What Are Stablecoins?
Stablecoins are a type of cryptocurrency that’s value is backed by a commodity, a different currency, or other financial assets. They were designed to maintain stable value over time in relation to the asset they’re backed by. Assets could be USD, gold, other types of crypto, and more.
The most popular stablecoins are pegged to USD. As in, the top 10 stablecoins by market cap are all pegged to USD except one, which is pegged to a basket of currencies which, you guessed it, includes USD.
However, this shouldn’t come as a surprise. The US Dollar is considered one of if not the most stable global fiat currencies.
TL;DR: Stablecoins may provide stability and predictability in volatile markets.
How Do Stablecoins Work?
You purchase the stablecoin for a number of reasons, including but not limited to:
- Parking your money in crypto, but in a stable way
- Investing in an asset without using a traditional broker
- Facilitating cross-border transactions without large fees
- Having your wallet loaded so you can deploy cash nearly instantly
- Not having to withdraw crypto from a wallet into fiat and convert it back in order to trade
Some stablecoins are backed by a reserve of other cryptocurrencies, while others are backed by good ol’ fashioned fiat. Others use algorithms to keep their value steady. There are four types of stablecoins, but we’ll get to those in just a bit.
You have $1,000 USD. It’s just sitting there, slowly dying. You know that at some point in the future, you want to buy some ETH, but you want to wait until the exact perfect second to do it. But financing takes a second and you don’t want to miss your entry because your bank is taking too long. You load your wallet with stablecoins instead, maybe some Tether, for example. When ETH is where you want it, sell the Tether, buy the ETH.
Top Stablecoins List
- Tether (USDT): Tether is the largest stablecoin by market cap and trading volume. It’s unsurprisingly pegged to Dollar, and for what it lacks in excitement, it makes up for in stability and liquidity. It remains stable as Tether pursues and achieves liquidity through fully-backed currency reserves.
- USD Coin (USDC): Less than half the value of Tether is still a lot. USDC is more transparent as they are audited monthly by third parties. USDC may have a smaller market share than Tether, which might be because the coin was established a few years later.
- Binance USD (BUSD): BUSD is issued by Binance and Paxos. Tether, or USDT, is issued by Tether themselves. BUSD is touted as the less fluid but more transparent little brother to USDT. Binance describes it as “…fully collateralized by a corresponding US Dollar.”
- DAI: DAI is pretty neat. It’s decentralized and swims about on the Ethereum blockchain. As you can imagine, there’s no exchange to manage USD reserves, so DAI is pegged (to the almighty Dollar) by multiple cryptocurrencies managed by smart contracts.
- True USD (TUSD): True USD is much smaller than Tether, and that could be because they are pretty similar and have to split that market share. They’re both pegged to the Dollar at 1:1, they’re both backed by cash reserves, and they’re both cryptocurrencies. Basically, Tether just got there first.
Types of Stablecoins
There are different types of stablecoins because there are different assets and asset classes they are backed by and tethered to. Despite most stablecoins being both pegged to the dollar and backed by it, sometimes you just wanna do something different, ya know?
Fiat-based stablecoins are backed by fiat currencies. These stablecoins are:
- The largest by market cap (by a lot)
- The only ones that are majority-backed by fiat
- The ones under the most regulatory scrutiny
They could be tethered to the Yen, the Dollar, the Euro, and the Canadian Dollar and are backed by those respective currencies. To use Tether as an example, Tether, the stablecoin, is issued by Tether Limited, the company. That company then purchases and holds the fiat equivalent of the stablecoin reserves.
Unlike fiat-backed stablecoins, commodity-backed stablecoins are coins backed by….commodities! Shiny things are the name of the game here—gold, silver, oil, and others. Like real estate.
Commodity-backed stablecoins are directly linked to the commodity they’re backed by. So, for example, let’s use Paxos Gold (PAXG). The token is backed by physical gold held in LBMA vaults. You can redeem it for USD at current gold prices or stuff your (deep) pockets with literal gold bars.
Crypto-backed stablecoins are pegged to a stable value like the USD, but instead of an institution holding the float in cash, it’s backed by a basket of crypto. Some consider it more stable than fiat-backed because it can rebalance a little more nimbly.
They aren’t bound by the “1:1” ratio that fiat-based currencies are. It allows for more creativity, which also means it’s riskier.
Algorithmic-backed stablecoins are balanced and maintained by algorithms. Behind the scenes, dark forces conspire to regulate the price of the stablecoin and maintain stability due to changes in demand.
Let’s use Frax as an example. Consider a drop in demand for the USD-pegged stablecoin. The algo adjusts the supply of the stablecoin in response to change.
How To Earn Interest On Stablecoins
Well, you can lend stablecoins. That’s simple enough.
If you’re not earning interest on your stablecoins, you might want to consider it. The idea is to keep them as a healthy, stable asset while you either wait for different opportunities to deploy your capital or just hoard your coins.
What we’re saying is you’ve already decided to have at least some percentage of your net worth in stablecoins. Let. Them. Work. For. You. Lend them out and make a pretty healthy percentage for doing so.
Are Stablecoins Safe?
Stablecoins can be considered safe when you compare them to most other crypto assets. They are designed to be stable (it’s there, in the name). They’re pegged to asset classes that generally behave themselves and are the shelter of choice for those who don’t know what to do and need to park some currency.
That being said, even stablecoins pegged to the same asset vary in terms of risk. Compare Tether to USDC. Which is safer?
Scary stuff. This needs to be included in this section both because it can wreck the stability of the coin and also because, well, it’s happened before. Tether depegged in late 2022 by more than 3%.
This means there was “slippage” between the pegged asset and the price of the stablecoin. Not a good look for something with stable in its name.
The Securities and Exchange Commission (SEC) hasn’t really figured out how to sink its teeth into this one. You can keep up to date with our index of crypto legislation. The only US agency to issue any guidance on USD-backed stablecoins has been the New York Department of Financial Services (NYDFS). Provisions are:
- All stablecoins must be fully backed, which means that the entire value of the stablecoin must be backed by a reserve of assets that’s equal to the value of the stablecoin.
- Holders should be able to redeem their stablecoins at any time.
- Reserves must be held in custody with US-chartered banks and must be in the form of US Treasury Bills and bonds.
- Reserves must undergo audits and examinations by a licensed CPA at least once a month.
Usage Of Stablecoins
The market capitalization of stablecoins showcases their significant adoption to date – upwards of $100 billion worth of them are in circulation.
But the amount of value that stablecoins are already transferring on blockchain settlement rails is staggering. Upwards of $7.9 trillion was transferred via stablecoins across Ethereum, Tron, and Bitcoin in 2022.
The chart below puts some much-needed context around those numbers. It shows how this stablecoin transfer volume compares to settlements using The United States Federal Reserve’s settlement network (Fedwire), annual purchase/transfer volume across Visa and Mastercard’s card networks, and payment volume processed by PayPal.
These payment methods are not perfect “apples to apples” comparisons: a transfer of stablecoins from one wallet to another is different from a consumer credit card purchase which is different from a large-scale interbank wire transfer. But analyzing them is useful for gauging relative levels of growth in adoption.
Stablecoin transfers have increased from $21M in 2015 (not pictured in the graph above) to $98B in 2018, to $7.9T in 2022 – this represents an annual rate of growth of 525% which is orders of magnitude higher than the single digit growth recorded by other payment networks (See how flat those lines are compared to stablecoins?)
Stablecoins came about because investors were looking for some stability, and parking crypto in stablecoins that are pegged to traditional assets like fiat currency seemed to provide that.
- July 2014: First Stablecoin Issued: BitUSD, the world’s first stablecoin was released on the Bitshares blockchain. Interestingly enough, the first stablecoin was crypto-backed, not backed by fiat currency.
- September 2014: NuBits was launched: NuBits was also pegged to the dollar, but was backed by an algo. It has since blown up spectacularly.
- November 2014: Tether was released: The granddaddy of stablecoins. Many consider Tether the first super-valid stablecoin.
- December 2017: DAI was released: DAI was released on the Ethereum network and many people took it seriously. DAI is decentralized.
- November 2018: USDC achieves regulatory approval: The stablecoin received regulatory approval to operate as a digital asset. This was given by the New York State Department of Financial Services (NYDFS). It’s fully collateralized by USD at 1:1.
- Jan-Dec 2020: Tether quadruples in value from $4B to $20B USD.
- March 2022: TerraUSD/LUNA blows up: This is a fun read on the LUNA crash. LUNA will be remembered as one of the ultimate fails of the crypto age. When it collapsed, over $400B was wiped from crypto markets.
- November 2022: USDT depegged: Tether depegged by more than 3% .
- March 2023: USDC depegged after SVB collapse: When Silicon Valley Bank went under in early 2023, USDC fell below 90 cents.
To Sum it Up
Stablecoins are a great place to put unused capital in traditional assets via crypto. It’s the “bury it in the backyard” or “stuff it in the spare mattress” of the crypto world. They’re called stablecoins, but sometimes they aren’t so stable, so account for this when parking your savings in stablecoins.
Frequently Asked Questions
The best stablecoin is the one that you like best and works best for you. This is the ultimate copout answer, but it’s also the only accurate one. We could tell you to throw everything you have at Tether, and you’d probably be ok but, what works for you might not work for someone else. Do your homework.
Yes, stablecoins are a cryptocurrency. They trade in a similar way—that is, on an exchange—but they are pegged to fiat currencies. Therefore, their value won’t change as dramatically as other cryptocurrencies, which tend to be more susceptible to liquidity squeezes and manipulation by absolute units.
Bitcoin is not a stablecoin. It probably—definitely—wouldn’t be as popular if it were. Much of the vibe around crypto is that it isn’t tied to an old-timey currency like the USD. If Bitcoin were a stablecoin, it couldn’t be used as a hedge. It probably wouldn’t see the high volume of trading it does currently.
The purpose of stablecoins is for investors and traders to park their bucks in a much less-volatile cryptocurrency product. Stablecoins allow you to gain the benefits of investing in a stable asset without actually forking that amount over to a government entity or financial scheme you don’t believe in. Stablecoins also give you a nice place to park your cash before deploying it into a different investment.
These are stablecoins secured by smart contracts on the blockchain, minting new stablecoins when the underlying crypto experiences volatility (or burning the coins if it swings the opposite way).
- Superintendent Adrienne A. Harris Announces New DFS Regulatory Guidance On The Issuance Of U.S. Dollar-Backed Stablecoins. (2022). Department of Financial Services.
- Tether’s USDT Stablecoin Drops 3% Below $1 Peg. (2022). CoinDesk.
- Transparency. (2023). Tether.
- Transparency & Stability. (2023). Circle.