coinbase and Circle, is being considered as a partner with Visa. This is an obvious signal that there’s value in trying to work out all of the red tape and legal issues to be domiciled in the United States.
Once you hold stablecoins, there are a number of lending and staking options available. For instance, you could lend on a decentralized platform, or provide liquidity in a liquidity pool on a platform like Uniswap. DefiRate has a good list of what you can earn here. Liquidity pools are a bit harder to understand, but DefiRate also has a guide here.
Soft-Peg
For soft-peg stablecoins, I’ll explain their method to maintain collateral. These types of stablecoins can generally be used for lending and on Uniswap, and at times may have high interest rates. This is a core reason to consider them. If created correctly, they also can’t be shut down with a bank seizure or legal action, which is possible and may be enough to encourage users to put some portion into decentralized stablecoins.
The main types you will see are collateralized soft-peg stable coins, and partially collateralized (Fractional Reserve). They vary in stability of price, but generally, the bigger the more stable. For instance, DAI is widely accepted and maintains relative stability.
- Frax: Fractionally collateralized with DAI, supply adjusted more aggressively.
- Empty Set Dollar (ESD) (price mechanics): Algorithmically increases and decreases supply based on demand. More volatile and relies on its acceptance on platforms. In general, uses EOS and Bitcoin held to back the issuance of fiat and adjusts based on collateral prices and supply.
- DAI (Faqs): Collateral based via MakerVaults and operated by MakerDAO. It uses Ethereum locked in the Vaults. Vault creators can create DAI when they supply collateral.
Conclusion:
As a quick overview, hopefully this has been helpful for understanding the stablecoin space, and will allow readers to engage in more fruitful conversations about the topic.
