What Are Stablecoins?

If you ever buy cryptocurrencies you can clearly see they go up 10% today and down 5% the next day. This makes it very hard to use them as a medium of exchange. For instance, imagine getting paid $1000 in bitcoin today and the next day you decided to buy a nice Phone with it. You go to the store and check your balance and see it drops 15%. Nobody wants that right?

In this article, we will explain stablecoins and their purposes.

I am not in any shape of form a financial adviser and none of this is financial advice. Always do your own research!

Understanding Stablecoins

Just put it like this: Stablecoins are simply cryptocurrencies that are stable. They are pegged to real world assets such as currencies or commodities. This gives them stability while being cheaper and faster to use.

You might be thinking why would I need a stablecoin? Well remember fiat currencies like the U.S Dollar are not in the blockchain which means in order to exchange in fiat, we would need a centralised exchange to do so. Also, trading would have been very hard to do without stablecoins. Just imagine you have ETH in your metamask and you decided to take profit when the market is pumping. Without stablecoins, you only have two options. you can either send your ETH to a centralise exchange like Coinbase and trade them with USD or Swap them in a Decentralised Exchange like Uniswap for another volatile asset.

While the first option seems convenient, we all know it is not the best way to go in crypto as we say “not your keys not crypto.” And the latter is somewhere you don’t wanna be.

Stablecoins on the other hand are designed from day one to be stable and they are cryptocurrencies just like BTC and ETH. This gives them the best of both worlds.

Stablecoins can be divided into two types:

Centralise Stablecoins

Decentralise Stablecoins

Centralise Stablecoins

These stablecoins are backed by cash and cash equivalent aka government or corporate debt held by third parties. The most common ones are Tether’s USDT and Circle’s USDC. They are both pegged to the U.S Dollar meaning 1USDT=$1.

Although these stablecoins are convenient, they are heavily centralised. The company that issues them can freeze your funds at any time. In fact, Tether has recently frozen over $1m worth of USDT for suspected fraud.

And since they are partially backed by cash equivalents aka debt makes them a bit risky. If it helps, consider them as half banks half crypto.

Decentralise Stablecoins

When it comes to Decentralise Stablecoins, there are many of them with different mechanisms. some of them are partially centralised while others are completely decentralised. We will focus on the two biggest ones in the space here Dai and UST.

Dai is the makerDao ‘s soft-pegged stablecoin backed by ETH and other ERC20 tokens. In order to generate Dai, a user would need to deposit collateral in one of MakerDao’s vaults. So the Dai that has been generated is backed by the collateral deposited by the user.

I know you might say why someone would need to lock ETH to just get DAI? Well for the sake of simplicity, let’s say you have $150 worth of ETH and you need $100 cash to buy a pair of NIKE. You don’t want to sell your ETH and you want to buy the shoes. With MakerDao, you can deposit the $150 of ETH and generate $100 DAI and go buy the shoes with that $100. The next Friday, you get your paycheck now you can just pay back the $100 DAI and withdraw your $150 ETH. This barely scratches the surface when it comes to DAI and MakerDao but let’s leave it like that for today.

However, since that DAI is partially backed by USDC which is a centralised asset gives DAI the exposure to centralisation and regulatory risks same as other centralised stablecoins.

Another big player in the stablecoins space is Terra’s UST. For starters, Terra is a multi-coin smart contract blockchain same as Ethereum that focuses on Stablecoins. Terra has multiple stablecoins that are pegged to the world’s major fiat currencies like the British Pound, the European Euro and the Korean Won.

UST is an algorithmic stablecoin that is pegged to U.S Dollar and backed by Luna Terra’s native coin but not in a way that DAI is backed by ETH and ERC20 tokens. In order to mint UST, a user would need to burn an equivalent amount of $Luna and vice versa. This arbitrage behaviour shown below helps UST to keep its peg over time.

Since there is no centralised entity involved in the minting and burning of UST, makes UST one of the best stablecoin out there. In the last couple of months, the UST demand has grown exponentially and for that reason, its Market Cap flipped DAI which makes UST the biggest decentralise stablecoin for now.

Final thoughts

Stablecoins have grown massively in 2021 and with more adoption in cryptocurrency, I easily see them becoming a multi-trillion industry.

However, centralised stablecoins such as USDT and USDC faces major regulations in the United State and in many other countries. We should also take into consideration that USDT is heavily backed by corporate debt. This puts the whole industry at risk in the short term.

With all that being said, decentralised stablecoins like UST are starting to take the spot and this just simply shows the importance of decentralisation.

Thanks for reading!

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