Stablecoins Explored | OpenPad DeFi
Exploring one of the core pillars of Web3 and crypto space.
A stablecoin describes any cryptocurrency pegged to another asset, like the U.S. dollar.
Stablecoins are the means of peer-to-peer digital valıue transfers without the need for third-party intermediaries to facilitate transactions.
There are four different types of stablecoins; namely fiat-backed, cryptocurrency-backed, commodity-backed, and algorithmic stablecoins.
First things first, let’s address the elephant in the room; for the foreseeable future, the topic of stablecoins will always be somewhat associated with the LUNA-UST scandal. In this article, we will not be talking about this catastrophe as there’s no point in beating a dead horse, and many regular Joes and Janes lost their life savings on it. Instead, we will try to establish the necessity of stablecoins and the vital role they play in the overall crypto-economic systems.
Why do they exist?
A stablecoin is one type of cryptocurrency designed to maintain a fixed price over time. The price of a stablecoin is typically pegged to a fiat currency, often the U.S. dollar. In this setup, one unit of the cryptocurrency typically equals one unit of the fiat currency.
Stablecoins, in whatever form, exist to make cryptocurrency price’s more predictable. Stablecoins may sound like an oxymoron, as “stable” is not an adjective one would think of when talking about cryptocurrencies. As the name suggests, stablecoins were created to counter crypto’s notorious volatility and provide a convenient way for crypto traders to preserve their fiat value without having to cash out of the market, as well as allowing users to pay for everyday goods and services in crypto without the budgeting headaches.
In theory unlike highly volatile cryptocurrencies such as Bitcoin, the price of stablecoins is not meant to fluctuate but theory doesn’t always translate to practice.
So, stablecoins are theroratically stable and practically experimental and should-be stable assets.
What are some of the most popular stablecoins?
Stablecoins don’t usually get the same hype compared to other cryptocurrencies because they don’t offer the same type of “get rich quick” vibe. But a few are among the most popular cryptocurrencies by market capitalization as of May 2022:
Tether (USDT): $82 billion
USD Coin (USDC): $49 billion
Binance USD (BUSD): $17 billion
The four types of Stablecoins
There are four different types of stablecoins, each with its own way of fixing the value of the tokens to a stable figure.
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Instead of fluctuating in value against other currencies, these stablecoins provide a certain level of price stability by maintaining a fixed price relative to the underlying fiat currency.
The most popular stablecoins in the market are ones backed by fiat currency. For instance, USD coin (USDC) is fiat-backed and pegged to the U.S. dollar (USD) at a 1:1 ratio. Other stablecoins are linked to the Euro, the British pound, the Japanese yen and the Chinese RMB.
As a result, these assets in the near term have the highest potential to help reshape the global financial system by constructing stable and frictionless payments possible between parties that don’t need to trust each other.
These cryptocurrencies peg to more established/popular cryptocurrencies like Bitcoin or Ethereum. Smart contracts are implemented heavily here to help pool enough of the backing cryptocurrency for use as collateral. Once this requirement is attained, these crypto-backed Stablecoins become available for users to mint. Moreover, these assets can be categorized depending on the level of collateralization - under 1:1 and over collateralized crypto-backed stablecoins can exist. Even though this topic is more profound than mentioned, we’ll cap this here to keep this article short.
Examples of Crypto-backed Stablecoins include DAI.
As the name suggests, commodity-backed stablecoins are collateralized by real-world assets. The most common examples include gold and even real estate. Pegged to these assets means the prices are likely to fluctuate sporadically, positively or negatively.
Interestingly, investors focused on commodity trading embrace these forms of stablecoins en masse because they appreciate the ‘option’ of investing in physical assets like gold or other minerals without needing to store them.
An example of a commodity-backed stablecoin is Tether Gold.
Not backed by any “real-world” commodities, this category of stablecoins uses algorithms to modulate the supply based on its market demand. In short, these algorithms automatically burn (permanently remove coins from circulation) or mint new coins based on the fluctuating demand for the stablecoin at any given time.
We all know a notorious member of this family (Terra’s UST ), and there’s been a lot of trial and error in the quest to successfully introduce algorithmic stablecoins to the crypto ecosystem.
Perks of Stablecoins
Devised for our increasingly global economy, stablecoins theoretically solve a few fundamental problems that inhibit the exchange of money.
Stablecoin users don’t need multiple international bank accounts to send crypto to their friends in other countries; they just need one crypto wallet.
Stablecoins make accurate peer-to-peer digital transfers possible without the need for third-party intermediaries to facilitate transactions without advanced price volatility.
In theory, stablecoins cut down on the fees, transfer time and potential privacy infringement we’ve grown accustomed to under the paradigm of central banking.
A Real Story
Say you were a Chinese business owner who wanted to pay an invoice to a client in Japan who also had subcontractors in Europe.
“You’d need to have a Chinese bank account, a Japanese bank account and a European bank account,” explains William Quigley, co-founder of the WAX blockchain and one of the founders of USDT issuer Tether. “If somebody wants to send you euros or yen or RMB, the intermediaries who can hold those accounts swap out those currencies for the currency you can hold and send it to your bank. And along the way, they’ve skimmed a lot of money off the top for that.”
Privacy lovers, in particular, appreciate this facet of stablecoins since they can avoid the process known as KYC or know your customer – aka submitting photo ID and Social Security information to open a financial account. While KYC has become, for most of us, a normal part of dealing with money, crypto proponents argue KYC is prohibitive when applied to central banking institutions in other countries.
“This is why it’s extraordinary to me that an individual in New York, California or Texas can hold in their wallet ten different tokenized currencies that stay in their native form,” said Quigley. “You don’t need a Chinese bank account. You can keep a token representing that Chinese currency and use it as though it is Chinese currency without ever converting.”
This direct, peer-to-peer model of stablecoins helps save money that otherwise goes to pay processing fees and administrative costs for third-party intermediaries.
DeFi-based Use Case of Stablecoins
To connect the possible utilities of stablecoins in DeFi markets, one such use case is as follows. OpenPad will use stablecoins while investing in early-stage Web3 projects, so the deposit format will be in stablecoins, more specifically $BUSD, from Chainlink Price Feeds and integrate them into rounds IDOs for investors to clearly capture the investment size in terms of U.S. dollar equivalent.
Most cryptocurrencies lack the price stability that stablecoins give, rendering them unsuitable as the money we are familiarized with. Those that use stablecoins, on the other hand, should be aware of the dangers they are accepting. While stablecoins may appear to have reduced dangers in ordinary market pulses, they may become the riskiest in a crisis when they should be the safest to own.
History may not repeat itself, but it often rhymes.
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