Stablecoins are a critical component in Decentralized Finance (DeFi). DeFi presents an alternative to the existing financial systems with one which is open and transparent, built on public blockchains and not controlled by centralized institutions.
If DeFi is to grow, stablecoins will undoubtedly play a vital role because people would need a volatility-free means of transacting with each other, without losing the benefits of cryptocurrencies.
What are Stablecoins?
A Stablecoin is a kind of cryptocurrency that holds a stable value against a pegged external asset class such as FIAT currency, cryptocurrencies and other real world valuable assets.
The primary purpose of stablecoins is to negate the speculative nature of most cryptocurrencies and help create a more consistent and reliable market environment in order to increase adoption of digital assets and curb high volatility.
The most prominent stablecoins are pegged against the world’s unofficial global fiat currency, the U.S. Dollar, on a 1:1 ratio.
However with increasing global market instability and unfolding trade wars, new entrants are offering stablecoins that are pegged against a weighted basket of real-world currencies such the Euro, British Pound, Japanese Yen and more.
Some of such new entrants include Eurbase (Ebase) by Eterbase Exchange which is pegged to the Euro 1:1, NairaX issued by NIRX and is pegged to the Nigerian Naira in a 1:1 ratio.
Brief history of stablecoins
The first stablecoin BitUSD was issued on 21 July 2014 and issued as a token on the BitShares blockchain.
BitUSD was collateralized by crypto and backed by the BitShares core token BTS, locked in a smart contract to act as collateral. Unfortunately BitUSD lost its parity to the USD in late 2018 and has come under heavy criticism as a result. It currently floats around only 80c to the dollar.
The second stablecoin issued in history is NuBits. NuBits was issued in September 2014, but NuBits has failed to be stable after having two serious crashes in 2016 & 2018. it is presently trading at around $0.06. Imagine this is stablecoin that is supposed to hold around $1?
In 2015 Tether (USDT) was introduced by Bitfinex Exchange. Tether was rebranded from Realcoin. Today USD-Tether is the number one stablecoin and number six cryptocurrency in terms of market capitalization but despite its popularity Tether and Bitfinex has been embroid in a number of controversies and allegations ranging from the $31 million hack in 2017, price manipulation claims that subsequently lead to the over 50% increase in bitcoin price in 2017 and recent claims that a majority of Tether Treasury is not backed by real US Dollars.
We also have stablecoins like USD Coin (USDC) issued by Coinbase and Circle, Paxos Standard issued by Paxos and backed to the US Dollar, TrueUSD (TUSD) issued by TrustToken, Ebase issued by Eterbase Exchange and backed by the Euro, Gemini Dollar (GUSD), Dai Token (DAI) issued by Maker DAO and its pegged 1:1 to the US Dollar but not backed by real fiat assets but rather maintains its peg by users who provide an over-collateralization in Ethereum (more than $1 in value) which they can redeem later.
While stablecoins offers an opportunity for traditional institutions to utilize and explore blockchain. We have had Tech companies and other conglomerates dug deeper into stablecoins.
This includes Libra by Facebook, JPM Coin by JPMorgan, Walmart are also exploring the possibility of issuing a stablecoin.
But this hasn’t been limited to institutions and tech companies. Governments and Central Banks have also began contemplating the idea of issuing stablecoins. The former Chairman of the US Commodity Futures Trading Commission (CFTC) headed an initiative to create a “digital Dollar.”
A draft document from the European Union hinted that they are also considering the creation of a new stablecoin. China is also rumored to be contemplating the idea of creating a digital Yen.
Types of stablecoins
1. Collateralized off the Blockchain (Centralized): these are stablecoins that are not backed by other cryptocurrencies, smart contracts or Blockchain algorithms. These are the most popular and widely used stablecoins.
They are backed by real world assets that are regulated and frequently verified by external auditors to make sure they are backed at all times.
Off chain collateralized stablecoins are divided into two classes
- FIAT collateralized: pegged against real world currencies such as US Dollar, Yen, Euro, British Pound, Naira, etc. Example includes Tether USD, USD Coin, TUSD, NairaX, Libra, Binance USD (BUSD), Gemini Dollar (GUSD), etc.
- Commodity collateralized: pegged against real-world commodities like gold, silver and oil, e.g. Digix Gold (DGD), Tether Gold, etc.
2. Collateralized on the Blockchain (Decentralized): These are a relatively new type of stablecoins which don’t have a central operator but are governed by a consensus of the users who take part in the network.
Blockchain collateralized stablecoins are stablecoins whose value is backed by other cryptocurrencies.
An Example is Maker DAO’s stablecoin – DAI. Users can lock up a certain amount of cryptocurrencies, such as Ethers, as collateral for borrowing DAI, which is pegged to the US Dollar.
Another example is BitUSD, collateralized by crypto and backed by the BitShares core token BTS, locked in a smart contract to act as collateral. BitUSD is pegged to the US Dollar.
3. Decentralized Algorithmic Stablecoins: These stablecoins are not backed by either real or digital asset collateral and instead, it depends on a complex combination of algorithms and smart contracts to keep a stable price by constantly buying and selling to maintain a stable value. These are relatively a new type of stablecoins and are still being improved on but have fallen out of favour. An example is the NuBits stablecoin which was visited further above in this article.
How can stablecoins be used?
- To hedge in times of high volatility in cryptocurrency markets
- For making payments off and on the chain.
- Remittances to protect against price fluctuations while payments are being processed.
- Recurring payments such as salaries, wages and rent
- Long-term loans
- As a store of value due to its stability.
- Trading and wealth management, that includes the likes of arbitraging opportunities.
Benefits of Using Stablecoins
- They have very low transaction fees
- Can be used for transactions anywhere in the world
- Are backed by real world assets, these means they are valuable.
- Has an incredible transaction speed
- Offers protection for traders and investors during times of market volatility
Stablecoins are an important protocol of the Decentralized Financial (DeFi) Ecosystem. We cannot over emphasize the importance of stablecoins in Cryptocurrency. They do not only make accessing cryptocurrency easy but have provided the opportunity for Financial Institutions, Governments, Corporations and Tech Companies to adopt Cryptocurrency and Blockchain Technology.
Ranging from Facebook, Twitter, Walmart, JPMorgan, Alibaba, IMF and others have all recently been interested in Cryptocurrency and Blockchain Technology mostly due to Stablecoins. As a component of Decentralized Finance (DeFi), stablecoins will play a pivotal role in the wide adoption of DeFi in the world.