The stability provided by stablecoins makes them attractive alternatives to traditional fiat currencies, particularly in regions where currency volatility is a concern.
Stablecoins: Game Changers or Dangerous Speculative Bubbles?
stablecoins have rapidly gained prominence, serving as vital pillars of liquidity within decentralized finance (DeFi) applications, including decentralized exchanges (DEX) and loan protocols. These digital assets provide stability, acting as a bridge between cryptocurrencies and traditional financial realms, offering stability, transparency, and utility to users. In addition to being a medium of exchange, stablecoins are also inherently valuable as a store of value.
The use of stablecoins as a medium of exchange is evident on more than 80 percent of the major centralized crypto exchanges. In addition, stablecoins accounted for 45% of DEX liquidity in May 2022, highlighting its importance for the growth of the DeFi market.
However, not all stablecoins are created equal. This article explores the contrasting dynamics between collateralized stablecoins like Tether and USD Coin and algorithmic stablecoins like DAI and TerraUSD. Despite contributing to the stability of the crypto asset ecosystem, different variants provide different levels of liquidity for decentralized trading.
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Stable Coin Types
Stablecoins currently have three types competing for market share. These are:
centrally issued
First, you have fiat-collateralized stablecoins, they are the easiest to understand; each stablecoin issue is pegged to one unit of a trust asset. Some examples include Tether, TrueUSD, Dai, Paxos, and USD Coin. However, fiat-collateralized stablecoins are centralized.
The main benefit of a centrally issued currency is that it is backed (usually by the issuer) and therefore stable. However, the lack of decentralization can pose a problem with respect to transparency. Also, centralized entities have a history of legal trouble.
For example, the former issuer of the BUSD stablecoin, Paxos, recently got into legal trouble because the SEC wanted to sue it for selling BUSD as an unregistered security.
guaranteed crypto
Crypto-collateralized stablecoins are collateralized by reserves of other selected cryptocurrencies (usually a diversified basket) in a greater than 1:1 ratio (to offset the volatility of the underlying collateral). Examples include the MakerDAO DAI stablecoin. However, it is also "soft pegged" to the US dollar, meaning it intends to match its value at any time. Although DAI is a stablecoin and does not require fiat collateral, the collateral can be volatile depending on other forms of crypto. DAI has sometimes risen above $1 or fallen well below.
Also, DAI provides fewer trading pairs than other cryptocurrencies and is not listed on as many exchanges as other cryptocurrencies. Because of this, it can have lower liquidity than other types of cryptocurrencies.
Uncollateralized (algorithmic)
Ideally, algorithmic stablecoins it must not be collateralized or at least be collateralized. Instead, they maintain stability by enforcing contract codes that manipulate supplies of coins in circulation to stabilize asset prices around a peg.
For example, TerraUSD. At the time, the model was criticized as "a way of creating something out of nothing". Still, investors were reassured by mega-yields of up to 20% APY +0.4% (annual percentage return), "true decentralization." However, since last year Dramatic Collapse of TerraUSD Stablecoin and its sister token Terra LUNA3 -5.3%, the crypto community reflected on the future of algorithmic or programmable stablecoins.
For collateralized stablecoins like Tether and USD Coin, the liquidity provision for decentralized trading or lending is relatively low compared to their total market capitalization (less than 8%). As a result, stablecoins serve multiple purposes beyond DeFi, emphasizing their broader adoption within crypto asset ecosystems.
A different trend is seen with algorithmic stablecoins like DAI and TerraUSD, which rely heavily on DeFi liquidity. Unlike, DAI liquidity provision it represents more than 30% of its market capitalization, while TerraUSD represents more than 75% before its fall.
Therefore, in the end, all stablecoins still do not meet the trinity below:
Having a stablecoin does not necessarily mean that its price is fixed at a specific value denominated in fiat currency. However, it is less susceptible to speculative fluctuations.
Looking ahead, stablecoins hold great promise for reshaping traditional financial systems and fostering greater financial inclusion. Furthermore, their stability, utility, and potential for broader adoption make them attractive alternatives to volatile fiat currencies, particularly in regions where currency stability is a pressing concern.
However, it is important to tread carefully in the realm of stablecoins. Regulatory oversight, transparency, and continuous evaluation of stabilization mechanisms are crucial to ensure user confidence. Additionally, collaboration between market participants, policymakers, and industry stakeholders is essential to establish robust frameworks that address potential risks and maintain the stability of stablecoins.
