The 2021 a-z of stablecoins

Share this article

Mike

An editor at Coincrop

14 Dec 2021 | 12 min read
20,727 views

tablecoins have grown to play an essential part of the cryptocurrency eco-system.

In this guide:

Are there different types of stablecoins?

What are the most popular stablecoins?

What rate of return can I earn on a stablecoin?

Disclaimer: All of the information written on Coin Crop is without influence and based on our analysis. No guarantee is offered concerning the accuracy of this information and therefore, any individual following up on it does as such completely at their own risk. Rates are correct at time of publication.

What is a stablecoin?

Stablecoins are a technology similar to cryptocurrencies but with a key difference in that they are backed by real-world assets.

Each stablecoin is composed of tokens and just like cryptocurrencies they can be sent and received between two blockchain addresses. The value of these tokens is typically stable as it is tied to a real world asset. For example, if you used a stablecoin to send someone $100 USD, they would receive $100 USD and its value over time would remain unchanged.

Are there different types of stablecoins?

Yes! Lets look at the various types below:

i) Fiat-backed (off-chain) stablecoins

These are the most simple to understand stablecoins as they are backed 1:1 by fiat currency (traditional money). As the underlying collateral isn’t a different cryptocurrency, we refer to this type of stablecoin as an off-chain asset.

The fiat currency used as collateral is held with the stablecoin issuer or a financial institution. At all times the reserves must be proportionate to the quantity of stablecoin tokens in circulation. For example, Tether (USDT) could only distribute 100 million stablecoins if it held 100 million U.S. dollars.

ii) Crypto-backed (on-chain) stablecoins

Crypto-collateralized stablecoins are backed by another cryptocurrency as the collateral. The process happens on-chain and makes use of smart contract rather than a central issuer.

If you choose to purchase a crypto-backed stablecoin, your cryptocurrency is locked into a smart contract in order to obtain tokens of a comparable value. When the time comes to exchange your cypto-backed stablecoin the token is sent into the smart contract and the original cryptocurrency returned.

One of the most popular crypto-backed stablecoins is DAI. It should be noted that these types of stablecoin are over-collateralized to account for the possibility of price fluctuations in the cryptocurrency that has been used at the collateral asset. As an example:

- If you wanted to acquire $1,000 of DAI stablecoins, $2,000 of ETH would need to be deposited – a collateralized ratio of 200%. In the event that the price of ETH decreases but remains higher than the defined threshold, the surplus collateral buffers DAI’s price to ensure stability. On the reverse, if ETH price drops below a define threshold, collateral is returned back into the smart contract in order to liquidate.

iii) Algorithmic stablecoins

In contrast to other stablecoins, algorithmic do not use fiat or cryptocurrency as collateral. The specialized algorithms and associated smart contracts manage the supply of the tokens that are in circulation. In the event that the market price decreases below the price of the fiat currency is mirrors, the algorithmic stablecoin system will decrease the number of tokens in circulation. Conversely, if the price of the token is greater than the price of the fiat current is follows, additional tokens enter into circulation to decrease the stablecoin value.

iv) Commodity-Backed stablecoins

Yet another type of stablecoin is that of the commodity-backed token – that is using physical assets such as oil, precious metals, real estate and oil.

The most popular is collateralized gold - Paxos Gold (PAXG) and Tether Gold (XAUD) are two such examples. Keep in mind that just as commodities can fluctuate in price, so too can commodity-backed stablecoins.

There are some interesting aspects to commodity-backed stablecoins that differentiate themselves from other stablecoin types. For example, in some parts of the world, purchasing a gold bar with appropriate storage is difficult. Thus, people are dissuaded from holding gold and silver. However, commodity-backed stablecoins now makes it possible to hold gold and silver without the purchase or storage difficulties.

Individuals that hold Paxos Gold (PAXG) or Tether Gold (XAUD) are able to sell the tokens for fiat currency or even take possession of the equivalent in physical gold - subject to minimum amounts that translate to gold bar sizes. Not all commodity-backed stablecoins can be exchanged for physical assets – The Venezuelan exploratory Petro stablecoin can’t be exchanged for oil. In terms of real estate based stablecoins, there has been little progress in this area.

Why use a stablecoin?

The biggest problem with cryptocurrencies is the high volatility that affects prices. Consumers and businesses do not want the currency risks when executing transactions in a cryptocurrency. This is where stablecoins have a beneficial role.

Stablecoins are potentially attractive in the transacting of everyday finance as their stability appeals to both parties in the transaction. At the point of agreeing the terms of a transaction, the payer and payee know that the amount will not change (unlike cryptocurrencies which can be volatile).

Individuals that trade cryptocurrencies make extensive use of stablecoins – the ability to move in and out of fiat currencies (using stablecoins) is very useful. Similarly, at times of high market volatility some individuals will move out of cryptocurrencies into the “save haven” of stablecoins.

Stablecoins in the digital currency form can be used to make immediate payments across the world – this has tremendous potential to many millions of “unbanked” and “underbanked”. Whether it is a migrant worker sending money home or a business settling an invoice with an overseas supplier, stablecoins have significant potential for replacing traditional expensive and slower currency transfers.

Are stablecoins safe?

At the time of writing, there is approximately $133 billion USD in fiat and commodity based stablecoins. There growth has increased by over five times in market capitalisation in the last year. Stablecoins have become essential to the global liquidity of crypto markets.

We can consider a number of risks posed by stablecoins. The equivalent of a “run on the bank” could pose significant difficulties for a stablecoin. For several years there have been rumours surrounding Tether (USDT) and how the stablecoin is collateralised – not all of the collateral is in fiat currency. This raises that question as to how quickly Tether could sell some of the assets in a mass liquidation event. It is conceivable that rumours as to the viability of a stablecoin could lead to a sell off and potential contagion into other stablecoins.

Earlier in 2021 Jerome Powell, chair of the Federal Reserve, stated the urgency of regulating stablecoins. There have been suggestions that stablecoins will be regulated like banks - it remains to be seen what regulations will be introduced. The risk of significant regulation in stablecoins could lead to a massive liquidity shock with massive panic selling.

What are the most popular stablecoins?

Organization	Symbol	Rank	Market capitalization
Tether	USDT	3	$78 billion
USD Coin	USDC	5	$50 billion
Binance USD	BUSD	13	$15 billion
TerraUSD	UST	16	$11 billion
Dai	DAI	19	$9 billion
Frax	FRAX	51	$3 billion
TrueUSD	TUSD	72	$1 billion
Paxos Standard	PAX	99	$1 billion