Stablecoins have emerged as a unique solution to the volatility that plagues traditional cryptocurrencies like Bitcoin. These digital assets have become a cornerstone in decentralized finance (DeFi) and garnered significant attention from investors, traders, and institutions.
Cryptocurrencies are one of the most exciting asset classes in global financial markets. They're convenient to hold and trade, offer efficiencies that traditional currencies and payment methods cannot offer, and are the future. But many investors are wary of the crypto market due to their innate volatility and unpredictability. This is where stablecoins come in - they entail all the benefits of being a cryptocurrency, such as transparency, security, and privacy, without the volatility and price fluctuations.
This comprehensive guide will explore the world of stablecoins. Read on to understand their purpose, mechanisms, types, and the latest developments in the stablecoin market.
What Are Stablecoins, and How Do They Work?
Stablecoins are a class of cryptocurrencies specifically designed to maintain a steady value by anchoring their worth to an external reference, ranging from traditional fiat currencies like the US dollar to commodities or other financial instruments. The primary aim of stablecoins is to mitigate the extreme price fluctuations that often characterize popular cryptocurrencies like Bitcoin, making them more suitable for everyday transactions and financial activities.
These stablecoins achieve price stability through various approaches. Some maintain a fiat currency reserve, such as the US dollar or Euro, as collateral to ensure their value remains consistent. In contrast, others utilize algorithmic formulas to manage supply and demand dynamically. The latter method automatically mints or burns coins to keep the price aligned with the target value.
What Are Stablecoins Used For?
The volatility of cryptocurrencies like Bitcoin can make routine transactions risky for buyers and sellers. Stablecoins address this challenge by providing a medium of exchange with relatively stable value. Businesses and consumers can transact without fearing sudden and substantial price changes, fostering confidence in using cryptocurrencies for everyday purchases.
What Are the Different Types of Stablecoins?
Stablecoins come in several varieties based on their underlying mechanisms for value stabilization. Primarily, the two types of stablecoins are fiat-backed and crypto-backed stablecoins. However, we can divide this further into four types:
These stablecoins are backed 1:1 by an underlying fiat currency asset as collateral, such as the US Dollar, Euro, or Canadian Dollar, or other financial reserves in fiat currency backed by regulated financial institutions, such as treasury bills and treasury bonds. All the underlying collateral is off-chain with an issuer or a financial institution. USDT, USDC, BUSD, GUSD, and PAX are some of the common fiat-backed stablecoins. Popular examples include Tether (USDT) and USD Coin (USDC).
Tether's USDT, the leading stablecoin in market cap, share, and liquidity, is the preferred digital asset for trading on major crypto exchanges like KuCoin due to its high liquidity. It enables businesses and individuals to conduct low-cost, secure, instant crypto transactions with price stability.
Tether maintains USDT's peg to the US dollar through diverse fiat-backed reserves. Despite past criticism for reserve transparency, Tether publicly discloses this information and has independent audits, boosting user trust.
Benefiting from a first-mover advantage, USDT operates across multiple blockchain ecosystems, including Ethereum, TRON, EOS, Algorand, Avalanche, and Solana. As of August 2023, USDT is the largest stablecoin by market cap, ranking third with a market capitalization of more than $83 billion. It also dominates the stablecoin market, accounting for over 68% of the market share.
USDT Dominates the Stablecoin Market | Source: CoinGecko
USD Coin (USDC)
USD Coin (USDC), a stablecoin managed by the Centre Consortium, founded by Circle and Coinbase, is pegged to the US dollar through dollar-denominated reserves. As the second most used stablecoin with high liquidity, it's a popular base currency for trading on major crypto exchanges.
Each USDC unit is backed by a dollar in reserves held by Circle, combining cash and short-term US Treasury bonds. Its issuance by regulated financial institutions and acceptance by regulatory authorities give it an edge in the stablecoin market.
USDC operates across multiple blockchains, including Ethereum, Avalanche, TRON, Stellar, Solana, Algorand, Flow, and Hedera. USDC ranks sixth in market cap among all cryptocurrencies and is the second most popular stablecoin with a market cap of over $26 billion and a market share of over 21% as of August 2023.
These stablecoins are backed by other cryptocurrencies, requiring over-collateralization to counteract the volatility of the reserve cryptocurrency. MakerDAO's Dai (DAI) and Reserve Rights (RSV) are popular crypto-backed stablecoins.
The DAI stablecoin is created and managed by MakerDAO, a prominent DAO in the crypto market. This decentralized stablecoin operates on the Ethereum blockchain, with its price stability managed by the Maker Protocol and MKR token via smart contracts.
With integration into over 400 applications and services, DAI enjoys widespread adoption. A mix of cryptocurrencies backs it as collateral, which increases when DAI demand rises to maintain its USD peg. Launched in November 2019, the multi-collateral DAI stablecoin is famous for its transparent management by a decentralized organization, not a central bank or institution.
DAI is an ERC-20 token used on the Ethereum blockchain. DAI ranks as the 15th largest cryptocurrency by market cap and the third largest stablecoin, with a market capitalization of more than $5.3 billion as of August 2023.
Reserve (RSV) is a prominent example of a crypto-backed stablecoin that embodies an innovative approach to addressing inflation and hyperinflation. Serving as the main token of the Reserve ecosystem, Reserve Rights (RSR) is integral to the mission of establishing decentralized banking infrastructure in regions affected by hyperinflation.
This stablecoin, with a market cap of over $28 million and a rank of 490 in terms of market cap, underpins the Reserve App, allowing individuals in hyperinflation-stricken areas to access stable currencies like the US Dollar. Influenced by the belief that stable currency is a human right, venture capitalists such as Peter Thiel and Sam Altman support the Reserve Rights movement.
These stablecoins are backed by physical assets like precious metals (gold, silver), oil, and real estate. Gold and silver are the most popular commodities kept as the underlying collateral. The stable value of these commodity-backed stablecoins is pegged to the equivalent dollar value of the underlying commodities. Popular examples of these stablecoins include Tether Gold (XAUT) and Pax Gold (PAXG).
Tether Gold (XAUT)
Tether Gold (XAUT) exemplifies a commodity-backed stablecoin that bridges the world of digital assets and physical commodities. Created by Tether, the company known for its USDT stablecoin, XAUT is a cryptocurrency pegged to the price of gold, providing an accessible means for investors to engage with the commodity.
Each XAUT token represents ownership of one troy fine ounce of gold, backed by physical London Good Delivery (LGD) standard bars. This commodity-backed stability offers advantages for investors, including the security of physical reserves and the convenience of an ERC-20 token, allowing easy movement on the Ethereum blockchain.
Pax Gold (PAXG)
Pax Gold (PAXG) offers investors a secure and efficient way to own investment-grade physical gold with the added benefits of blockchain technology. Each PAXG token represents ownership of one fine troy ounce of gold, stored in LBMA vaults in London and held in custody by Paxos Trust Company.
This gold-backed stablecoin is designed to provide a cost-effective solution for owning physical gold, with advantages such as lower costs, zero storage fees, and the security of audited and regulated custodianship. PAXG enables instantaneous settlement and offers the unique feature of being redeemable for LBMA-accredited Good Delivery gold bullion bars or even for USD at current gold market prices, providing flexibility and tangible value for investors.
These stablecoins don't rely on collateral but instead use algorithmic mechanisms to control supply and demand, thereby maintaining price stability. However, they can be challenging to implement successfully. Following the crash of TerraUSD (UST) stablecoin, other popular algorithmic stablecoins existing in the crypto market include USDD (USDD) and Frax (FRAX).
USDD (USDD) is an example of an algorithmic stablecoin introduced on the TRON blockchain as a TRC token. As part of the new generation of stablecoins, USDD utilizes mathematical algorithms to maintain its peg to the US dollar. The Peg Stability Module (PSM) of USDD enables users to exchange with other stablecoins at a 1:1 ratio, enhancing its stability.
Despite being relatively new, USDD has attracted attention within the cryptocurrency community due to TRON's involvement and experience. USDD's presence represents TRON's entry into decentralized algorithmic stablecoins, aiming to collaborate with other blockchains and industry leaders to establish a fully decentralized USD exchange mechanism.
As of August 2023, it ranks seven in market cap among stablecoins and enjoys a total market capitalization of over $723 million.
FRAX, a decentralized stablecoin protocol introduced in 2020, exemplifies a fractional-algorithmic stablecoin innovation. Within the Frax Finance ecosystem, two distinct tokens play essential roles: $FXS, a governance and utility stablecoin, and $Frax, a stablecoin pegged to the US dollar at a 1:1 ratio. Unlike over-collateralized stablecoins like DAI and USDC, FRAX employs a partial collateral mechanism and a partial algorithmic model, classifying it as a "hybrid algorithm stablecoin."
While algorithmic processes contribute to the creation of $Frax, the protocol's rapid development also entails multiplied risks. However, incorporating hard currency USDC as a backing ensures intrinsic value even during extreme market volatility.
Founded by Sam Kazemian, Frax Finance aims to offer a scalable, decentralized algorithmic currency that could eventually challenge fixed-supply mainstream digital assets. The governance token, Frax Shares (FXS), was launched alongside this initiative to carry out algorithmic procedures and enhance protocol governance.
FRAX is the sixth largest stablecoin by market cap, enjoying a market capitalization of more than $810 million as of August 2023.
New Stablecoins in the Crypto Market to Know About
In recent developments, PayPal has introduced its own stablecoin called PayPal USD (PYUSD), pegged to the US dollar. This move by a major financial player highlights the growing relevance and adoption of stablecoins in the cryptocurrency ecosystem. You can trade PYUSD/USDT on the KuCoin Spot Market.
Learn all about PayPal USD (PYUSD) stablecoin here.
Introduced in June 2023, First Digital USD (FDUSD) is a relatively new entrant in the stablecoin market. FDUSD is issued by Hong Kong-based First Digital Group on Ethereum and BNB Chain blockchains and will expand to other blockchains in the future. Unlike some other stablecoins, FDUSD is redeemable for USD, making it a redeemable stablecoin. This means that users can exchange their FDUSD for physical USD, enhancing its credibility. FDUSD's launch coincided with the implementation of crypto regulations in Hong Kong, signifying its compliance with regulatory standards.
In the short time since its launch, it has gone on to become the ninth-largest stablecoin by market cap. Its surge in popularity was driven by Binance’s announcement to halt support of Binance USD (BUSD) stablecoin following regulatory concerns. The leading crypto exchange has advised its users to convert their BUSD holdings to FSUSD by February 2024, making it the platform’s preferred stablecoin. As of early September 2023, FDUSD enjoys a market cap of just under $400 million.
Euro Coin (EUROC) is another recent entrant in the stablecoin market. EUROC was announced by Circle - the issuer of USDC, in May 2023. The Euro-backed stablecoin is entirely backed by Euros, making it fully redeemable at 1:1 for EUR. As of August 2023, this Euro stablecoin is available on Ethereum and Avalanche blockchains.
Another example among the newer stablecoins that gained considerable attention at launch is Cardano's Djed stablecoin. As of August 2023, it has a market cap of over $3.5 million, and it ranks 1,006 in terms of market cap.
What Are the Benefits of Stablecoins?
Stablecoins offer a range of benefits that contribute to their rising popularity:
The foremost advantage is their ability to provide price stability, making them suitable for everyday transactions and financial activities.
Stablecoins are a better medium of exchange than other mainstream cryptocurrencies like Bitcoin and Ethereum due to less volatility and wild price fluctuations. They bridge the gap between fiat currencies and cryptocurrencies and provide a safe gateway for businesses and investors who want less volatility and associated risks.
Hedge Against Volatility
Stablecoins mitigate the wild price swings associated with traditional cryptocurrencies, reducing buyer and seller risks. Due to the less volatile nature of stablecoins, many traders use them to hedge against volatility and secure their holdings in other assets.
If the price of Bitcoin and other altcoins declines, investors and traders can instantly sell them for stablecoins to avoid further losses. This is evident from an uptick in the on-chain volume of stablecoins during bear market conditions.
Share of Total Stablecoin Supply on Ethereum | Source: The Block
Stablecoins play a crucial role in decentralized finance, enabling users to access various financial services without intermediaries like banks or brokers. They are widely used to serve as collateral in many DeFi lending protocols and the process of liquidity mining across various decentralized exchanges (DEXs).
Stablecoins transcend geographical barriers, enabling borderless transactions and financial inclusion for individuals who lack access to traditional banking services.
Passive Income Generation Opportunities
Stablecoins can also be used to generate passive income through various DeFi platforms and cryptocurrency exchanges like KuCoin. By holding lending stablecoins on these platforms, you can earn interest over time, providing a potential source of passive income.
How Many Stablecoins Are There?
As of August 2023, Coinmarketcap lists more than 140 stablecoins on its website. The stablecoin market has witnessed remarkable growth, with numerous stablecoins available. From well-established players like Tether (USDT) to newer entrants like PayPal USD (PYUSD), the stablecoin landscape continues to expand, catering to diverse preferences and use cases.
Stablecoins have emerged as a cornerstone in the cryptocurrency realm, addressing the volatility concerns that have limited the broader adoption of digital assets. By anchoring their value to external references and employing innovative mechanisms, stablecoins offer a reliable medium of exchange and play a pivotal role in driving the adoption of cryptocurrencies for everyday transactions and financial activities. As crypto adoption grows worldwide, stablecoins will likely continue shaping the landscape and contributing to developing a more stable and accessible financial future.
1. What Was the First Stablecoin?
Introduced in 2014, Tether (USDT) is widely considered the first stablecoin in the crypto market. It aims to maintain a 1:1 peg with the US dollar.
2. What Is the Best Stablecoin?
Determining the "best" stablecoin depends on specific use cases and preferences. Some popular options include USDT, USDC, DAI, and USDD, each with unique features and mechanisms.
3. Are Stablecoins Regulated?
Stablecoins are gaining regulatory attention due to their potential impact on the financial system. While no standardized regulations exist, jurisdictions like Singapore have finalized rules for stablecoins, focusing on reserve backing and transparency.
The Monetary Authority of Singapore (MAS), which serves as the country's central bank, completed the establishment of a regulatory structure for stablecoins in August 2023. This framework mandates that regulated issuers must maintain the requisite reserves at hand.
4. Can Stablecoins Crash?
Stablecoins can risk crashing if they are not adequately backed, regulated, or managed. Instances like the collapse of algorithmic stablecoin UST have raised concerns about the stability of certain types of stablecoins.
5. Can Stablecoins Increase in Value?
Stablecoins are designed to maintain a stable value, often pegged to a specific currency like the US dollar. While their primary goal is stability, market dynamics, and external factors can impact their value, causing fluctuations.
6. Can You Store Stablecoins on Ledger?
You can store stablecoins on hardware wallets like Ledger. It is a secure offline storage option for your stablecoin holdings.