Stablecoins are tokens linked to external assets, such as national currencies or precious metals, issued through smart contracts on a blockchain.
Also known as "stable cryptocurrencies", they digitally represent the value of currencies such as the dollar, the euro or even gold. They emerged to address the volatility of cryptocurrencies such as bitcoin and ether, allowing the use of U.S. dollars on exchanges without regulatory restrictions. Designed to closely track the value of their underlying assets, they maintain stable prices, similar to the dollar or euro, and offer cryptographic features such as fast settlements and global transfers.
In 2014, the first proposals for stable cryptocurrencies emerged with the aim of offering a means of payment that would reduce volatility and provide low operating costs and privacy.
BitUSD from Bitshares and NuBits from Nu were launched in the middle of that year. In parallel, the launch of Tether USD (USDT), then known as Realcoin, was brewing and officially issued in late 2014 on the Bitcoin sidechain, Omni Layer.
BitUSD, NuBits and Tether were the pioneers. Tether was traded on exchanges in 2015, with Bitfinex being one of the first to support this stablecoin. Other similar projects, such as SteemUSD by Steem, also emerged, although not all of them lasted over time.
Stable cryptocurrencies are tokens issued on various networks and sidechains, and their behavior is strongly influenced by the network to which they belong.
For example, stablecoins in Ethereum are identified through smart contracts as ERC-20 tokens. In addition, these coins can be issued by a provider, company or governance system, who determine the issuance of tokens, the linkage to units and how they back up reserves, playing a crucial role in the stablecoin economy.
Despite the variety of the stablecoin market, four general categories can be identified that determine how these tokens work in relation to how they are anchored to the value of other assets.
This category of stablecoins is the most common, as their tokens are linked directly to a national currency in a 1:1 ratio. Each unit of token issued represents one dollar, euro or yen, and the issuing company is responsible for backing the token with the equivalent in the corresponding fiat currency or through assets such as bonds or instruments such as bank loans.
Cryptocurrency-backed stablecoins use crypto assets as collateral to back the token, even though their value reflects that of a fiat currency.
Take DAI as an example: it operates through a MakerDAO smart contract, where users can deposit ether (ETH) or other crypto assets to create a new token. Despite the cryptocurrency collateral, the value of the DAI token tracks the US dollar to which it is anchored. The issuance of these cryptoassets relies exclusively on the smart contract, providing transparency and eliminating the need to rely on third parties.
Commodity-backed tokens are similar to stablecoins linked to fiat money in that their issuance is secured by exchangeable assets that can be physically reserved, such as precious metals.
These stablecoins reflect the market price of the backed commodity, with gold being the most common commodity, although there are also coins backed in oil, real estate and other rare metals. Pax Gold (PAXG) is a standout in this market, where the provider owns the tangible asset and reserves it to issue new tokens on the network, requiring users to trust the transparency and honesty of the issuing company.
Algorithmic stable cryptocurrencies, or also known as uncollateralized, have the characteristic of not being backed by fiat currency or other cryptocurrencies. Instead, their value is established by algorithms that emulate the price of these assets.
No stablecoin is completely decentralized, as in all projects there is some entity that influences the protocol. Those issued by companies such as USDT, USD Coin and Binance USD show centralization, as the issuing company backs the tokens and can regulate the issuance and freeze funds if necessary.
In the case of cryptocurrency-backed or algorithmic stablecoins, they usually have a decentralized DAO that maintains the protocol, but there are still individuals with the power to decide on the stablecoin's monetary policy, despite diverse participation in the decisions.
Determining the security of a stablecoin is complicated and depends on several factors. Responsible issuance by the regulator is crucial; if more tokens are issued than are backed, stability is compromised.
In addition, underlying assets, such as national currencies, also influence security. While no stablecoin is infallible, the 2022 bear market particularly affected algorithmic stablecoins such as Decentralized USD (USDD) and UST. The relative security among stablecoins varies, and it is recommended to research each project, evaluating the reputation of the developers and managers, as well as their experience in the market, before investing in them.
Stablecoins have stood out as a financial tool because theycombine features of fiat currencies and cryptocurrencies. These cryptoassets offer lower costs than settlement systems and a verifiable public record in a distributed ledger. In addition, they offer price stability.
Users use coins such as Tether and USD Coin as protection and hedging tools against the volatility of cryptocurrencies. As cryptoassets such as bitcoin decline in value, users opt to exchange them for stablecoins to safeguard their investments and ensure profits before further losses.
In countries with devalued official currencies or currency restrictions, such as Venezuela and Argentina, stablecoins serve to protect savings from inflation. In addition, stablecoins do not have the purchase restrictions that the dollar does have in some countries, such as Argentina.
Depositing and withdrawing fiat money between bank accounts and exchanges can be costly and even impossible on platforms not affiliated with banking agencies, such as decentralized exchanges (DEX). For this reason, some users prefer to use stablecoins to buy and sell cryptocurrencies, as they are interchangeable with various cryptoassets and are accepted on most exchanges, allowing users to transfer them from their wallets to fund trading operations.
Stablecoins anchored to the dollar or euro, being digital representations of fiat money, are considered by many to be efficient payment methods. With lower operating costs, easy accessibility and the ability to conduct cross-border transactions, these stablecoins can be used to purchase goods and services online.
Stablecoins such as USDC, USDT and DAI are central to decentralized financial services (DeFi), powering decentralized applications and alternative banking. Users block bitcoin or dollar collateral on these platforms to generate interest, and stablecoins are essential in practices such as yield farming, where investors accumulate returns from various applications and receive tokens as rewards.
Although stablecoins are popular and have a variety of use cases, it is important to consider certain issues before using them as financial tools. Counterparty risks, regulatory oversight and price fluctuations, although minimal, are elements that can hinder their use.
Stablecoins backed in national currencies reintroduce counterparty risk, which had been eliminated with cryptocurrencies such as bitcoin or ether that allow users to have full control over their money.
With stablecoins, control is compromised as each token issued is backed by a dollar in a bank account, inaccessible directly to users. The company issuing the token manages the reserves, requiring users to rely on a third party to hold their money, raising concerns about transparency and the real value of the asset if there are no regular audits or transparency in bank movements.
The operations of stablecoins, anchored to fiat currencies, are affected by central bank guidelines and are more limited in regulatory terms compared to other crypto assets.
Regulators have considered imposing licensing, oversight and KYC measures for legal stablecoin transactions. In addition, fiat-backed stablecoin transactions are more susceptible to confiscation and censorship, as they rely on banking entities subject to government ordinances that can terminate accounts as directed by regulators.
The price of a stablecoin does not always match the value of the asset to which it is anchored, as they represent the asset and are not literally the asset itself.
Factors such as supply and demand in their own trading markets can cause stablecoins to decouple from their backing asset, outperforming or falling below their price.
Although this has happened with assets such as USDT and DAI, their markets have mechanisms such as arbitrage, monetary policies and issuance algorithms to address it. In addition, the value of currencies such as the dollar or the euro can vary due to inflation, affecting people's purchasing power.
The most popular stable cryptocurrencies are:
