Stablecoins can help crypto investors avoid volatility in the markets, but they have plenty of other real-world use cases (and risks) too.
Stablecoins have exploded in popularity since the start of the decade, helping to fuel the cryptocurrency industry’s growth and push new use cases for digital assets. Many pundits believe that it is the ubiquity and versatility of stablecoins that is in fact driving the ascent of assets like Bitcoin, as it allows investors to convert fiat to their equivalent value in digital assets, earn passive income through staking and trade cryptos with ease according to market conditions.
In fact, while governments are still struggling to get their controversial central bank digital currency (CBDC) schemes off the ground, the adoption of stablecoins is booming, and its January 2023 total market capitalization of $138 billion is destined to only get more “swol” as the Great Crypto Winter continues to thaw out.
In fact, it is projected that in 2023, stablecoin on-chain settlements will be bigger than the aggregate volume of the 4 biggest payment networks - Visa, Mastercard, AmEx and Discover.
This was certainly not always the case and, for a long time, stablecoins were viewed with suspicion and distrust due to a lack of regulation and dubious collateralization practices, problems that still persist to a certain degree today.
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Why Are Stablecoins Needed?
Stablecoins serve as a much-needed antidote to price volatility in the cryptocurrency markets.
The world’s biggest stablecoins are all collateralized by an underlying asset (either real-world or digital, which we’ll get to later) to deliver price stability.
Basically, crypto markets can be so volatile that investors need to have access to digital assets that resemble traditional finance (TradFi) assets in order to enter and exit markets smoothly, invest in fixed interest-bearing decentralized finance (DeFi) protocols, or themselves protect against crashes, to name a few.
Stablecoins fulfill that role and are usually pegged 1:1 to that of a currency or asset you find in traditional markets, such as money or gold. It gets tricky (and dangerous) when they use other cryptocurrencies as collateral.
The number of stablecoins out there has exploded in recent years. It's also possible to find crypto assets that are pegged to fiat currencies, such as the euro, and even other cryptoassets! Sadly, not all stablecoins are equal, and it’s important to do your due diligence before buying one, as the Luna Terra implosion of 2022 taught us.
It seems that the possibilities are endless with this new technology. Some stablecoin projects have tied their digital assets to precious metals, or to other cryptocurrencies. Stablecoins are easy to buy and are listed on almost every possible cryptocurrency exchange, including Binance and Coinbase.
For example, one of the most common types of stablecoins is the one pegged to fiat currencies.
A stablecoin, such as Tether (USDT) claims to be backed on a 1:1 basis with the U.S. dollar. For every single unit of USDT that's in circulation, $1 is supposed to be set aside and held in reserve by financial service providers. Popular alternatives include Circle’s USD Coin (USDC), Binance’s BUSD and Gemini’s GUSD.
What Are the Main Use Cases for Stablecoins?
So why would you want to invest in a volatile-free asset that is designed not to increase in value? Here are a few use cases.
Protecting Value
Well, as we saw last year, a good reason to convert your money into stablecoins is if you expect your domestic fiat currency (say the Euro) to drop in value against the US Dollar due to economic or political reasons. This allows you to retain the value of your funds and the option to convert them back to your local currency later for a profit.
Crypto Trading
Stablecoins can be used as a trading pair on cryptocurrency exchanges, allowing traders to buy and sell digital assets without having to convert to fiat currency. For example, a trader could use a stablecoin, like USDC, to buy Bitcoin on an exchange without having to worry about the volatility of the Bitcoin price.
In times of market turmoil, such as the 2022 crypto bear market, stablecoins also provide a safe haven to park your funds and buy your cryptos back at a cheaper price later.
Lending and Borrowing
Stablecoins can be used as collateral for lending and borrowing platforms, allowing users to borrow funds or earn interest on their digital assets. For example, a person could use a stablecoin, like DAI, as collateral to borrow funds on a decentralized lending platform, or lend their stablecoins to earn interest.
You can earn low-risk (never risk-free!) interest or yield on your assets by staking or lending your stablecoins like USDC or USDT. These were some of the biggest drivers behind the 2020 DeFi Summer, which was powered by lucrative stablecoin-powered yield farming APY returns, which eventually imploded due to unsustainable token supply inflation.
Remittances and Payments
For everyone, from foreign workers to businesses and central banks, stablecoins offer the convenience of near-instantaneous remittances and transfers that bypass the costly assistance of intermediary parties. It’s simply faster and cheaper to pay another party in stablecoins than through traditional fiat.
For example, whether you’re a Mexican migrant worker sending money back home from the US, a small business owner paying freelance staff located on the other side of the planet, or a major bank that needs to conduct cross-border payments with other institutions, stablecoins allow transfers to happen almost instantaneously on the blockchain, at only a fraction of the cost.
Popular Stablecoins
While we are not making a value judgment on whether these stablecoins are the “best” or not, here is a list of the top seven stablecoins by market cap on CoinMarketCap. As should be obvious by now, this list of stablecoins will not be in the order of price, since the price of stablecoins is always… stable.
Tether Stablecoin: USDT
Tether (USDT) is the biggest stablecoin by market cap (at the time of writing), pinned 1:1 to the U.S. dollar, and it is ranked third on CoinMarketCap as of Jan. 28, 2023, with a market cap of over $67 billion.
Tether is issued by a Hong Kong-based company, called Tether Limited.
The company originally claimed that each USDT was backed by $1, but has since said that there is more of a fractional reserve system, backed by the company's assets and reserves.
Tether is widely available and one of the most popular ways for crypto traders to get in and out of the crypto markets. New USDT is often printed (which can be controversial at times, as Tether has never released an official public audit) and the company has been at the heart of several lawsuits over alleged market manipulation in recent years. In the aftermath of the 2022 UST and FTX collapses, withdrawals topped $10 billion as the latest round of “Tether FUD” spooked markets. Until now, USDT has weathered all storms and continues to thrive.
Coinbase/Circle Stablecoin: USD Coin (USDC)
USD Coin (USDC) has risen dramatically in popularity in the last few years, thanks to the 2021 bull run and the continuing controversies with competitors, such as USDT and UST. As the biggest US-domiciled stablecoin, it enjoys a strong reputation within the industry. However, it has also been accused of being overly centralized, as it can freeze users’ funds if required by authorities.
USDC is currently ranked the 5th biggest crypto and second most popular stablecoin on CoinMarketCap on Jan. 28, 2023, with a market cap of over $43 billion. The stablecoin, whose price is $1, was launched by crypto exchange, Coinbase, and payments company, Circle, as part of the Centre Consortium.
USDC launched in September 2018 with the aim of providing a safe haven to traders in times of volatility, as well as letting businesses accept payment in cryptocurrencies, due to the stable price of USDC.
Both Circle and Coinbase are regulatorily compliant as US entities (tell the SEC that!), and a major accounting firm verifies the 1:1 USDC to USD peg.
Binance USD Stablecoin: BUSD
Binance USD is a 1:1 USD-backed stablecoin issued by the world’s biggest crypto exchange, Binance, in partnership with Paxos. It’s the world’s 7th biggest cryptocurrency and 3rd biggest stablecoin after USDT and USDC with a market cap of over $15 billion. BUSD is regulated by the New York State Department of Financial Services (NYSDFS).
Launched in September 2019, BUSD is independently managed by Paxos and its monthly audits are available on its website. You can buy BUSD on Binance, and redeem the stablecoin from Paxos if needed. BUSD has the same function as any stablecoin — to help crypto traders in the volatile crypto markets by providing a cryptocurrency with a stable price.
BUSD plays an integral role in DeFi and Web3, thanks to its usage across the BNB Chain ecosystem and associated applications, like PancakeSwap. It can be stored on a wide variety of decentralized wallets, like MetaMask, TrustWallet, Ledger and more.
It can be traded and staked on the world’s biggest DEXs and DeFi protocols like Uniswap, 1inch, Curve Finance, Sushiswap, Aave and more. In September 2022, Binance announced that it would auto-convert USDC, USDP and TUSD deposits to BUSD for trading on its site in order to improve liquidity and capital efficiency for users. However, withdrawals for these stablecoins would remain in place.
Dai Decentralized Stablecoin (DAI)
DAI is an ETH-based stablecoin launched in November 2019 and managed by Maker Protocol and MakerDAO. It’s available on all major centralized exchanges as well DEXs like Uniswap. According to its whitepaper, "Dai is a decentralized, unbiased, collateral-backed cryptocurrency soft-pegged to the US Dollar".
The DAI stablecoin is over-collateralized by a mix of other cryptocurrencies that are deposited into smart-contract vaults every time a new DAI is minted.
Dai is backed by multiple stablecoins and cryptocurrencies, with the lion’s share consisting of Ethereum (ETH), the world’s 2nd biggest cryptocurrency.
What makes DAI different is that anyone can issue it (unlike centralized stables like USDT and USDC) since the MakerDAO is open-source and on the highly decentralized Ethereum blockchain. Minting and burning DAI occurs when users borrow funds and then repay their loans.
To generate new DAI, users must borrow DAI by depositing ETH-based funds into a Maker collateral vault via a compatible Dapp. Users’ deposited assets are held in escrow by a smart contract until their DAI loan is repaid, which then burns the borrowed DAI.
True USD (TUSD)
TrueUSD is a U.S. dollar stablecoin pegged to USD at 1:1 and launched in October 2018 by TrustToken, a platform for tokenizing real-world assets, which describes TUSD as “the first regulated stablecoin fully backed by the US Dollar.”
Just like other stablecoins, TrueUSD aims to facilitate increased liquidity and a trusted non-volatile crypto alternative to the likes of Bitcoin. It creates “trust” in TUSD by submitting the stablecoin’s reserves to frequent auditing and attestations by independent external parties. At the time of writing, TUSD is not at peg with the US Dollar (99c).
Tron USD Stablecoin (USDD)
USDD is a collateralized stablecoin issued by the TRON DAO Reserve with a 1:1 US Dollar peg and diverse use cases. It features a built-in incentive mechanism and a responsive monetary policy, to help it self-stabilize against any price fluctuations.
The Tron-based stablecoin USDD was launched in May 2022 and has commanded a consistent market cap of around $700m since then, thanks to generous staking and yield farming options for investors. While it claims to be over-collateralized, USDD is currently not at peg with the US Dollar (99c) and was depegged to as low as $0.95 last year.
Gemini Stablecoin: GUSD
The Gemini Dollar (GUSD) is the stablecoin issued by Gemini, a cryptocurrency exchange founded by the Winklevoss twins. The Gemini stablecoin is the 8th biggest stablecoin as ranked by CoinMarketCap as of Jan. 28, 2023, with a total market cap of just over $600 million.
The Gemini stablecoin, issued by Gemini and available there for purchase, is meant to provide tokens on the Ethereum network, with the ERC-20 standard, that offer price stability for the crypto markets.
The Gemini stablecoin’s 1:1 price peg is audited monthly by an independent registered public accounting firm.
The Disadvantages of Stablecoins
Whereas cryptocurrencies such as BTC are fully decentralized, the same can't really be said for stablecoins because of how underlying assets need to be held in reserve. A big challenge is ensuring that these digital currencies are properly collateralized — indeed, Tether has faced legal action in New York following claims that USDT may not be backed 1:1 with the U.S. dollar.
Centralized stablecoin issuers are under intense regulatory scrutiny and need to comply with strict domestic accounting requirements in most cases. This means that they must put up with the whims of regulators and law enforcement and carry out their requests in most cases or risk getting shut down, as was seen during 2022’s Tornado Cash sanctioning, which goes against crypto’s largely libertarian origins.
Then there's the tricky issue surrounding broad regulation. Many central banks reacted with horror when Facebook unveiled Libra in 2019, fearing that this crypto asset could undermine the sovereignty of fiat currencies (read: the US Dollar’s hegemony) and even trigger an economic crash. The project was soon enough shelved but arguably kicked off the arms for central bank digital currencies (CBDCs) which are set to roll out globally in coming years and are feared to possibly replace stablecoins.
What Are the Different Types of Stablecoins?
There are several different types of stablecoins, each with its own unique features and characteristics. The most prominent are collateralized, decentralized, fractional and algorithmic.
Some stablecoins may combine different traits in order to make them more resilient against market forces. For example, DAI is collateralized, decentralized and algorithmic in nature, while FRAX is both a fractionalized and algorithmic stablecoin.
Collateralized Stablecoin
A collateralized stablecoin is backed by a reserve of assets such as fiat currency or gold. This reserve is used to ensure the stability of the stablecoin's value and provides reassurance to investors and regulators alike that the stablecoin issuer will be able to honor all withdrawals at any time. All big centralized stablecoins claim to be fully collateralized, with even USDT providing transparent reporting on their website.
Decentralized Stablecoin
A decentralized stablecoin is not controlled by a central authority and is instead maintained by a network of users on a blockchain, which enables a more transparent and decentralized system that’s resistant to censorship, but may also make it more vulnerable to volatility if it is not properly managed. At present, the leading decentralized stablecoin is DAI.
Fractional Stablecoin
A fractional stablecoin is a stablecoin that is backed by a fraction of the value of the underlying asset, rather than the full value. This allows for more flexible and efficient use of reserves, but it also increases the risk of volatility.
FRAX, the stablecoin of Frax Finance, claims to be the world’s first fractionally backed stablecoin, with parts of its supply backed by collateral and parts of the supply algorithmic.
It's partially backed by Frax Shares (FXS) and USDC and can be minted by depositing both. The FRAX supply is not fixed and changes according to the supply and demand for the stablecoin. The collateralization/algorithm ratio relies on the FRAX price. If it is trading at above $1, the protocol decreases the collateral ratio. If FRAX is trading at under $1, the protocol increases the collateral ratio.
Algorithmic Stablecoin
An algorithmic stablecoin is a stablecoin that uses an algorithm to maintain its value, rather than being backed by a reserve of assets. Based on the concept of Seigniorage Shares, introduced by Robert Sams in 2014, algorithmic stablecoin attempts have received a lot of support in the past from the cryptocurrency sector, thanks to their potential to help the industry reach the holy grail of a truly decentralized and stable currency that is impervious to regulatory or law enforcement intervention. Unfortunately, the history of algorithmic stablecoins is littered with failed or scam projects (such as NuBits and Basis, another failed Do Kwon project) that cost investors billions of dollars.
Despite still-unproven new innovations like FRAX, algorithmic stablecoin adoption was severely damaged by the catastrophic Luna Terra collapse in 2022, which saw UST (now rebranded as Terra Classic) drop from $1 to under 1c in value, from which it has yet to recover. It is considered highly risky to hold these types of coins and, in the author’s personal view, should be avoided where possible.
Are Stablecoins Backed by Gold?
Not all stablecoins are solely backed by fiat currency or pegged to it. There are also a number of smaller crypto stables collateralized by precious metals such as gold and silver. In some cases these stablecoins are also pegged 1:1 to the price of these real-world assets, making them particularly appealing in times of rampant inflation, currency devaluation, or political uncertainty.
This is because they share the same traits of scarcity as Bitcoin, but come with significantly less volatility, thanks to the underlying asset’s massive global market cap and reputation as a safe haven asset. For example, gold in January 2023 has a total market of over 12 trillion USD, about 25x that of Bitcoin.
You can read more about gold-backed stablecoins in this CoinMarketCap article here.
Warning: It’s important to DYOR before investing in any stablecoin that claims to be collateralized by a precious metal, as they can suffer from liquidity issues, regulatory bans, or just plainly be fraudulent.
Are Stablecoins Regulated?
At present, there is no global or US umbrella regulation of stablecoins, but it’s likely coming very soon, expedited by last year’s crypto custodial and LUNA disasters. Indeed, the US White House in January 2023 urged its Congress to speed up its efforts to regulate crypto.
United States: Stablecoin Trust Act
In the US, pro-crypto U.S. senator Pat Toomey introduced the Stablecoin TRUST Act bill in December 2022, which aims to establish a federal regulatory framework for payment in stablecoins and allow several types of entities, including depository institutions, state-based money-transmitting businesses and national trust banks, to act as stablecoin issuers.
It would also extend that privilege to entities with “a new federal license designed specifically for payment stablecoin issuers.”
In the United Kingdom, then-Chancellor of the Exchequer and now Prime Minister Rishi Sunak made waves in April 2022 when he laid out plans to make “the UK a global hub for crypto asset technology”.
Core to this is the legislation and regulation of stablecoins as means of payment, thereby creating favorable conditions for stablecoins issuers and service providers to operate and invest in the UK.
Europe: MiCA Set to Regulate Stablecoins Across EU
Our CMC 2023 Crypto Playbook covers in detail the outlook for EU regulations this year, and central to this is the passing and implementation of the Markets in Crypto Assets (MiCA) framework, which will have far-reaching consequences for stablecoin issuers in Europe.
How to Invest in Stablecoins?
There are several ways and reasons to invest in stablecoins. While some people buy them to immediately convert them into other cryptocurrencies, others keep them as a result of different motives, as we saw in the main use cases section earlier.
Nowadays stablecoin interest expectations are much more realistic, thanks to the DeFi “Real Yield” pivot in 2022, which dictates that passive income should flow from the actual revenue of the DeFi protocol being used. Thanks to compound interest that the 5-10% interest you may annually accrue remains a smart move and will also help you stay on top of inflation.
If you already own crypto and keep it on an exchange or unhosted wallet, the process is super straightforward and just requires you to swap your existing asset (e.g. Ethereum) for the stablecoin of your choice, incurring a small transaction fee in the process.
It gets a bit more tricky when you need to convert a fiat currency into a cryptocurrency. Stablecoins are usually the preferred crypto to be received due to the fact that if you buy BTC or ETH with fiat, you may receive significantly less than what you bargained for due to sudden volatility and the resulting cost of arbitrage.
Buying stablecoins with fiat is easier than ever nowadays, with not only centralized exchanges or marketplaces but also decentralized exchanges and private wallets integrating the services of regulated fiat-to-crypto service providers, such as Simplex, to make the whole process as simple as possible via bank transfer, card networks or e-wallets options.
Buying Stablecoins on a CEX or Centralized Custodian
Most users, especially newcomers to crypto, buy stablecoins on a centralized exchange, such as Binance or Coinbase, by using fiat currency or other cryptocurrencies. This is because they can then effortlessly purchase and trade the cryptos they want on this platform, or stake the stablecoin for fixed interest or yield.
The process works just like buying or trading any other cryptocurrency on an exchange, and generally requires a list of steps to follow such as creating an account, verifying your identity, and linking a payment method, such as a bank account or credit card. Keep in mind though that if you keep your stablecoins or other cryptos on centralized platforms, you don’t truly “own” it, as the private keys to it are controlled by your custodian. This can come to bite you later on, as we saw last year with the cascading bankruptcies of FTX, Voyager, Celsius, Genesis and others.
Buying Stablecoins the Decentralized Route
More experienced (paranoid?) crypto users may choose to get their stablecoin through a DeFi protocol like a decentralized exchange (DEX), for example, Uniswap or 1Inch. DEXs allow users to buy and sell cryptocurrencies directly with each other, without the need for a central intermediary, and retain full self-custody over their assets in line with the proof of keys core tenet of crypto.
Importantly, most leading hot and cold private wallets now include integrated features to purchase stablecoins with either fiat or other crypto. Swapping crypto for stablecoins is straightforward, however, if you want to use a fiat option like a credit card, you’ll still need to register with the registered service provider in compliance with global anti-money laundering (AML) regulations.
Buying Stablecoins From the Issuer
Stablecoins can also be purchased directly from the issuer, such as USDT’s Tether Limited. However, this option is usually limited to bigger investors like financial institutions.
How to Stake Stablecoins?
Crypto investors can easily stake stablecoins and earn a tidy bit of passive income such as interest or yield as a result.
You can stake your stablecoins at either a centralized custodian or decentralized protocol, however as 2022 showed, both come with substantial risks. Several centralized custodians went down due to the LUNA and FTX collapses, taking user funds with them in the process. DeFi protocols weren’t spared either, with over $3 billion stolen last year.
While you may control the keys to your crypto with a private wallet, you are locking your stablecoins into a smart contract when staking, which can be exploited through scams (rug-pulling) or hacks (such as reentrancy attacks) and cost you all your assets.
Therefore, it’s really important to deeply research any centralized or decentralized staking option before investing, and mitigating your risk by getting insurance or diversifying across different service providers as much as possible.
Don’t be blinded by the high APYs offered by some yield farming protocols either (where you provide liquidity to a balanced pool of two cryptos), as the value of your investment can slowly be eradicated by impermanent loss during volatile markets as the pool rebalances itself.
It is best to have realistic expectations of how much interest you want to earn through staking and remember, if it sounds too good to be true, then it probably is. Just ask Celsius investors, who eventually found out that its 18% interest rate returns were too hot to handle.
Conclusion
Stablecoins are integral to the crypto space. With the plethora of benefits they bring to both retail and institutional investors, it is difficult for the industry to survive without them. When dealing with stablecoins, it’s important to understand why you’re investing in them, and the risks associated with the way you are storing or applying them.
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