Stablecoins: From Dusk Till Dawn

Stable Coins (stablecoins) have proven to be a product that fits well in the crypto market: since the beginning of 2021, their combined market capitalization has grown from $25 billion to over $130 billion.

Stablecoins are cryptocurrencies whose price is tied to and linked to a single collateralized asset or group of fiat or tangible assets. These price stabilization reserves can range from fiat currencies and national currencies to the now banned due to the bankruptcy of the most famous of them — Terra (LUNA) – algorithmic or backed by commodities.

As we know, altcoins, or even Bitcoin are extremely volatile at times. Their value can fluctuate wildly due to substantial inflows and outflows of funds. This can be cumbersome if you want to use cryptocurrencies in your DeFi wallet as a medium of exchange. Fortunately, with stablecoins, the numerical value of invested assets can be fixed because they are designed to maintain their value tied to the dollar or any other implied accounting equivalent (most often, it’s still USD though). This wouldn’t let us increase the value of our assets using trading or investing, but it will make it easier for investors and traders to convert fiat money into cryptocurrencies, as the corresponding exchange transaction can be implemented with minimal price volatility.

In addition to being a reliable medium of exchange, crypto traders also use stablecoins to participate in decentralized financing projects (DeFi smart contracts), which typically involve either Ether or a stablecoin lending or collateralizing. This provides investors with low-risk passive returns as they provide additional liquidity on the chosen platform. Ultimately, this makes offering or lending stablecoins a viable option for investors during periods of high volatility and/or bearish sentiment.

Stablecoins reemerged as the most popular crypto sector during the third quarter of 2023, with daily active addresses of more than 400,000, outpacing growth of other categories, including Bitcoin –  let alone NFTs.

The most recent report revealed that stablecoins active addresses grew by 45% between the first and third quarters of 2023, while its transactions increased by 41% during the same period. A closer look at the report reveals that Tether’s USDT (more below) is driving stablecoin’s dominance as it is leading others in terms of market capitalization, active addresses, and transactions. However, it still lags behind rival USDC regarding on-chain volume, which witnessed its volume drop by 62% following exposure to the U.S. banking crisis in March 2023.

Now that we've covered the basics of what stable coins are and their different uses for them, let's move on to looking at the different types of stablecoins in the cryptocurrency space.

What are Different Types of Stablecoins?

Fiat-backed Stablecoins

Fiat stablecoins, as the name implies, are pegged to a particular fiat currency – most commonly the U.S. dollar, as we already mentioned above. We know that the word “fiat” means the currency is essentially unsupported by a commodity and is a government obligation (often called a “legal tender”). These types of stablecoins usually have a collateral reserve in the form of an equivalent amount of the fiat currency to which they are pegged. For example, the USD Coin is one of the most well-known stablecoins that is heavily backed by the U.S. dollar. Fiat-backed stablecoins can be used for transactions like other cryptocurrencies and are considered more secure.

Stablecoins Backed by Cryptocurrencies

Essentially, these stablecoins are backed by a group of cryptocurrencies, thereby diminishing their implied price volatility. By relying on another cryptocurrency – or even a group of liquid cryptocurrencies – as a collateral, the average investor may understandably fear that the pool of cryptocurrencies that the stablecoin is backed by would still be highly volatile. To alleviate these concerns, such cryptocurrency stablecoins are usually somewhat over-collateralized to ensure that their value is maintained during periods of severe price fluctuations.

The benefits of having a project’s own stablecoin include an additional revenue stream, increased accumulation of management token value, changing the interest rate to achieve a desired outcome, deploying an external strategy, and creating competitive leverage. Risks include the complexity of the peg mechanism and audit (if any), a short history of user experience, and a moment of liquidation that can lead to large balance sheet losses.

Stablecoins still have the strongest product-market correlation of all cryptocurrency products, as they allow us to use dollars in DeFi to trade, make payments, store value, or generate income. The market capitalization of all stablecoins has grown steadily since their inception, with the largest players now holding a capitalization of over $150 billion.

Algorithmic Stablecoins

Algorithmic stablecoins, also known as algo stablecoins, are a new type of cryptocurrency that aims to maintain price stability through algorithmic mechanisms. Unlike traditional stablecoins that are pegged to a specific asset such as a fiat currency or a commodity, algorithmic stablecoins use complex formulas and algorithms to regulate their supply and demand in order to stabilize their value.

These stablecoins rely on smart contracts and algorithmic mechanisms to adjust their token supply in response to changes in demand. When the demand for the stablecoin increases, the algorithm increases the token supply to maintain stability. Conversely, when the demand decreases, the algorithm decreases the token supply. This process helps maintain a stable value for an algorithmic stablecoin, making it quite competitive and relatively effortless as a store of value.

Algorithmic stablecoins have gained popularity in 2021 due to their potential to provide stability without relying on external collateral or central authorities. However, they also came under harsh critique after the sudden collapse of Terra/LUNA by Terraform Labs — the most well-known algo stablecoin back then, revealing a huge set of risks and insecurities, such as potential algorithmic failures or vulnerability to market manipulations. 

Let’s briefly revisit those infamous events. Terra was the third largest cryptocurrency ecosystem after Bitcoin and Ethereum, which abruptly collapsed in just 3 days in May 2022 and wiped out $50 billion in valuation. At the center of the collapse was a run on a blockchain-based borrowing and lending protocol (Anchor) that promised high yields to its stablecoin (UST) depositors.

Over the course of just a few days, two top 10 digital assets by market cap (LUNA and UST) erased nearly $40 Billion in investor value. UST lost its $1 peg completely, and LUNA collapsed to a price of $0.00001, or what was referred to as becoming ‘hyperinflated’. As a result, the Luna Foundation Guard (LFG) and the $30 billion Terra ecosystem deployed their then not-long-ago established reserves of 80,394 BTC to defend the peg, remarkably without much success – demonstrating the fact that panic is a game-changing phenomenon across all markets, not just traditional ones.

Later in that unsettling week, heating up the momentum of UST de-pegging news, the market expressed broadening concern over the quality of Tether's peg (USDT). USDT (Tether) traded briefly down to a low of $0.9565 but recovered swiftly. Amid the crash, UST, designed to stay pegged at $1— and associated lending protocol Anchor – bottomed out at just 13 cents.

Anchor Protocol, Terra’s high-interest savings account, has been steadily reducing the rates it offers holders for depositing UST. What began at 20% and had been marketed as “stable,” steadily began to drop following the passing of so-called Proposal 20. That proposal meant that if Anchor’s reserves increased by 5%, the interest rate would increase. If those reserves decreased by 5%, the interest rate would also go down.

Despite those mind-unsettling events, as the cryptocurrency industry evolves, after a deep overhaul, algorithmic stablecoins still offer an interesting development that could shape the future of stablecoins and decentralized finance.

Gold-backed Stablecoins

Coins backed by gold became an elegant way to lawfully bypass any emerging stablecoins’, which are typically pegged to the dollar, overregulation and have become the newer benchmarks of this class of crypto assets. The largest of them, Pax Gold, developed by the company Paxos, or PAXG, has jumped almost 18% annually in early November 2023, while main rival Tether Gold (XAUT) has leaped almost 19%. PAXG has seen its market value rise by almost a third to $477 million this year, while Tether Gold has risen 20% to almost $500 million. By comparison, the latter's 8-year-old sibling, the 8-year-pegged Tether – the world's largest stablecoin – has a market cap of over $85 billion, which means gold-backed stablecoins have an enormous capacity to grow. Tether Gold has also been warmly welcomed by bigger investors, including whales with $1 million or more of cryptocurrency, using the token to change some of their holdings into gold.

Over the longer time horizon, Tether Gold has seen a 300% jump in its market cap since January 2021. At the same time, PAX Gold (PAXG) has seen an approximately 400% hike in its market cap in the same time period. Their growth of this metric has far outpaced the rest of the cryptocurrency market – not only due to their inherently low volatility, but also because of the ease of getting into.

Gold-backed stablecoins are helpful for investing in assets that are not always easy to find in the nearest geographic location. For example, physically buying and storing gold can be expensive and unavailable in many locations. However, by purchasing duly audited gold-backed stablecoins, investors can gain access to a tokenized form of bullion.

Stablecoins Backed by Other Commodities

Like fiat and gold-backed stablecoins, these stablecoins are backed by external assets that are not cryptocurrencies. In this case, this segment of stablecoins is backed by commodities that are pegged to other exchange-traded tangible assets. Stablecoins backed by non-gold commodities offer a unique and innovative approach to digital currencies. They allow for a more diverse and resilient backing, reducing the risk of sudden market fluctuations.

By pegging the value of stablecoins to non-gold commodities such as oil, natural gas, or even agricultural products, issuers aim to maintain a stable and reliable value. That idea ensures that users can hold and transact with these digital assets without the worry of extreme volatility associated with other cryptocurrencies, and remain closer to their assets of interest.

Furthermore, using non-gold commodities as backing offers a wider range of real-world applications. For instance, stablecoins backed by oil could be used in the energy sector for seamless and efficient transactions without the need to face certain restrictions of the dollar-pegged stablecoins. Similarly, stablecoins backed by agricultural commodities could transform the way farmers and suppliers engage in trade, streamlining processes and ensuring fair prices.

Overall, stablecoins backed by non-gold commodities provide an interesting avenue for cryptocurrency users and businesses alike. With increased stability and practical use cases, these digital assets have the potential to reshape the financial landscape in a beneficial and sustainable way, because while commodities also fluctuate in value, they tend to hold their value better than other types of assets in times of economic inflation.

What are the Best Stablecoins?

In order to identify the best stablecoins, we must first understand what makes them good. From a fundamental point of view, the best stablecoins should provide transparency in their assets and the corresponding backing. In addition, the best stablecoins should have a high trading volume so that they can act as a liquid medium of exchange. These two factors combine to create a foundation of confidence for investors who can trust in the stability of a stablecoin, knowing that it is backed by a robust pool of assets and that it can be easily exchanged for other stablecoins.

From UDSC to DAI, there are some of the best stablecoins one can reliably include in your portfolio.

In recent news, Aave and Curve have announced their own stablecoins: GHO and crvUSD. If they prove successful, it will likely spur the growth of protocol-specific stablecoins.

Latest Stablecoins’ Intricacies

In October, the largest stablecoin by market capitalization, Tether (USDT), faced another 1.9% increase in its supply. As a result, the present market valuation of USDT is about $84.98 billion. On September 30, 2023, the market capitalization of this cryptocurrency was recorded to be $83.22 billion at the end of business hours.

Tether has been acknowledged to enjoy a growing significant presence in the world of cryptocurrency trading. Specifically, there have been 456 crypto exchanges that have listed Tether, and these exchanges have recorded a global trade volume of $19.79 billion. This volume constitutes over 27% of the total trades conducted in the entire cryptocurrency ecosystem, which amounted to $71.77 billion over the same time period.

Over the course of the last 30 days, the market value of Circle's USD coin (USDC) has declined by 3.4%, which puts its current value at $24.50 billion. In contrast, Makerdao's DAI, which is the third largest in terms of market value, is significantly lower at $3.72 billion. During October, DAI also saw a decline of 3%.

During the month, the supply of TrueUSD (TUSD) decreased by 3.1% and is now valued at $3.34 billion. The standout drop for October, however, was the redemption of a significant 13.1% of BUSD's supply.

The market valuation of BUSD has recently slipped below the threshold of $2 billion and currently stands at $1.95 billion. In contrast, the USDD token issued by Tron underwent a marginal reduction of 0.4%, while the supply of FRAX experienced an even lighter drop, at 0.2%.

More interestingly, PayPal, the world's best-known fintech company, announced that its managers recently received a subpoena from the SEC for its newfangled PYUSD stablecoin. According to the latest data from CryptoSlate, PYUSD has a market capitalization of $158.93 million with an average daily trading volume of about $7.2 million. As specified by Reuters, the move followed PayPal's decision in August to become the industry's first payment gateway to accept transfers in certain cryptocurrencies.

PayPal's debut into the world of digital currencies began in August with the launch of the PayPal-USD-stablecoin PYUSD, fully backed by deposits in U.S. dollars, U.S. Treasuries, and similar dollar equivalents. PayPal's PYUSD — an ERC-20 token issued on the Ethereum blockchain — was envisioned as a natural bridge between fiat and digital currencies for the plethora of online vendors and their consumers, online shoppers, borrowers, and DevOps. However, as the SEC's subpoena points out, the path to achieving that goal is now complicated by regulatory constraints in the form of an injunction that must now be scrutinized and satisfied.

However, challenges are being encountered in this new line of business. Despite the almost seamless registration of its planned issuance with the UK Financial Conduct Authority (FCA), PayPal faced the most unexpected and harshest restrictions on its cryptocurrency activities in its home country. The fintech giant now deals with the risk of being banned from allowing new customers to buy and sell not only its own stablecoin but also all-new crypto assets listed on the portal, as well as expanding its current crypto asset offerings and automatically exchanging them for fiat money without regulatory approval.

But despite the fact that on October 31, before PayPal received a subpoena from the SEC, the British Treasury published a proposal to include cryptocurrency activity in the regulation of financial services. It’s hard to imagine a more frustrating incoordination between the world’s best-known financial regulatory agencies.

After applying mutually agreed amendments, now, according to the proposal, all companies declaring cryptocurrency transactions must first obtain authorization from the UK Financial Services Authority to operate in the country. The formerly largest global crypto exchange, Binance's sad lesson of failing to stay away from unfriendly jurisdictions seems not to have been taken into account by its unfortunate follower, PayPal.

In addition, the SEC has demanded full transparency of PayPal's operations and has prioritized that activity, hinting that it will be a key factor in overcoming the mutual controversy. In this regard, Paxos Trust Company, which controls the issuance of PayPal USD, has committed to publishing monthly reports on the reserves securing PayPal USD starting in September 2023. This report should

DeFi Trading Platforms and Variety of Tradable Stablecoins

DeFi trading platforms support a wide array of stablecoins, allowing users to choose their preferred option. Some popular stablecoins include the above-detailed Tether (USDT), USD Coin (USDC), Dai (DAI), and TrueUSD (TUSD). Each stablecoin has its unique features, such as different mechanisms for maintaining stability or varying levels of decentralization.

The availability of multiple stablecoins on DeFi trading platforms provides users with flexibility in their trading strategies. Traders can choose stablecoins that align with their individual levels of risk tolerance, regional preferences, or desired liquidity. Moreover, it enables arbitrage opportunities across different stablecoins, enhancing market efficiency.