While cryptocurrencies got their start without being tied to fiat money, value-linked, less volatile cryptos are now playing a major role in the industry.
How did stablecoins come to be? Which are the biggest and best projects? Blockchainwelt takes a closer look at stable value tokens.
Realcoin: The first stablecoin is created
At the beginning of everything there is Bitcoin – so it is also in the case of Stablecoins. In fact, the first fiat-linked token was also created on the Bitcoin blockchain.
To extend the capabilities of Bitcoin, the Mastercoin sidechain was created in January 2012. The project designed a communication protocol that still exists today. In the meantime, it bears the name Omni Layer.
This opportunity was used by the creators of the first stablecoin Realcoin, which was first introduced in July 2014. On October 6, 2014, the first stablecoins emerged as bitcoin tokens.
Today, Realcoin is known by the much better-known name Tether (USDT). USDT is the largest stablecoin and, on top of that, the most traded cryptocurrency ever.
However, USDT gained great popularity not as a Bitcoin token, but as an Ethereum token.
Why do stablecoins exist?
USDT aims to address a bitter criticism of bitcoin: its volatility. Enormous price fluctuations can drive users to adjust their spending to cycles.
In addition, USDT has allowed crypto investors to avoid losing value between buying and selling for the first time.
If a user sends Tether instead of a volatile cryptocurrency, they can still invest the desired amount after the funds arrive. However, stablecoins are particularly important as a liquidity and trading currency. Traders primarily rely on USDT. The oldest stablecoin is the most widely used.
It can be deposited on most crypto exchanges as well as linked to buy and sell orders, so that desired purchases and sales with a stable value are automatically realized without the need for an exchange in fiat currencies.
In addition, investments can be moved outside the traditional financial market, which have the value of a fiat currency, but are not subject to the monitoring and control of traditional financial channels.
Furthermore, stablecoins allow a stable value to be deposited as liquidity. However, contrary to what the term stablecoin suggests, they are usually tokens and not coins.
The abbreviated form Stables is used less frequently. The stable value tokens exist primarily as tokens on third-party blockchains.
Meanwhile, thanks to Terra, the principle of native stablecoins is gaining acceptance.
Is the value of stablecoins immutable?
Contrary to the popular belief that a stablecoin always reflects the exact value of a fiat currency or other store of value, the price of a stablecoin is never unshakeable.
Fluctuations are not uncommon with stablecoins. However, unlike volatile cryptocurrencies like bitcoin, the movements are much smaller.
Even centralized stablecoins like USDT are not immune to fluctuations. Both an increase and a decrease in value are always possible.
In the end, the market alone determines the value of a token. Although Tether has so far offered to exchange each USDT for exactly one dollar, the value of the stablecoin on crypto exchanges sometimes falls below this amount.
TerraUSD (UST) experienced a particularly severe collapse in early May 2022, with the stablecoin losing its dollar peg in the long term due to a mass panic. Despite many accusations, there was no technical failure at any point.
The same event is conceivable for other stablecoins, other cryptocurrencies, or even any other store of value. All it takes is a deep distrust in the product.
What happens if the anchor value of a stablecoin collapses?
In addition, since many crypto users have an inherent skepticism for fiat money, the question of what happens to a stablecoin in the event of a crash of the value-creating fiat currency often arises.
The behavior of the stablecoin in such a case depends on the project itself and the market’s reaction.
If the anchor value falls, a large proportion of stablecoin holders will inevitably assume an impending loss of value and will try to get rid of the tokens as quickly as possible.
Consequently, price drops are inevitable. In purely theoretical terms, however, this does not have to happen.
A detachment from the anchor value or – in the case of an algorithmic stablecoin – the use of a completely new anchor value is conceivable.
Can a stablecoin exist independently of a fiat currency?
Maker is a decentralized, autonomous organization. It operates DAI, one of the oldest algorithmic stablecoins. Its founder, Rune Christensen, when asked what happens to DAI in the event of a US dollar crash, responded as follows:
DAI should always be the most convenient and secure form of money. Currently, the peg to the US dollar is very beneficial to users.
However, once the U.S. dollar loses its stability, it could be quickly replaced as an anchor value.
If the U.S. dollar is no longer a good target, it would be very easy for makers to decide to peg to another currency or, more likely, to a contingent of currencies.
In Christensen’s view, however, the ultimate goal is to abandon a peg to a fiat currency in general and keep the value stable against consumer goods.
In the long run, the goal might even be to have a choice of consumer goods so that DAI becomes truly independent of existing fiat currencies.
In its current form, therefore, DAI is merely the representation “of the U.S. dollar with an added safeguard against hyperinflation.” At the same time, the sheer feasibility of the potential adjustment points to a problem:
The MakerDAO could make the choice to unpeg DAI. That choice could be flawed and cause significant harm to many users.
What types of stablecoins are there?
Tether (USDT) emerged as the first ever stablecoin to be a centralized stablecoin. This means that there is a central organization acting behind the currency – in this case, the company Tether Limited.
The mere existence of a company responsible for backing the stablecoin is considered by many crypto enthusiasts to be an insurmountable shortcoming. Consequently, algorithmic stablecoins developed.
The existence of an algorithm means that there is no need for a central authority. The algorithm thus provides the possibility for decentralization.
No central organization is behind algorithmic stablecoins such as TerraUSD (UST), DAI or FRAX.
While a centralized stablecoin establishes its value through backing in all cases, an algorithmic stablecoin can function completely unfunded, use partial backing, or full backing.
While the escrow of an algorithmic stablecoin is transparent through the blockchain, in the case of a centralized stablecoin, it cannot be traced beyond doubt which value escrow exists.
Therefore, centralized stablecoins often lie about the value escrow. Both USDT and USDC originally promised 1:1 coverage with US dollars, which was then not kept.
Tether: king of the stables or dangerous powder keg?
Tether was founded by iFinex, the company that also operates the Bitfinex crypto exchange.
Because of its central role, the company Tether Limited has sovereignty over the stablecoin USDT, which exists as a token on a wide variety of blockchains.
Depending on the blockchain, it is even possible for Tether to freeze funds against the user’s will – this is possible on the Ethereum and Tron blockchains.
So, it is noticeably not a decentralized cryptocurrency. Several leaders of the iFinex conglomerate are accompanied by a shady reputation.
They are considered untrustworthy, having been involved in dishonest dealings before Tether was founded. These include Raphael Nicolle and Giancarlo Devisini.
Unsurprisingly, therefore, some market participants consider that Tether advertised full dollar coverage for years, even though it was not true. New York Attorney General James comments:
Tether’s claim that its virtual currency was fully backed by U.S. dollars was a lie at all times.
In a transparency report compelled by the New York Attorney General’s Office, it came to light that at the time less than three percent (2.96 percent to be exact) of Stablecoin was directly backed by US dollars.
In a later report, the percentage rose to nearly ten percent. As of the current date (June 30, 2022), the share is 10.25 percent.
Due to false statements in this context, there have been repeated accusations against Tether by the authorities. Tether has already had to pay many millions in fines.
By October 2021, a total of $42.5 million in fines had been incurred. Despite all the criticism, Tether has by far the safest position on the market of all stablecoins.
On many platforms, Tether serves as liquidity – including in the DeFi space. A majority of crypto exchanges use Tether as a trading currency by default.
USDT is part of most trading pairs.
Worth noting: for some time bitcoin was the common trading currency. Years ago, its popularity in this role decreased due to its volatility. It was replaced by Tether for the majority.
Exchanging USDT for US dollars directly at Tether – a deception.
To boost trust in USDT, Tether allows tokens to be exchanged at the rate of one dollar through its own website.
What sounds good is made so unattractive in practice that hardly any users take up the offer.
In addition to the usual KYC measures, users are burdened with costs for the verification process in the amount of 150 US dollars, and a lower limit of 100,000 US dollars puts another hurdle in the way.
In addition, they charge a fee of 0.1 percent on each fiat withdrawal. It can therefore be concluded that Tether wants to avoid exchanging USDT for US dollars as much as possible.
Users prefer to trade the currency at the current market price on crypto exchanges, even if it is below the US dollar.
Is Tether driving up the bitcoin price?
On the one hand, Tether is a company that has sovereignty over the most widely used cryptocurrency in the world, and on the other hand, it places little emphasis on proper escrow.
While the latest reports in May 2022 show that Tether is over-collateralizing USDT’s circulating supply, much of that is in securities that Tether uses to make money.
Tether thus assumes a role similar to a central bank and can create USDT at will. At the same time, there are close ties to the crypto exchange Bitfinex, which belongs to the same parent company.
Money transfers of $850 million should already cover up a lack of liquidity.
Combine these points, and one major danger stands out: Tether could create USDT out of thin air and invest it in cryptocurrencies. There is a risk of a bubble forming in the cryptos involved.
A U.S. professor as well as an assistant professor investigated this danger more closely in late 2019 and came across ominous signs.
According to this, an unknown investor bought large amounts of Bitcoin via Bitfinex with freshly minted USDT as soon as the BTC price dropped.
While it is not clear who is behind this trade, the scale is large enough to affect the Bitcoin price, according to the report. The circumstances suggest that Tether itself could be behind these investments.
What are the advantages of USDT?
Despite all the risks, Tether is not only the cryptocurrency with the largest trading volume, but it is also one of the most widely used cryptos – and not without reason.
It’s not just its pioneering role that made this possible. Tether rapidly evolved alongside the crypto market.
As Ethereum emerged and offered better capabilities than the Bitcoin blockchain, Tether developed an ERC-20 token.
Later, the Ethereum blockchain became less and less interesting for end users. Tether responded and developed a TRC-20 of the Tron blockchain.
Rapidly, its importance as a TRC-20 token increased. To this day, Tether is mainly used in this form – due to fast transactions and low fees.
It can also be used as a Solana, Terra or Cronos token. Besides wide adoption, USDT can convince with a stable price most of the time.
Due to its implementation in the Omni Layer, it is even possible to use USDT in the Lightning Network. Work on this function is already taking shape in spring 2022.
USD Coin – the role model among stablecoins?
USDT’s most vexed opponent is USD Coin (USDC), which emerged in September 2018 only several years after Tether.
Although USDC is also centralized and subordinated to Centre – a consortium founded by Coinbase and Circle – it enjoys a good reputation.
From the very beginning, the goal of the stablecoin was to create an alternative to USDT that would adhere to the intended value deposit, provide more transparency, and in turn, more trust.
The spread of the USDC on modern blockchains was extremely slow. The USD Coin has only been available as a token on the Tron blockchain since the summer of 2021.
Further months passed before crypto exchanges integrated the new token. In the meantime, the USDC is adapting more quickly to the respective circumstances.
The establishment of a token on a new blockchain is proceeding more swiftly. The developers learned from Tether in this regard. So just like USDT, USDC can now be found on a variety of different smart contract platforms.
Looking at USDC’s growth, it lags well behind Tether. However, it recently managed to make up ground on Tether.
While Tether’s market capitalization dropped by ten billion US dollars, USDC grew by five billion. These changes are directly related.
After rising star TerraUSD (UST) collapsed, trust in USDT dropped because of its bad reputation. Users got scared and converted their USDT to USDC.
Is the USD Coin completely covered?
There is no doubt that the USDC enjoys a better reputation than the front-runner Tether. But can this state of affairs be justified at all
What is certain is that the USDC is fully backed. This is confirmed by reports from the auditors Grant Thornton.
That these assessments correspond to the truth reinforces the knowledge of the USDC makers’ close ties to US authorities.
However, it is a fact that Centre only claimed a complete deposit by US dollars until a few months ago.
A report from 2021 shows that the promised deposit is only 61 percent. This still leaves direct dollar backing significantly higher than Tether.
Centre, of course, knew when the report was going public and shared public information shortly beforehand that mentioned a 1:1 escrow.
This process shows that Centre is willing to intentionally deceive its customers. Thus, the advantage of trustworthiness that many users erroneously assume does not exist.
One of the reasons for the emergence of USDC is that Coinbase, as a crypto exchange, aims to establish its own currency as a trading currency. Therefore, most of the trading pairs with the USD Coin exist on the strict US exchange.
Why are Tether and USDC lying about the deposit?
Incidentally, the fact that the promised deposit of value is not being kept is no coincidence, but purely intentional. Tether and USDC are now huge projects.
Both stablecoins have a market capitalization beyond $50 billion. But that also means that the companies behind the projects have access to tremendous amounts of money.
The emergence of Bitcoin and Web3 is largely attributed to the growing power of centralized companies.
An example that can be found precisely in the largest stablecoins and is somewhat ironic because of their significant role in the crypto industry.
To make money, Tether and Centre use funds that were supposed to be for escrow to invest. So, their role is similar to that of banks in this view as well.
In doing so, the organizations purchase securities – often so-called commercial papers (money market papers). These certify the debt of the seller.
In return, the seller receives capital, which he then has to pay back to the buyer of the paper – along with interest. It is through this interest that Tether and Centre make money.
In 2022, Tether proudly announced that it had reduced the proportion of private securities in favor of U.S. government bonds. The same principle applies to government bonds. However, since a government is the debtor, repayment of the funds is considered more certain.
DAI – the first decentralized stablecoin
In the crypto scene, of course, the problems behind centralized stablecoins did not go unseen for long, and so a decentralized alternative was developed in the form of DAI.
To enable decentralization, inventor Rune Christensen created a decentralized autonomous organization called MakerDAO (often just Maker).
In order for value stabilization to succeed without a centralized organization in the background, DAI relies on an algorithm. DAI is therefore an algorithmic stablecoin. Maker rejects this designation. According to Maker, an algorithmic stablecoin is not backed by a value.
However, DAI follows exactly the same principle as most other algorithmic stablecoins. The token’s value is stabilized by shifting liquidity.
DAI resorts to overcollateralization in this regard. Accordingly, DAI is backed by more value than exists in market capitalization.
On May 24, 2022, the deposit is 160.36 percent – the target is an overcollateralization of at least 150 percent.
The stablecoin is deposited in Ether or Ethereum tokens (mainly USDC, Wrapped Bitcoin and USDP).
Information in this regard can be viewed publicly at Daistats at any time according to the current status. The large share of USDC makes DAI dependent on a centralized competitor.
For a long time, DAI was only distributed as an Ethereum token, which is why it was only comparatively expensive and uncomfortable to use.
In the meantime, DAI can also be found on various blockchains. Users who deposit cryptocurrencies to obtain DAI have to pay an ongoing stability fee.
This fee is unusual. If interest in DAI drops, people often reduce this fee to increase the attractiveness of the stablecoin.
TerraUSD (UST) – the former big climber
Since May 28, 2022, the UST has carried the name TerraClassicUSD (USTC). Big buzz in the stablecoin offering was brought by TerraUSD (UST) since its launch in 2020.
TerraUSD is not only an algorithmic stablecoin, but also a native one. It was designed by the developers of the Terra blockchain, on which it finds application.
There it forms a pair with the volatile cryptocurrency LUNA. By exchanging the two currencies with each other, liquidity can be shifted and thus a price increase or decrease can be achieved.
Over time, they added a value deposit in the form of various cryptocurrencies. The largest asset of the contingent was bitcoin. It was managed by the centralized Luna Foundation Guard (LFG), roughly translating to: Luna Foundation Guard, was in charge of it. The goal of this measure was to become the largest Bitcoin holder next to inventor Satoshi Nakamoto, thus taking advantage of the security that Bitcoin offers.
The UST not only formed a novelty, but was also extremely successful. It has been the main reason for tremendous growth of the entire Terra blockchain before its collapse eventually made the entire Terra ecosystem obsolete. For a long time, UST was able to impress with many strengths. The network demands only low fees, but performs fast transactions.
The Anchor Protocol allows liquidity to be deposited in the form of UST, which for a long time was extremely stable in value and still delivered returns of around 20 percent per year.
Many blockchains joined the trend of native stablecoins. Among them, Near Protocol with USN, Tron with USDD, or Cardano with Djed.
Due to the Terra crash in early May 2022, the UST lost its dollar peg and the circulating supply of LUNA took on inflationary proportions.
As a result, a rescue plan was developed targeting a new blockchain, which was launched on May 28, 2022. Henceforth, the UST and all other stablecoins, which depicted fiat currencies such as the euro, will be dispensed with.
The old ecosystem described here will then bear the name Terra Classic and the cryptocurrency previously called LUNA will then be called LUNC.
BUSD and USDP – the superior outsiders?
The world’s largest crypto exchange Binance supports Tether as a trading currency.
On top of that, they developed Binance USD (BUSD) in cooperation with New York-based Paxos Trust Company, which they released in 2019.
Thus, Binance established its own alternative to USDT and supports it by offering perks for trading. Some trading pairs on the crypto exchange with the BUSD exist.
However, Tether is still the frontrunner on Binance. However, Binance has little responsibility in the management of the stablecoin named after it.
The driving force is Paxos
With New York, the company is headquartered in a city known for strict regulations towards crypto companies.
Nevertheless, Paxos managed to be one of the first companies of its kind to obtain a license in the US.
Paxos is strictly supervised by the authorities and publishes a report every month from the accounting firm Withum, which discloses the company’s reserve.
Under the name Pax Dollar (USDP), Paxos has been running its own product since 2018, which is almost identical to the BUSD. However, the current name of the stablecoin has only been official since August 2021. Before that, USDP and Paxos were known standard.
Besides the different designations, it is only features on the Binance crypto exchange that make a difference.
Paxos invests any reserves in either US dollars or US government bonds. However, the reports do not indicate the proportion in which these reserves are distributed.
Due to the monthly reports and consistent quality of the stablecoins issued by Paxos, they enjoy an excellent reputation. The company has not afforded itself any shady methods so far.
While BUSD and USDP have risen to become the third and seventh largest stablecoins by May 2022, there is a huge gap between them and Tether and the USD Coin in absolute terms.
Both are at home on the BNB Chain and on Ethereum. BUSD is now also supported by many other blockchains.
FRAX – first algorithmic stablecoin with dynamic partial backing
While DAI is the first algorithmic stablecoin to be over-backed, the developers of FRAX wanted to take a different approach.
Therefore, their product is only partially backed by store of value assets. The problem with overcollateralization is the financial inefficiency of the product.
The special feature: FRAX’s algorithm and deposit work together – unlike the UST. The UST’s collateralization is managed by a central entity – the LFG.
The value deposit of FRAX, on the other hand, is changed by the algorithm depending on the price of the stablecoin and is therefore dynamic.
If the FRAX price rises above the targeted U.S. dollar price, the algorithm ensures a decreasing cover. On the other hand, if the price falls below the US dollar, the cover increases.
The project emphasizes decentralization and aims for broad adoption in the DeFi sector. It is managed by holders of the governance token FXS.
FRAX exists on seven different blockchains – approximately, ETH, BNB, Solana or Fantom.
What is FRAX backed by?
FRAX does not handle escrow very transparently. As of May 2022, there is no explanation on the project’s website as to exactly what store of value FRAX is backed by.
Founder Sam Kazemian explained that the backing consists of an extremely diverse contingent of cryptocurrencies.
In the future, he plans to expand the deposit with real world assets, which should provide better stability especially in phases of a bear market.
In contrast, the distribution between coverage and algorithm can be seen publicly. At the time of going to press, the deposit was 89.25 percent. The algorithm thus achieves an increase in value of 10.75 percent.
Which stablecoin should I use?
The most widespread use of stablecoins is due to its function as a trading currency.
The lone leader in this category is Tether as both the largest and perceived riskiest option.
If one does not want to hold USDT for a long time, but only wants to use it as an intermediary on a trading platform for a short period of time, the risk of loss is extremely low, while Tether is the most convenient option.
On the other hand, for traders who use a long-term buy or sell order, Tether is less interesting. The risk that Tether could collapse is considered too high by many investors here.
In this case, alternative trading pairs can be found on many of the well-known crypto exchanges – for example, with USDC. Often, this option is again only available when trading with the largest cryptocurrencies.
If the desired trading pair with an alternative stablecoin is not given, sometimes at least a volatile cryptocurrency can be used as an intermediary.
BUSD, USDP as well as TrueUSD (TUSD) performed trustworthy so far and are under constant investigation.
In case of infidelity, a lack of coverage could then be noticed. Reports on the TUSD deposit are even made in real time.
All of the three centralized stablecoins can therefore be used without a bitter taste, provided one trusts the companies behind the projects and wants to use a coin backed by US dollars and US government bonds.
For those who prefer to use a decentralized alternative, DAI and FRAX are recommended. UST is no longer an advisable option due to its collapse.
Investing liquidity with Tether – is it advisable?
The extent to which USDT’s trading volume is driven by its role as an intermediary is suggested by data that sheds light on DAO reserves or deposits on lending platforms.
While Tether leaves all other cryptocurrencies far behind in terms of trading volume, its role as liquidity is not as significant.
On platforms like Aave or Compound, Tether is not the list leader. Private investors prefer to invest USDC or DAI there, as they consider a loss with these currencies less likely.
Similar conditions are emerging on token bridges. USDC is the most common there. DAOs also use stablecoins to invest their assets with stable value.
As things stand, however, Tether only ranks third. Again, DAI and USDC are more popular.
Tether is particularly uninteresting as a cover for other cryptocurrencies. In this case, USDC is particularly popular. DAI also plays a role. The crashed UST was also popular for this purpose – at least until May 2022.
Other Stablecoins worth mentioning
While there are already some differences among the examples mentioned so far, they essentially follow certain functional patterns.
All of the examples mentioned are transparently trackable on most blockchains. USDT, USDC and USTC also exist as tokens on the Secret Network.
This smart-contract platform allows confidential sending, making tracking avoidable for arbitrary viewers.
In addition, all of the systems mentioned so far map to a price. The two examples below challenge previous trends.
Haven Protocol and xUSD – the confidential stablecoin.
The transparency of many blockchains is seen by the developers of Haven Protocol (XHV) as a potential weakness. Through a fork of Monero, they developed a network whose goal is to provide confidential assets.
With xUSD, Haven provides its own stablecoin tied to the US dollar. Just like Monero, transactions cannot be easily tracked by any observer.
The aim is to come closer to a digital version of cash. The xUSD not only replicates the price of the U.S. dollar, but its confidential blockchain also makes it untraceable and therefore completely fungible.
In terms of adoption, the project cannot compete with larger competitors. On several popular crypto exchanges, xUSD or XHV can be purchased and exchanged with each other on the Haven Protocol website.
The project puts a lot of emphasis on integration in Thorchain’s Atomic Swap.
Ampleforth – purchasing power parity instead of price pegging
Stablecoins usually replicate the price of a particular asset. Not so Ampleforth (AMPL). The goal of the unusual stablecoin is to map a certain purchasing power.
This idea is achieved through what is known as rebasing. In this process, the circulating supply of AMPL is adjusted every 24 hours.
So that the purchasing power of the holders remains the same, tokens are either subtracted or added to them. Tokens of this type are therefore also called Elastic Supply Tokens.
AMPL replicates the purchasing power of the U.S. dollar. Rebasing takes place every day at 2 o’clock (UTC), and its data is provided by Chainlink. Ampleforth exists as an Ethereum token.
The main advantage of the unusual project is an independence from the increasing inflation of the US dollar – an idea that is quite popular in the crypto scene.
Since the token does not represent the dollar itself, but a specific purchasing power, it aims to remain stable despite growing inflation.
This, in turn, can only succeed if the US dollar of a specific point in time is mapped. The purchasing power of the U.S. dollar from 2019 serves as the image.
The developers hope for broad adoption in the DeFi sector in the future, as the long-term performance of the token is easier to predict and therefore potentially highly attractive for lenders and borrowers.