Stablecoins are fixed-value digital assets, meaning that the crypto market price of such coins is tied to a stable asset, be it regular money, gold, or other tokens. The main objective of such tokens is to reduce the opportunity of losing funds due to excessive market volatility, to which many digital assets are exposed. But, not all stablecoins are the same. Let’s talk about what they are and what their differences are below.
What are stablecoins?
Simply put, a stablecoin is a digital asset with a steady exchange rate. It is a unique coin for settlement, convenient for trading, hodling funds, and an excellent way to protect your portfolio from price spikes. There is no single definition of such tokens, but experts divide stablecoins depending on the centralization of the issuer, reserve norms, and what asset the coin is backed by.
A distinction is made between stablecoin and the dollar rate by the way stablecoin is pegged:
- With fiat reserves. These include Tether (USDT), USD Coin (USDC), and Binance USD (BUSD). When such coins are issued, there must always be a legal entity whose purpose is to hold enough money in a financial institution to exchange it for fiat in case of any risks.
- With cryptocurrency reserves. This includes the DAI stablecoin. This digital asset is backed by cryptocurrency. Because of the volatility, over-collateralization is used for more excellent reliability: cryptocurrency collateral is frozen for every $1 coin with a current value of $1.5 or higher.
- Algorithmic. The infamous Terra (UST). With a usual dollar pegging mechanism that automatically issues/redeems special tokens depending on the balance of supply and demand.
There are many stablecoins. Some are still working, but others, like UST and Nirvana, have already collapsed. There is no point in describing all of them, so let’s look at the main ones and find the difference between them.
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Fiat stablecoin with the largest capitalization and liquidity. To avoid collapse, the coin must always satisfy certain conditions, including the reliability of the asset’s reserves, the way it is stored, and the legal holding entity’s ongoing efforts to exchange tokens into and out of fiat.
As far as reliability is concerned, it’s not all that smooth. The cryptocurrency’s creators have been seen doing some not-so-good things more than once, for example:
- The company wasn’t exactly telling the truth when it announced that it only kept reserves in safe assets. It was later revealed that the funds were being placed in unreliable places. Tether was fined tens of millions of dollars more than once for this.
- No one knows for sure in which banks Tether’s reserves are deposited and how reliable they are.
- The company hardly shares its financial statements and is not checked by auditors.
- Many reserves are placed in assets where it’s almost impossible to estimate risk in the current circumstances.
The coin generally works as a bridge between regular money and cryptocurrencies. It can reduce transfer fees and increase its stability and transparency.
USD Coin (USDC)
It is still behind USDT in terms of volume in circulation, but the gap is gradually narrowing. At the beginning of 2020, the market capitalization of USD Coin was about ten times less than USDT; now, in 2022, it is only a third. In terms of what the flip side of this stablecoin looks like, the following points can be highlighted:
- Just as USDT lacks full auditing, documentation transparency is worse than Tethers.
- The reserves chart was last published in October 2021 and has not been issued since then.
- According to the company, all assets are held in segregated accounts at U.S.-regulated financial institutions. That’s promising, but it’s not enough.
The creators of the coin claim that USDC can always be exchanged back into dollars whenever you want through Circle Account. According to observations by several users, this is true, which shows that arbitrage works well. Generally, the token is respected and considered one of the most reliable. This is probably because it is regulated by a company registered in the United States.
Binance USD (BUSD)
This stablecoin is also backed by fiat. It is the property of one of the largest crypto exchanges, Binance. However, the company does not issue tokens but delegates this task to Paxos Trust Company.
The capitalization of the coin is lower than that of previous stablecoins. Still, daily trades of BUSD are relatively active – the turnover is ~$5.9 billion, which is higher than USDC but much lower than USDT.
According to the company, the entire coin reserve is held in fiat in U.S. bank accounts or ultra-secure U.S. government bonds. However, the audit report is also not available. The document does not specify what and who is in the reserves. Still, Withum is engaged in maintaining the total amount of resources and assures that they are kept in reliable assets.
Stablecoin has the following mechanism for maintaining value: cryptocurrency collateral above the current market value is stored in special smart contracts directly on the blockchain under each DAI with a face value of $1. If the digital asset price in the collateral starts to fall, and there is a chance that it won’t be enough to cover DAI=$1, the smart contracts can quickly sell the collateral. It’s similar to how a broker ensures himself if he suddenly doesn’t get a loan back when trading with leverage.
Stablecoin has had several severe crises in the past where the coin fell in collateral very hard and fast, and the token itself didn’t drop much below $1. It’s true that when that happened, bugs in the smart contracts surfaced. So stablecoin is stable, but it has its drawbacks in terms of reliability.
There is no perfect stablecoin. Each has its advantages and disadvantages, as well as risks. It’s up to you to decide which one suits you best. You have to determine what’s best for you based on your needs.
- If you need to transfer funds from crypto to fiat or vice versa quickly — Tether (USDT) is best because this coin has the most excellent liquidity;
- USDC, BUSD, and DAI may be best for long-term storage.