What are Stablecoins?
Stablecoins are cryptocurrencies that attempt to peg their market value to some external reference
They have been described as the backbone for Defi, and they are a simple thing in practice, but they cause a lot of controversy in the crypto space, today we will look at why.
A stablecoin is a class of cryptocurrencies that attempt to offer price stability and are backed by a reserve asset.
Stablecoins are most commonly linked to a fiat currency, such as the U.S. dollar, but they can also have value linked to precious metals or other cryptocurrencies.
The stablecoin is the most important product in crypto, uniquely serving the currency function of cryptocurrencies. — Do Kwon
A stablecoin is a cryptocurrency that is designed in such a way that their price is pegged to another currency or asset, making their prices stable whilst other cryptocurrencies move around with volatility.
USDT is still the biggest stablecoin, but others like UST are catching up
The most famous of the stablecoins, Tether is responsible for a huge amount of the stablecoin volume in todays markets. Each Tether minted is backed by real world assets, which allows investors in Tether (USDT) to know that what they are buying is worth $1.
The controversy with Tether is that they have never been audited and so the claim that their USDT is backed by a dollar equivalent of assets has never been backed up. This means that the whole enterprise could be built on a false promise and the USDT in the market are actually not worth the $1 peg. For now though, the market has accepted that their claims are acceptable and the volume in USDT is one of the highest in the market.
These do not rely on a third party and instead rely on an algorithm to keep the price in check, this is much more advanced and in a way more trusted and transparent than a centralised method like Tether.
This is a really interesting project and we dedicated a whole article to it here - essentially they have created a sibling cryptocurrency ($luna) and change the supply of that currency to create arbitrage opportunities that keep the coin (UST) pegged to $1.
DAI, which was created by blockchain company MakerDAO, is an ERC20 token whose value is pegged to the US dollar, and can be used for transfers between Ethereum wallets.
At time of writing, tether was still top, with Terra UST gaining.
- They offer traders relief from volatility of the cryptocurrency markets
- They are essential for Defi, as many protocols are built on stablecoins - you earn interest on the stablecoin, thus removing the risk and guaranteeing a consistent return.
- Many large exchanges, including Kucoin and Binance, don't allow traders to trade in fiat currency and therefore the stablecoin takes the place of the dollar. This explains why the volumes are so large
Stablecoins can lose their pegs, if there is a run on the coin or the algorithm fails. This has happened in the past with projects as big as Tether dropping as low as 0.51c on some exchanges. That means that these coins are not perfectly stable, and there is inherent risk in holding them. Furthermore, the centralised coins like Tether may not be holding the reserves that they claim, as they haven't been audited. This leaves the risk that the project could implode should investors feel that their funds are not backed up by assets. This would be a nuclear event for the cryptocurrency world.