In our last article, we learn how stablecoins work and different types of stablecoin. Stablecoins have been employed for many of the same use cases as other cryptocurrencies like bitcoin, with the added benefit of price-stability.
We are going to explore different stablecoin projects in Part 2. In this article, we would learn the taxonomy behind some popular stablecoins and their adoption. Last but not least, we would discuss the challenges stablecoins face so far and their future prospect.
Which are the biggest stablecoins?
Tether is by far the most popular stablecoin and is used primarily by exchanges to offer dollar-like liquidity.
Tokenize Xchange will introduce some prominent stablecoins here including Tether (USDT), Dai (DAI), USD Coin (USDC) and Gemini Dollar (GUSD).
Despite the entrance of new competitors, Tether continues to dominate the stablecoin market and rises into the Top-10 stablecoin rankings.
Formerly known as RealCoin, Tether (USDT) was established in 2014, making it one of the oldest stablecoins. It is a cryptoasset that leverages distributed ledger technology to allow individuals and organizations “to store, send, and receive digital tokens pegged to dollars, euros, and yen person-to-person, globally, instantly, and securely for a fraction of the cost of any alternative”.
A ‘tether’ (the currency unit) is issued and redeemed using the Omni Layer protocol (previously known as Mastercoin), which is an ‘overlay network’ that runs on top of the Bitcoin blockchain. Backed by off-chain collateral, Tether is designed to protect its stakeholders from cryptocurrency volatility by maintaining a one-to-one reserve ratio between the cryptocurrency token (tether) and its associated real-world asset (fiat currency). This configuration is supported by a ‘Proof of Reserves’ process and “Tether Limited”, the business entity responsible for custody of fiat reserves and conversion of value across the network.
Once a tether has been issued it can be transferred, stored, spent, etc. just like a bitcoin or any other cryptocurrency. The fiat currency held in reserve is thereby effectively transformed, gaining the general properties of a cryptocurrency while also having its price “tethered” (stabilized) to the price of the fiat currency held in reserve. Tether tokens have no transaction fees and can be traded for other tokens at exchanges or withdrawn and held in any bitcoin wallet where the user controls their private keys. Tether Limited generates revenue from imposing a small fee on the issuance of new tokens.
Tether dominates the current stablecoin landscape. It is the most widely adopted stablecoin and is used by many industry-leading exchanges such as ShapeShift, Bittrex, Bitfinex, Binance, and Poloniex. It has proven particularly attractive to major exchanges that do not offer US dollar customer accounts.
Tether is more centralized and opaque than other stablecoins. These shortcomings have created an opportunity for an alternative stablecoin to enter the market.
As one of the early Ethereum projects, Dai has developed over several years a relatively strong community.
Dai is an on-chain collateral backed stablecoin, backed by the ether (ETH) cryptocurrency. ‘Maker’ is the entity that created the decentralized technology that runs on top of the Ethereum blockchain that powers Dai. The Dai stablecoin system employs smart contracts on Ethereum that actively stabilize Dai’s exchange rate through the use of Collateralized Debt Positions (CDPs) and autonomous feedback mechanisms. Appropriately incentivized external actors (e.g., market traders) also play a role in stabilizing Dai.
CDPs are collateralized smart contracts that allow users to generate Dai in proportion to the value of the deposited assets. A user deposits ether into the CDP smart contract, where it is held until the debt (as well as interest) is fully paid.
In order to combat the volatility of the underlying collateral, the Dai system can liquidate CDPs by auctioning off the underlying collateral held by the smart contract whenever the value of the collateral falls sufficiently.
The Dai system has a governance token called MakerDAO (MKR). Ownership of MKR gives these token holders governance rights over the Dai system’s risk parameters and types of collateral that can be held in CDPs. When users close CDPs they must pay a stability/governance fee in the form of MKR which is then burned by the Dai system. This reduction in the supply of MKR is one of the direct financial incentives for holding MKR and supporting the Dai ecosystem.
Dai’s price is stabilized through the following autonomous feedback mechanisms:
- Target Price
- Target Rate Feedback Mechanism
- Sensitivity Parameter
- Global Settlement
Dai’s structure, backed by ETH in a smart contract, is inherently decentralized. Users do not rely on a trusted third party, as is the case with more centralized stablecoins such as Tether, where the stablecoins are essentially IOU coins. Dai is also not subject to the same counterparty risks or traditional banking risks as Tether. Since Dai’s launch in December 2017, the token has managed to stay quite stable relative to its USD soft-peg. The forthcoming launch of multi-collateral CDPs will help expand the reach of the token and allow the circulating supply of Dai to increase further.
There will continue to be ongoing concerns over whether Dai’s economic model is scalable and whether the collateral used for CDPs will be uncorrelated enough to protect Dai from the risk of large scale market price crashes. In short, only time will tell whether Dai’s stability mechanism is robust enough for the topsy-turvy world of cryptoassets. Should Dai continue to perform it is well positioned to see increased usage as a decentralized alternative to Tether and other fiat-backed stablecoins.
USD Coin (USDC)
USD Coin is launched by Circle, a leading cryptocurrency exchange and liquidity provider, with major investors (e.g., Goldman Sachs).
USDC is an off-chain collateral backed by the dollar running on the Ethereum blockchain. The design is based on the open source fiat stablecoin framework developed by CENTRE, an open source initiative established by Circle in late-2017. Initially, only U.S. dollars is supported, but Circle plans on adding tokens for the euro and pound.
As one of the leading cryptocurrency exchanges, which now includes Poloniex via an acquisition in February 2018, Circle is arguably one the best positioned organizations to destabilize Tether’s exchange dominance and drive widespread adoption of a competing stablecoin.
Circle’s view is that all fiat currency will become cryptocurrency, and USDC is one step forward in bringing mainstream financial services to the world of cryptocurrency and blockchain technology. With its other suite of offerings, including Circle Invest and OTC trading, USDC can speed up transactions made with dollars and provide a less volatile and compliant alternative to institutions and users interested in embracing cryptocurrency. Circle is also very familiar with the strict regulations applicable to the still-nascent cryptocurrency space and knowledgeable about navigating regulatory uncertainty. CENTRE is expected to be highly transparent with audits and financials. Overall, USDC appears well positioned to provide strong competition for Tether and other similar fiat backed stablecoins.
Gemini Dollar (GUSD)
The Gemini dollar is the world’s first regulated stablecoin. It combines the creditworthiness and price stability of the U.S. dollar with blockchain technology and the oversight of U.S. regulators. As an ERC20 compliant token, the Gemini dollar can be transferred on the Ethereum network. Gemini dollars are created at the time of withdrawal from the Gemini platform and redeemed or “destroyed” at the time of deposit into the Gemini platform.
The GUSD will be providing a link between the traditional banking system and the crypto world. Once a verified Gemini user purchases the Gemini Dollar, the user is free to move it to any address he or she wishes on the public Ethereum network. This means that the user has complete freedom when it comes to the holding, transferring, buying and selling of this token. With the use of GUSD businesses can start accepting payments faster, without delays and with lower fees. In addition to these users can also use it for e-commerce transactions, lending and smart payments.
What are the challenges stablecoins face?
One of the biggest challenges stablecoins facing is scaling. For reserve-backed stablecoins to reach a level where liquidity is deep enough to support interesting applications of the technology, backers will have to invest millions or even billions in each coin. This could create a cap on how fast the stablecoin can grow. Having any upward limit or friction on how quickly something can grow is potentially a huge problem.
b) Regulatory Scrutiny
Another potential hurdle is regulatory scrutiny. Central banks may be quicker to act on stablecoins than they were on cryptos like bitcoin because stablecoins more closely resemble fiat money and could have effects on monetary policy.
c) Technical Challenges
The emerging digital assets such as stablecoins face a variety of technical challenges as the technology is still nascent and it is highly unlikely that the perfect stablecoin design exists at present. Further and more experimentation and innovation are needed to come out with an “almost perfect” designed stablecoin.
Future of Stablecoins
It has not been uncommon for a new stablecoin to be announced each week, and the evergrowing number of stablecoin projects raises questions around competition and how many stablecoins the cryptoassets ecosystem can support.
There are many different ways that stablecoins can differentiate, including stability mechanism design, technology platform, reference pegs, jurisdictional/regional focus, fundraising, and so on. In terms of the core stablecoin design, different choices create trade-offs across a number of dimensions, such as the degree of transparency and automation (trust-minimization) offered by a stablecoin, as well as the complexity of the price stability mechanism.
Beyond developing the software and core product, obtaining a sufficient number of exchange listings and liquidity are seen as the two most important success factors by many stablecoin projects.
The success of Tether offers at least some evidence that so far the market has prioritized stability over decentralization (i.e., transparency and automation). Market participants are likely to continue to place a premium on stability over decentralization for the near-term. Anyone who prioritizes decentralization already has the option to own arguably the most decentralized cryptoasset, bitcoin. Indeed, the current preference for price stability is recognized by many of the algorithmic stablecoins, some of which are in the process of developing hybrid algorithmic/asset-backed launch designs.
Stablecoins are expected to become increasingly decentralized in the longer term as projects continue to experiment with various designs and additional empirical data is gathered on ‘what works’. For now, design uncertainty, as well as other factors such as regional/local regulations, lead us to believe that space may exist for approximately 5–8 significant stablecoins in the short to medium-term.
A successful, well-designed stablecoin could help create a tipping point for much broader cryptoasset adoption by successfully addressing concerns around volatility, which are often cited as a key reason why many institutions and individuals have remained on the digital assets sidelines to date.
The rise of stablecoins may also affect the prices for some cryptocurrencies, such as bitcoin, that will face greater competition for certain medium of exchange and store of value use cases. However, in our view stablecoins are more complementary than competitive with major cryptocurrencies like bitcoin or ether. Indeed, many stablecoins rely on the security, compatibility and infrastructure provided by cryptocurrencies like bitcoin and ether. Overall, stablecoins are best viewed as a form of ‘infrastructure’ or foundational layer for cryptoassets that will generate immense value for the overall digital assets ecosystem.
In addition to competing with other more volatile cryptoassets like bitcoin, they are also competing against national legal tender currencies. How successful or unsuccessful central banks are at managing national currencies will certainly influence the fate of stablecoins and cryptocurrencies as a whole. But stablecoins do not simply offer great competition in the marketplace for currencies and money. Like bitcoin, stablecoins are helping to usher in a new era of monetary innovation and encouraging established institutions like central banks to re-examine the nature and possibilities around one of our oldest institutions, money, and its role in the financial system.
Now, you may trade stablecoins such as Gemini Dollar (GUSD) and USD Coin (USDC) on Tokenize Xchange. Check out more details here!