What are stablecoins and how do they fail?

Read this detailed guide to understand what stablecoins are and case studies where they have failed miserably.

The only thing that continues to make fun of cryptocurrencies is their volatility.

Computer coins such as Bitcoin and Ethereum are completely unreliable and cannot survive as a medium of exchange. For example, would you accept a payment worth $100,000 in Bitcoin, knowing that the value could plummet to $80,000 by the time you finished watching Avengers: Endgame?

I wish it was a mountain range, but unfortunately it’s Bitcoin, whose value fluctuated from $10,000 to over $60,000, then back down to $30,000 in less than two years. Masu.

And this is the most powerful cryptocurrency we are talking about, minus altcoins.

Ultimately, we needed to come up with something that would give us some stability in behaving like real-world currencies while still keeping the innovative ideas of cryptocurrencies intact.

Eureka! We invented stablecoins.

What is a stablecoin?

Stablecoins are stable cryptocurrencies that are backed by real-world assets or algorithms to avoid large fluctuations in value. This is in clear contrast to standard cryptocurrencies, which are backed solely by public speculation.

Let’s take a look at the value of popular stablecoins.

This is Tether (USDT), which is currently the front runner in daily trading volume, surpassing Bitcoin, Ethereum, and several other cryptocurrencies combined.

Even the extreme spikes show that Tether has changed less than 10% from its peg (approximately $1 USD) over the past few years.

A peg is a specific value that a stablecoin must maintain as a sign of its stability.

Therefore, the sole purpose of stablecoins is to avoid wild price fluctuations. This stability inspires confidence among those who promote its use as a medium of exchange, similar to fiat currency.

Next, we’ll look at the types of stablecoins and how they avoid volatility.

Types of stable coins

Based on collateral, stablecoins can be categorized into four types.

#1. Stable coin backed by fiat currency

These stablecoins are issued on a one-to-one basis against equivalent fiat currencies.

Typically, the issuing authority will maintain a precise amount of cash or cash equivalent reserves before commencing distribution of the tokens. And ideally, the authenticity of that reserve is verified by a third-party auditor who confirms the token company’s claims.

However, there is no way to know for sure whether the issuer will not default and whether the collateral is actually secured.

Additionally, although these are referred to as fiat-backed stablecoins, the percentage of actual cash may be quite low.

For example, USDT is not backed entirely by fiat currency, but rather by a collection of cash-like entities, including precious metals, bonds, and other digital tokens. As of this writing, the actual fiat currency percentage of USDT reserves is approximately 5.81%. , also listed on the website.

#2.Stablecoin backed by cryptocurrency

Since cryptocurrencies themselves are volatile, stablecoins backed by cryptocurrencies are backed by significantly more collateral than the value of the issued stablecoin.

For example, DAI, a popular stablecoin, is backed by more than 50% of its issue value in crypto assets to address reserve volatility.

However, as the price fluctuations of cryptocurrencies are not limited to a certain range, these stablecoins can lose their peg if the underlying cryptocurrency fluctuates beyond a certain threshold.

#3. Stablecoins backed by commodities

As the name suggests, these coins are issued against commodity reserves like investment grade gold. Therefore, for each decentralized token, an equivalent amount is stored in a trusted custodian.

Moreover, the best part about these stablecoins is that investors can exchange their tokens for goods whenever they see fit.

For example, PAX Gold (PAXG) is a digital token equal to one fine troy ounce of a 400-ounce London Good Delivery gold bar. Additionally, when you return your PAXG, you will receive an equivalent amount in LBMA-certified physical gold according to the company’s standards.

#4.Algorithmic stablecoin

Stablecoins backed by algorithms are programmed to protect their value and avoid major changes.

When a stablecoin’s value spikes past a certain point and you put it back on the peg, the supporting algorithm will supply more coins. Similarly, when stablecoins go down, we reduce the distribution rate to make stablecoins appreciate.

In conclusion, these stablecoins are not based on any assets and are the most risky of the four.

Now that you understand the types, let’s take a look at some…

tops stable coins

Since each project is unique and there are different factors when ranking a stablecoin, we simply base it on the total current market value according to CoinMarketCap .

Tether (USDT)

Tether is a multi-blockchain stable token that enables a hassle-free alternative to fiat currency transactions. Blockchains that support Tether include Bitcoin Cash’s Simple Ledger Protocol (SLP), Ethereum, EOS, Liquid, Omni, and Avalanche.

Tether is pegged to the US dollar and ranks only behind Bitcoin and Ethereum in market capitalization.

It is also one of the most transparent stablecoins from the issuing company, Tether Holdings. Ltd, which lists its reserves and composition on its website.

US dollar coin (USDC)

USDC is another stablecoin that exists on various blockchains and improves accessibility. The list of compatible blockchains includes Ethereum, Alogorand, Solana, TRON, and Stellar.

In terms of market capitalization, it ranks second among all stablecoins and fourth when considering all cryptocurrencies.

The brainchild of Circle Internet Financial Ltd., USDC is also pegged to the US dollar and can be redeemed on a 1:1 basis.

BUSD

BUSD, as the name suggests, is another USD-pegged stablecoin jointly offered by Binance, the largest cryptocurrency exchange, and Paxos, a blockchain infrastructure company.

Thanks to this tradition, you can get better deals when buying BUSD or trading with other stablecoins, including minimal or zero fees.

BUSD is also one of the most regulated stablecoins approved by the New York State Department of Financial Services (NYDFS).

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DAI differs from those mentioned above in that there is no underlying central authority.

It is managed and regulated by MakerDAO, a decentralized autonomous organization. DAI runs on the Ethereum blockchain and is equivalent to 1 USD.

As a crypto-backed stablecoin, DAI is overcollateralized to maintain its peg even in the worst-case market scenarios.

Can stablecoins crash?

If you were asked before May 11, 2022, the answer could be no.

On that day, the entire cryptocurrency industry was shaken by the spectacular collapse of the stablecoin TerraUSD (UST).

It was an algorithmic stablecoin that was indirectly connected to LUNA, a non-stablecoin cryptocurrency created by the same parent company, Terraform Labs.

Even before the UST fiasco, its sister coin LUNA, like most other cryptocurrencies, was already facing difficult times. It started to fall from $119 (April 4, 22) to almost $17 (May 22, 10).

Around the same time, nearly 10 billion USD was reportedly de-staken from Anchor Protocol (Terra’s lending and borrowing platform), and huge chunks were sold, creating pressure on its ecosystem.

This clearly unpegged UST.

And due to algorithmic connectivity and panic among users, this depeg removed whatever was left of LUNA, which was already in trouble.

Currently, the Terra blockchain is defunct and both coins (LUNA and UST) have lost almost 100% of their value.

Efforts are underway to revive LUNA, but the Terra stablecoin is gone forever.

The bottom line is that every project, whether called a stablecoin or not, is different and can be hit by a terrible recession that crushes dreams and evaporates wealth.

last word

Stablecoins are trying to replace fiat currencies and standard cryptocurrencies. And in fact, some companies have better protocols in place to maintain value against the daily onslaught of the cryptocurrency market.

However, the end result is potentially vulnerable code. And in some cases, these bugs have resulted in huge losses.

So, while it’s known to hold its value, read the detailed print and whitepaper, and engage with the community to get tips.

PS: Read this crypto terminology to find out how lending and borrowing works in the crypto realm.