For the last few years, stablecoins have proven to be some of the most popular assets on the cryptocurrency markets. In the first half of 2018, the total market cap of all stablecoins was under $3 billion – lower than the market cap of DAI today, according to Messari’s Stablecoin Index. Now, the total market cap is around $70 billion.
So, what’s all the fuss about stablecoins? Here, we answer some common questions.
What is a Stablecoin, and What is Their Purpose?
A stablecoin is a type of cryptocurrency that offers price stability by pegging the value to another asset. How the peg maintains stability can vary according to the type of stablecoin. The overall purpose is to overcome the volatility traditionally associated with cryptocurrencies like Bitcoin or Ethereum.
The biggest and best-known stablecoin is Tether (USDT,) which is pegged to the value of the US dollar. Tethers are also backed 1:1 by reserves of US dollars. Other stablecoins that use the same model are Circle’s USDC, Binance’s BUSD, and TrustToken’s TUSD.
There are also several examples of decentralized stablecoins, which are backed by cryptocurrency. MakerDAO’s DAI is the biggest and best-known. DAI depends on users depositing cryptocurrencies in Ethereum-based smart contracts called Collateralized Debt Positions (CDPs.) DAI’s peg to the US dollar is maintained using an algorithm, and users are required to overcollateralize their DAI. This reduces the risk associated with the underlying cryptocurrency falling in value. If it does fall below a particular threshold, the DAI may become liquidated automatically by the CDP smart contract.
Are Stablecoins Trustworthy?
Using any type of cryptocurrency comes with some risk. Usually, this is the risk of volatility, but although stablecoins are stable in value, there may be other risks.
For instance, most US dollar-pegged stablecoins are issued by centralized entities, requiring the user to trust there are sufficient reserves. As mentioned above, the risk with DAI is that the underlying cryptocurrency may be too volatile to support the value of the DAI issued. As with any digital assets, you should do some research before putting your funds in.
What Are Some Other Types of Stablecoins?
Not all stablecoins are backed by fiat or cryptocurrencies but may be backed by other assets. For example, BondAppétit is a new DeFi protocol offering a stablecoin called USDap, which is the first-ever to be backed by bonds. While the price of the asset is maintained at one US dollar, the underlying reserves are based on a basket of real-world government debt obligations.
BondAppétit aims to solve the challenge in DeFi of requiring users to overcollateralize their loan. Overcollateralization is a core challenge making DeFi unattractive to many potential borrowers who may not have the excess funds for a loan.
Unlike most DeFi protocols, the BondAppétit protocol uses real cash flow based on bonds, meaning users don’t have to stake more than they own to mint the USDap coins. However, the platform itself is still completely decentralized, run by Ethereum smart contracts, and governed by holders of the BAG governance token. BAG is rewarded to BondAppétit token holders who mint the USDap stablecoin. At any time, users can view the reserve assets on the blockchain.
BondAppétit is fairly unique among asset-backed stablecoins in that it’s designed to offer businesses and individual users the opportunity to borrow funds without over-collateralization. Most other types of asset-backed stablecoins are simply designed to give users exposure to an underlying asset. For instance, gold-backed stablecoins are backed by, and pegged to, the value of gold. Examples include Digix or Paxos Gold.
Will Governments Eventually Create Stablecoins?
It’s indisputable that governments will create stablecoins, called Central Bank Digital Currencies (CBDCs.)
However, there is still plenty of debate about the form they will take. For instance, China has already started to issue a digital yuan, but it’s not based on a blockchain. Other central banks, including the Bank of England, the European Central Bank, and the Bank of Japan, are all in various stages of research regarding the issuance of a CBDC.
So far, talk of CBDCs has mainly been limited to central banks in developed economies. It remains to be seen whether or not developing economies will launch their own CBDCs. Given the pace of innovation in cryptocurrency and DeFi, it seems possible or even likely that they wouldn’t go to the time and expense, as they could easily adopt other available coins such as BondAppétit or even Facebook’s Diem stablecoin (formerly known as Libra.)
Overall, stablecoins are a significant source of value within the cryptocurrency sector. It seems inevitable that this value will eventually spill over into the real world, spurring cryptocurrency adoption among a far broader audience of users.