ELI5: Stablecoins

When you buy crypto, the value of your purchase can change by 10, 20, even 30+ percent in just a matter of minutes. That $100 you just put into the markets 2 minutes ago? It’s $65 now…

Oh wait, just kidding! It’s actually at $110. 

For people who actually want to *spend* their crypto, you can see how this would be a problem. What if you have $100 of $BTC, but by the time you try to spend it the value has gone down? Introducing stablecoins. Stablecoins are essentially a way to keep cash onchain. Thanks to stablecoins, users can do all kinds of fun stuff onchain without being exposed to price volatility!

What are they?

Stablecoins are one of the few things in crypto that are actually quite easy to understand. They are literally the “stable coins” of crypto. Where most cryptocurrencies aim to “reach the moon”, stablecoins do the exact opposite - their goal is to stay grounded. Maintain a specific price. Stablecoins stay (the good ones at least) pegged to a specific fiat currency. Some stablecoins pegged to USD include $USDT, $USDC, $DAI, along with many others. There are stablecoins pegged to the Euro that follow the same concept as well, such as $EURS, $EURC, and $EURt.

I want a moonbag, who needs stablecoins?

Stablecoins might be the most underrated aspect of the crypto industry. With 100s of billions (with a B) of dollars sitting in stablecoins as of 2024, it is by far the best product-market-fit crypto has discovered so far.

For starters, there are a lot of people who send money back and forth to loved ones in other parts of the world. If this is you, not too long ago your best option would have been Western Union or some similar company. They’d charge you a 15% fee on whatever money you’re sending, it would take 3-5 business days, and oh yeah, they’re only open from 7am-3pm Monday-Thursday. Need to send money at 3:30pm on Thursday? Try again on Monday - sorry!Stablecoins enable average people around the globe to send onchain fiat - not speculative assets - across borders, 24/7.

Stablecoins are also a great way for citizens of countries with economic challenges to hedge against their native currency. For example - to someone who earns in Argentinian Pesos, holding a USD-backed stablecoin which only has single digit yearly interest is much more appealing than holding the Peso that is currently facing inflation in the triple digits.Stablecoins also allow crypto market participants to exit trades while staying onchain. Because stablecoins exist, traders can trade in to and out of $BTC or $ETH, straight back to USD-pegged assets. Without having to go through the process of offboarding and onboarding everytime you want to trade USD, or any other fiat currency with a stablecoin.

Last but definitely not least, stablecoins make it easier and more palatable for huge institutions like Blackrock or VanEck to enter crypto. This increases overall volume and stability in the crypto markets, which is always a plus!

How do they work?

Stablecoins come in 3 different flavors:

1. Asset-Backed

These are stablecoins that are backed by real world assets like fiat currencies, gold, and even sometimes real estate! For asset-backed stablecoins, each token issued is supposed to represent ownership of a portion of these assets. The backing asset (usually fiat) is held in reserves by the issuer, and they often have to go through rigorous financial audits to prove that they really have the assets they say they do. Although asset-backed stablecoins are considered more ‘stable’, users do ultimately have to trust a centralized entity to properly manage those assets.

Examples of asset-backed stablecoins include $USDT and $USDC.

2. Crypto-backed

Crypto-backed stablecoins are collateralized by other cryptocurrencies. Sometimes even other stablecoins! Crypto-backed stablecoins often have to be overcollateralized in order to account for the risk of volatile price swings in the underlying backing assets. Unlike asset-backed stablecoins, the collateral here is purely digital and managed onchain. The collateral can be adjusted dynamically if the value of the backing crypto assets change significantly.An example of a crypto-backed stablecoin is $DAI by MakerDAO, which is mostly collateralized by ETH along other assets.

3. Algorithmic

People either love or hate the idea of algorithmic stablecoins. These stablecoins use algorithms to maintain their peg to a reference asset, typically through smart contracts. They don’t require traditional collateral. Instead, they might use a secondary token (like a governance or bond token) to stabilize the price. For instance, if the price of the stablecoin rises above its peg, more tokens would be issued, and if it falls, tokens might be burned or locked. 

In theory, algorithmic stablecoins can be more decentralized since there’s no need for a central entity to hold any assets as collateral. But on the other hand they’ve proven to be super sensitive to market sentiment.

For example, there once was a crypto project that did a really cool play on words with their stablecoin-based blockchain. Terra Luna - they had a stablecoin named TerraUSD, or $UST, which was supposed to stay pegged (spoiler alert, it didn’t), and a token named $LUNA, meant to “moon”. They were one of the most successful algorithmic stablecoin protocols until one day it all came crashing down. 

It’s a long and intense story, but to make a long story short - confidence in the token dropped and the algorithm failed spectacularly. Many who believed in the system lost everything. A somber reminder of the risk we all take participating in cutting-edge crypto protocols.

Which are the most popular?

Tether ($USDT) is the most widely used stablecoin around the world. Being asset-backed, its value is tied to its reserves, held in fiat currency and other cash equivalents. $USDT is pegged 1:1 to the U.S. dollar, and its issuing company, Tether Limited, claims to back every $USDT token with an equal amount in reserves. 

Tether's massive market presence and integration across nearly every crypto exchange make it a popular choice for traders looking to swap assets in and out of volatile positions without exiting crypto entirely. However, critics argue that Tether’s reserve audits are not as frequent or as detailed as those of its competitors, leading to ongoing debates about its reliability.

USD Coin ($USDC), issued by Circle in partnership with Coinbase, is another asset-backed stablecoin pegged to the U.S. dollar and is often considered one of the most transparent stablecoins on the market. 

Unlike Tether, $USDC publishes monthly attestations by third-party firms to verify its reserves, which consist mainly of cash and U.S. government bonds. This transparency has led many users to perceive $USDC as a safer, more regulated option compared to $USDT, especially for institutions and individuals who prioritize oversight. 

While both $USDT and $USDC share similar use cases, $USDC’s focus on regulatory compliance has helped it gain acceptance among institutions and regulatory bodies that may be cautious about entering the crypto market.

Dai (DAI) stands out as a decentralized, crypto-backed stablecoin. Created by MakerDAO in 2017, $DAI maintains its value through a complex system of smart contracts and is collateralized primarily by Ethereum along with other cryptocurrencies. 

Unlike $USDT and $USDC, which rely on centralized entities and fiat reserves, $DAI achieves its peg through over-collateralization, where users must deposit a higher value of crypto assets into a smart contract to mint $DAI. This decentralized model makes $DAI popular among crypto enthusiasts who want to stay within the decentralized space without relying on traditional banking systems. 

But it isn’t all sunshine and rainbows. The stability of $DAI can sometimes be challenged by extreme market volatility due to its underlying collateral, which is something you always should be aware of.

Honorable Mentions:

PayPal USD ($PYUSD) is an asset-backed stablecoin issued by PayPal, designed to provide a more accessible digital dollar for mainstream consumers. Fully backed by U.S. dollar reserves and U.S. Treasury bonds, $PYUSD is a highly regulated stablecoin, aligned with traditional financial standards and overseen by many regulators. 

Given PayPal’s enormous global user base, $PYUSD aims to bridge the gap between traditional finance and crypto, allowing users to make purchases, send money, and interact with digital assets within the PayPal ecosystem. This approach positions $PYUSD as a stablecoin with a broad appeal, potentially accelerating crypto adoption among people unfamiliar with or cautious about the space.

Frax ($FRAX) is a hybrid stablecoin that combines both algorithmic and asset-backed elements to maintain its peg. Created by Frax Finance, $FRAX represents a unique approach that adjusts its reliance on collateral based on market conditions, making it a “fractional” stablecoin.

Frax’s model dynamically shifts between collateralization and algorithmic mechanisms. When market demand for $FRAX is high, it leans more on an algorithmic mechanism to maintain its peg, reducing its need for collateral. Conversely, in periods of lower demand or higher volatility, $FRAX becomes more heavily collateralized to ensure price stability. This fractional-reserve model allows Frax to maintain a $1 peg without fully backing every FRAX token with collateral, setting it apart from purely fiat- or crypto-backed stablecoins.

Ondo USDY ($USDY) targets a more specialized market segment by providing a stablecoin that emphasizes security and institutional-grade transparency. Backed by a combination of U.S. Treasuries and other low-risk assets, $USDY is designed to offer a secure and compliant option for institutional investors and sophisticated retail users. Unlike more retail-focused stablecoins, $USDY appeals to financial institutions looking for secure, stable options within the digital asset market.

If stablecoins are calling your name, you can buy and swap them directly in all of our wallet products. Get started here!

Crypto moves fast and is ever-evolving. Keeping up with everything can feel like a full-time job in itself, but that’s what we’re here for. To synthesize complicated crypto topics into easy-to-digest, bite-sized consumables. We hope you gained some insight into stablecoins after reading this, thank you so much for taking time out of your day to read our blog piece on stablecoins! If you found any value in this, please feel free to share it with anyone and everyone who might be interested. And good luck on your crypto journey!