Cryptocurrencies are known to be volatile investment instruments, with their prices fluctuating widely. The considerable jumps and crashes in crypto prices prevent them from being used for goods and services in everyday life. This is where stablecoins come into the picture.
It is a type of crypto asset whose value is pegged to another asset, such as a fiat currency or commodity, to stabilize its price. This way, unlike Bitcoin, Ether, and other altcoins, stablecoin‘s price remains steady in accordance with the asset backing them.
Typically, the entity behind a stablecoin will set up a “reserve” where it securely stores the basket of assets backing the stablecoin. These funds serve as collateral for the stablecoin, meaning whenever a stablecoin holder wishes to cash out their tokens, an equal amount of asset is taken from the reserve.
There isn't just one type of stablecoin, though, as different stablecoins use different strategies to achieve price stability.
One type of stablecoin is backed by real-world assets like fiat, the government-issued currency such as dollars or euros. A more complex type of stablecoin is collateralized by other cryptos. Collateralized stablecoins use a variety of types of assets such as fiat, precious metals, crypto, and other investments like bonds as backing. Then there is an algorithmic stablecoin which isn't collateralized at all; rather, coins are either burned or created to keep the coin's value in line with the target price.
This shows that stablecoins come in a range of flavors. Thanks to their stability, stablecoins are used as a medium of exchange or store of value. As such, they can be used in the rapidly growing sector of decentralized finance (DeFi) as well as to provide a reprieve from volatility when the market is tumbling.
Stablecoins are not without drawbacks, though. For starters, stablecoins aren't really stable, as many of them have fallen off their peg at times. Not to mention, investors need proof of reserves. Also, if the reserves are stored with a third party, like a bank, it leads to counterparty risk. This puts a question on the collateral claims of the stablecoin. The centralized nature of stablecoin also presents the risk of censorship. For instance, USDC has frozen transactions several times at the behest of law enforcement.
Still, over time, stablecoins have become tremendously popular, and many options have emerged in this growing category that has their total market capitalization currently standing at almost $126.7 bln, according to CoinGecko.
Stablecoins' popularity, however, has captured regulators' attention all over the world as well, who are now taking steps to regulate them. US lawmakers, in particular, are not in support of them. Most recently, the US House Financial Services Committee advanced a bill to establish a federal regulatory framework for stablecoins while preserving the authority of state regulators.
Now, let's look at some of the most popular stablecoins!
One of the first, most famous, and largest stablecoins is Tether (USDT). Launched in 2014, USDT was originally called Realcoin and was created by software developer Craig Sellars, Bitfinex CFO Giancarlo Devasini, and Philip Potter, a former executive at Bitfinex.
Tether was originally launched on Bitcoin's Omni Layer but has since then expanded to several protocols, including Ethereum — which has the most USDT supply, TRON, EOS, Solana, Bitcoin Cash, Liquid Network, Algorand, and SLP.
The primary purpose of USDT is to maintain its value of $1 at all times. However, it has seen some price fluctuations over the years. In July 2018, USDT hit an all-time high (ATH) value of $1.32 and went as low as $0.57 in March 2015. The price swings occur when demand for the token changes, which happens during times of bear and bull markets. Despite some minor deviations, USDT generally remains close to $1.
Tether's USDT has no known maximum supply as new coins are issued based on user demand and reserves held by Tether.
USDT is one of the most valuable cryptocurrencies overall by market capitalization of $83.86 billion, its highest and 3x more than the stablecoin next in line. With this, USDT continues to dominate the stablecoin space, with its market cap surging by 26.4% in 2023 so far.
It actually emerged as one of the biggest winners since the COVID-19 pandemic shocked the world in 2020 when its market cap was a mere $4.2 bln. The asset pegged to USD became more attractive to those looking for alternative financial options amid the economic collapse.
As of writing, the stablecoin accounts for more than 41% of all cryptocurrency trading volume at just over $13.13 billion, making it the most traded crypto in the market.
USDT was actually created to reduce the friction of moving real currency throughout the crypto ecosystem. Today, USDT is primarily used to park funds in, trade crypto, send funds across the border, and move money between exchanges quickly to take advantage of arbitrage opportunities when the price of crypto differs on two exchanges.
However, this journey wasn't without challenges. Tether Ltd., the company that issues USDT, was engaged in a 22-month-long legal battle with the New York Attorney General (NYAG) over allegations that crypto exchange Bitfinex, a sister company of Tether, tried to cover up an $850 million shortfall using Tether funds. Tether and Bitfinex settled the case in Feb. 2021 for $18.5 million.
At the time, it also agreed to submit quarterly reports of USDT's reserves for the next two years, which shows that Tether's reserve contains a mix of cash, cash equivalents (money market funds, US Treasury bills), corporate bonds, loans, commercial paper, and other investments including digital currencies.
USD Coin (USDC)
In second place is USD Coin, a stablecoin launched jointly by financial services provider Circle and crypto exchange Coinbase in 2018 through the Centre Consortium. Just like Tether, USDC is pegged to USD and backed by real assets that are issued by a centralized entity. When it comes to its composition of reserves, USDC holds cash and short-term US government bonds.
The Centre is the one that develops the technology and governing framework of USDC. It was founded in 2017 by David Puth, and at the end of the same year, it raised $20 million during an initial funding round and then another $20 mln through a late 2018 venture funding round led by Digital Finance Group, according to Crunchbase. Meanwhile, Circle and Coinbase issue the stablecoin.
Back in 2021, Circle announced plans to go public through a $4.5 bln SPAC merger deal with Concord Acquisition Corp, right after closing a $440 mln funding round involving FTX, Digital Currency Group, and Fidelity Management and Research Company.
With a market cap of $26.6 billion, USDC accounts for almost 21% of the stablecoin market, compared to USDT's over 66% market share. Unlike USDT, USDC's market cap has plunged 40.5% this year, though still up from $450 mln in the first half of 2020.
USDC's value is pegged 1:1 with the US dollar, which means holders can redeem 1 USD coin for $1 at any time. USDC can be generated by sending USD to the token issuer's bank account and interacting with the smart contract on the blockchain one wants to use.
And when a user redeems the stablecoin for $1, the team permanently removes the appropriate amount of USD coin from circulation, and funds from reserves are transferred to the client's bank account. The funds backing USDC are held in accounts with U.S.-regulated financial institutions.
USDC is available on multiple public blockchains, including Ethereum, Tron, Solana, Algorand, Stellar, Hedera, and L2 Optimism. The token is also interoperable with all features on the public blockchains it resides on, including smart contracts. In fact, USDC is the key stablecoin in the DeFi world.
While designed to maintain a stable value, USDC's price spiked to a peak of $1.19 in May 2019 and noted a low of $0.877647 in March 2023. This low was caused by the failure of Silicon Valley Bank, where Circle had its $3.3 billion locked up. At that point, it was thought that those funds might be lost forever. However, the problem was eventually solved by the intervention of the Federal Reserve.
Unlike the other two stablecoins, DAI is a decentralized and trustless crypto asset that was created by blockchain company MakerDAO in Dec. 2017.
To generate DAI, the native cryptocurrency of Ethereum, Ether is deposited as collateral in Maker Vaults. This enables DAI to be minted and enter into circulation. So, users lock up their ETH and receive DAI in return, and to redeem, they have to repay the amount of DAI plus a small interest fee which allows them to withdraw their locked ether.
It is the Maker Protocol that makes it possible to generate DAI and is governed by a decentralized autonomous organization (DAO) called MakerDAO (MKR), which was created in 2014 by Danish entrepreneur Rune Christensen. Using DAI, users can lend, borrow, and invest in various protocols, applications, and services.
The project has raised $54.5 million across seven fundraising rounds from investors, including a16z, Paradigm Capital Management, Dragonfly Capital Partners, Placeholder, Iconium, Bloccelerate, Walden Bridge Capital, 1confirmation, and Polychain Capital.
The 3rd largest stablecoin has a market cap of $4.16 bln, down from $5 bln at the beginning of this year but up from about $100 mln in 2020. Compared to USDT and USDC, DAI only accounts for a mere 3.3% of the stablecoin market share.
The ERC20 token is pegged to USD, which means, DAI's price typically maintains the $1 mark, but changes in supply and demand have caused it to surge as high as $1.14 in September 2020 and as low as $0.8819 in March 2023.
To maintain its peg to the US dollar, DAI relies on a “target rate feedback mechanism” (TRFM), under which if the value drops below $1, the TRFM increases to move the price back to the original peg. This makes DAI holders profitable leading to an increase in the stablecoin demand.
Most recently, lending protocol MakerDAO's community voted to introduce the Enhanced DAI Savings Rate (EDSR), which may temporarily increase the interest rate DAI holders can earn to as high as 8% to spur demand for the stablecoin. This comes after the DSR was hiked to 3.49% in June 2023, despite which investors only deposited $306 million, which is less than 7% of the total supply.
In addition to this, the platform has been taking several steps, including increasingly backing DAI with yield-generating assets. In March this year, Maker increased its holdings of the US Treasury bonds to $1.25 billion from just $500 mln to increase its exposure to “high-quality bonds” and real-world assets.
Interestingly, the stablecoin sector has shrunk by almost 8% to a two-year low despite the crypto market jumping by around 50% to $1.2 trillion in 2023, according to researcher CCData. This could be due to investors rotating out of stablecoins and into appreciating crypto assets like Bitcoin and Ether, as well as rising interest rates which makes it expensive to hold wealth in stablecoins.
Developments in the stablecoin sector are still continuing, though. Just recently, Palau, a country comprising some 340 islands in the Pacific Ocean, announced that it is running a trial of a USD-backed stablecoin on Ripple's XRP ledger.
Overall, stablecoins continue to see expansion and growth in usage and adoption, and the future looks bright for these crypto assets, especially the top stablecoins; USDT, USDC, and DAI.