Introduction to Stablecoins
Stablecoins are a type of cryptocurrency designed to maintain a stable value. They are often pegged to a currency like the US dollar and aim to combine the stability of fiat currencies with the benefits of digital currencies. Stablecoins can be divided into two main categories: centralized and decentralized.
Centralized Stablecoins
Centralized stablecoins are issued by a centralized entity. They are backed by reserves held by the issuer and are often pegged 1:1 to a fiat currency. Normally the reserves are fiat currencies and cash equivalents. Here are some examples:
- USDT (Tether): Tether is the largest stablecoin by market capitalization ($83.688B, DefiLlama, 7th August 2023). It is issued by Tether Ltd. and is pegged to the US dollar. According to its website, all Tether tokens are pegged at 1-to-1 with a matching fiat currency and are backed 100% by Tether’s reserves.
- USDC (USD Coin): USD Coin is a digital stablecoin that is pegged to the US dollar. It is issued by Circle, and the stablecoin is redeemable on a 1:1 basis for US dollars, backed by dollar denominated assets held in segregated accounts with US regulated financial institutions. These include cash and US Treasury securities.
- TUSD (TrueUSD): TrueUSD is a USD-pegged stablecoin, backed by US dollars held in escrow accounts, ensuring a 1:1 ratio between the circulating token supply and the USD reserve. TrueUSD provides regular attestations of escrowed balances, offering transparency and assurance to users.
- FDUSD: FDUSD is a Hong Kong-regulated stablecoin issued by First Digital Trust (FDT), a Hong Kong-based digital asset trust company. FDUSD is pegged 1:1 to the US dollar and is backed by cash and cash equivalents.
Decentralized Stablecoins
Decentralized stablecoins operate on a different mechanism. They are not backed by fiat currency reserves but instead, use smart contracts to maintain their value relative to the underlying asset. These stablecoins are often over-collateralized to absorb price shocks and maintain stability. Here are some examples:
- DAI (MakerDAO): DAI is a decentralized stablecoin pegged to the US dollar. It is generated by depositing collateral into the MakerDAO system. The system uses smart contracts to automatically manage the collateral and ensure the stability of DAI. It is primarily backed with ETH and wstETH (45.4%) and real-world assets (35.6%).
Source: Dai Stats, 7th August 2023
- GHO (Aave): GHO is a decentralized overcollateralized stablecoin that is pegged to the US dollar. Native to Aave Protocol, GHO is minted by users via borrowing against multiple collaterals. When the user repays their GHO borrow position, the protocol burns that user’s GHO.
- FRAX: FRAX is a fractional-algorithmic stablecoin protocol pegged to the US dollar. FRAX uses a hybrid design to keep its price pegged to the U.S. dollar. It is 80% backed by crypto asset collateral and partially stabilized algorithmically, burning and minting the protocol’s governance token FXS.
- crvUSD: crvUSD is a collateralized-debt-position (CDP) stablecoin pegged to the US dollar.Users can mint crvUSD by posting collateral and opening a loan within this protocol. Currently, only ETH, wstETH, wBTC, sfrxETH can be used as collateral.
Key statistics
Source: DefiLlama, 7th August 2023
As seen from the table above, centralized stablecoins generally have a higher market cap. USDT dominates 67.16% of the stablecoin market while USDC dominates 20.58%. This makes up 87.74% of the total stablecoins market cap. Centralized stablecoins are also widely available on multiple chains as well as major CEXs, while their decentralized peers mostly trade on Ethereum.
Here are 3 possible reasons that explain this phenomenon:
Firstly, centralized stablecoins are mainly backed with real-world assets and managed by established entities. These stablecoins tend to be subjected to a certain degree of regulatory oversight. As a result, investors often demonstrate greater confidence in entrusting their funds to these tangible organizations, particularly when exchanging their assets back to fiat currency.
Secondly, centralized stablecoins serve a crucial role in facilitating trading on major exchanges, which act as primary access points for retail markets into the blockchain space. Given that these exchanges tend to operate under more regulatory scrutiny and adhere to specific restrictions, it is a logical strategy for them to partner with issuers of centralized stablecoins and incorporate their stablecoins on their trading platforms.
Lastly, converting centralized stablecoins back to fiat currencies tends to be simpler. Centralized stablecoins offer enhanced trust through their robust backing by real-world assets, ensuring sufficient reserves to support seamless conversion to fiat currencies and fostering user confidence. This trust facilitates convenient asset exchange directly through issuers or affiliated providers, streamlining accessibility for on/off-ramp processes. In contrast, decentralized stablecoins lack such established infrastructure due to their crypto-based reserves, often leading to higher volatility. Consequently, transitioning between crypto and traditional fiat currencies using decentralized stablecoins typically necessitates a prior conversion to centralized variants, introducing complexities in the process.
Conclusion
Both centralized and decentralized stablecoins are key to a balanced web3 ecosystem. Centralized stablecoins provide trust and stability, facilitating seamless fiat-to-crypto transitions, particularly for new entrants into the crypto space. On the other hand, decentralized stablecoins leverage blockchain’s promise of autonomy and inclusivity, driving innovative financial interactions. While centralized stablecoins currently lead in market capitalization, the potential of decentralized ones are substantial. In the future, the balance might shift, or new models might emerge, but for now, both centralized and decentralized stablecoins play a vital role in the growth and maturation of the web3 space. Their co-existence and collaboration could lead us towards a more versatile, inclusive, and decentralized financial future.
About DigiFT
DigiFT aims to provide regulated decentralized finance solutions on the Ethereum public blockchain. We are operating the first regulation-abiding decentralized digital asset exchange where asset owners can issue blockchain-based security tokens efficiently and cost-effectively. Investors can trade with continuous liquidity via an AMM mechanism and retain control over digital asset tokens in their own wallets. We are a global outfit backed by well-established venture partners. The founding team originates from international financial institutions and has deep blockchain technology knowledge.
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