What are stablecoins and why is it important in DeFi?

One of the main reasons why cryptocurrencies have not yet become part of mainstream commerce is that these are extremely volatile. The value of cryptos keeps fluctuating rendering them unreliable for day-to-day transactions, such as buying and selling of goods. Stablecoins, on the other hand, as the name suggests, are coins that are more stable than regular cryptocurrencies and are created to address the volatility of the coin price of assets. Since stablecoins take away much of the instability it has become a critical part of Defi and the crypto economy enabling people to borrow, lend, trade, and other economic exchanges with less risk. Also, transactions made through these can be done is instantaneous; hence more convenient to the crypto traders and investors.

“The aggregate supply stablecoins supply has grown by 388% — from $29 billion to over $140 billion, a record high. Annual stablecoin adjusted transaction volume crossed $5 trillion in 2021, an over 370% year-over-year growth relative to 2020 volumes,” The Block Research’s 2022 Digital Asset Outlook reported. According to the crypto research firm, Messari’s 2021 Q2 Defi Review, “The stablecoins story continues to rhyme each subsequent quarter — climbing up and to the right. Q2 was no different. In Q2 2021 the stablecoin monetary base reached over $107 billion, up 70% since Q1 and 803% year-over-year. In this quarter stablecoins facilitated an impressive $1.7 trillion in transaction volume, up 1,090% year-over-year and 59% since Q1. The biggest winners this quarter were USDC, BUSD, and DAI which grew their share to 23%, 9%, and 5%, respectively.”

Stablecoins can either be centralized or decentralized and usually have their value pegged against stable assets or fiat currencies making them price-stable digital assets. Stablecoins merges the stability of fiat currencies with the fast processing, mobility, and safe transaction of the blockchain-based cryptocurrencies and hence is considered a bridge between fiat and crypto. One can acquire stable coins by collatarising or in exchange for fiat currencies. Depending on the collateral structures backing them, there are three kinds of stablecoins — fiat-backed (when you get cryptos in exchange for real fiat currency in a bank account), commodity-backed (interchangeable assets such as oil, real estate, and precious metals are used as collaterals) and crypto-backed.

While crypto-collateralized stablecoins offer better decentralization (decentralization makes transactions trustless, secure and transparent) and offer better liquidity than the fiat-backed stablecoins, crypto-backed stablecoins are also the most complex of stablecoins. Fiat-backed stablecoins are the simplest and easiest to work with especially if you are just stepping into the crypto world. Currently, the most popular of the stablescoins such as Tether / USDT, USD Coin / USDC , Binance USD / BUSD, Dai / DAI, TerraUSD / UST , TrueUSD / TUSD, have their values pegged 1.1 to the US dollar and are reside as tokens on smart contact-supported blockchains such as Ethereum, Binance Smart Chain, and the likes.

Top 6 stablecoins according to market cap:

Tether (USDT)
Market cap: US$ 80,041,368,430

Tether, named such because it “tethers” itself to the value of the USD (these coins can always be exchanged for an equal value in U.S. dollars), is today available on 428 exchanges making it the most widely-available stablecoin. This fiat-based stablecoin is backed by traditional currency, cash equivalents, and gold and is developed by crypto exchange BitFinex. The coins, which are the native tokens of the Tether network, trade under the USDT symbol. Originally launched as RealCoin in 2014, it was the first-ever stablecoin to enter the market.

Despite being the market leader, Tether is mired in legal tangles for not being open to audits. In February 2021, Tether along with its sister concern company Bitfinex, a crypto exchange, was accused of financial transparency by the New York attorney general’s office and fined $18.5 million. The companies were also banned from trading in New York. Post this although the company tried to be more transparent and released an assurance report conducted by auditor Moore Cayman in August, its legal woes were far from over. In October, independent US derivatives regulator, Commodity Futures Trading Commission (CFTC), fined Tether a further $41 million. In December a new case was slapped on Tether in the South New York district court, where plaintiffs Mathew Anderson and Shawn Dolika accused the firm of maintaining less than 4 percent in cash reserves and its public account disclosures being vague and ambiguous.

USD Coin (USDC)
Market cap: US$ 52,531,794,914

USD Coin, which is redeemable 1:1 for U.S. dollars, was introduced in 2018 by the world’s first publicly-listed crypto exchange, Coinbase. Today, it is the 2nd largest stablecoin according to market cap. The crypto-backed stablecoin operates on blockchains such as Solana, Algorand, and Ethereum among others. Unlike Tether, USDC publishes monthly status reports of its reserves. It is available on 294 exchanges. These digital dollars are managed by Centre, a consortium founded by Circle that includes members from Coinbase and Bitcoin mining company Bitmain and is considered the safest alternative among the centralized USD-pegged stablecoins. The coins have a low-risk rating from Investors Observer, a market analysis firm.

Binance USD (BUSD)
Market cap: US$ 18,003,804,390

Launched in 2019 by the world’s largest crypto exchange Binance, BUSD is currently the #3 stablecoin according to market cap. However, it is available on just 103 exchanges. However, it makes up for this by offering unique, such as zero-fee trading and conversion and lending services with an annual yield of up to 15% for investors on Binance, its native exchange. Unlike Tether, BUSD keeps its accounts transparent to investors by publishing monthly audits and is approved and regulated by the New York State Department of Financial Services (NYDFS). This 1:1 USD-backed stable coin is among the three stablecoins (the other two being PAX and GUSD) approved by Wall Street regulators and are greenlisted by Department of Financial Services.

TerraUSD / UST
Market cap: 13,770,540,023

TerraUSD (UST) of the Terra blockchain was launched in 2020 and it claims to be the first decentralized algorithmic stablecoin that is interchain, scalable, and yield bearing. Although its value is pegged 1:1 to the US dollar, unlike centralized stablecoins it doesn’t require a bank account transaction. But one needs to burn US$1.00 worth of TerraUSD’s reserve asset LUNA (the Terra blockchain protocol, created by South Korea’s Terraform Labs, is stabilized by its native crypto-asset, LUNA) to mint each TerraUSD. InvestorsObserver considers it a low-risk stablecoin.

Dai (DAI)
Market cap: US$ 9,886,529,545

The fifth-largest by market cap, Crypto-backed stablecoin MakerDAO’s Dai, is the most popular collateralized stablecoin and is available on 221 different exchanges. According to the MakerDAO’s white paper, Dai is a decentralized, unbiased, collateral-backed cryptocurrency soft-pegged to the US Dollar. One can “generate Dai using that system by leveraging Ethereum (ETH) as collateral through unique smart contracts known as Collateralized Debt Positions (CDPs),” it says. Dai stablecoin system is called the Maker Protocol; this decentralized application runs on the Ethereum blockchain. Investor Observor puts DAI in the low-risk bracket.

TrueUSD (TUSD)
Market cap: US$ 1,456,165,157

TrueUSD is a legally protected and fully collateralized stable coin that is transparently verified by third-party attestations. It is built on TrustToken, a platform to create asset-backed coins and TrustToken does not charge any trading fees on these coins. Launched in 2018, it was the first regulated stablecoin100% dollar-backed stablecoin valued 1:1 against the dollar. It is a relatively transparent coin; TUSD, the exchange that issues TrueUSD (it also has stablecoins pegged to other major currencies such as TrueAUD, TrueGBP, and TrueHKD, etc), is regularly audited by cryptocurrency audit and tax firm Cohen & Company. Since the TrustToken platform is not fully decentralized, regulatory actions on the platform are applicable to the holders of TUSD.