What are stablecoins and why do we need them?

It doesn’t matter how long you have been in crypto, at some point or another, you most definitely stumble across the term #stablecoin - pretty sure you did so in the aftermath of the Terra/Luna meltdown that took part in May and which effects are still to be felt (more about that here).

What are the USPs of stablecoins?

In this piece about Circle and the USDC stablecoin, the author, Packy McCormick does a great job of distilling the major USPs of stablecoins and why they are a killer use case for #DLT. It also illustrates the reasons, why we need all that #blockchain hoo-ha after all and can’t simply rely on the current banking system/a fancy fin-tech app. Here they are:?

?? “crypto gives physical properties to digital assets”

Big quote by Mr. McCormick to start the list. While it is obvious if I hand you a dollar, that you have the dollar and I don’t since it cannot physically exist in two places at the same time, it is not so straightforward for digital assets because what you are actually sending is a copy not the original. Maybe not so bad for your favorite cat picture, really bad however for money (aka. the double spend problem, which was first really solved by Bitcoin and the underlying blockchain technology)?

?? Programmable

You can program your money to be able to do certain things automatically via smart contracts.

?? Permissionless

Like sending emails, all you need is an address to send the money to - no gatekeepers or middle man, think of your typical cash transaction: from one hand directly to the other.

?? Borderless

Bye-bye ‘international wire’ - public blockchains are the new rails that are open 24/7 all around the globe.

?? Low-cost

To be fair, this depends on which chain you’re transaction but with fewer middle-man, fewer parties want a cut of your transaction.

?? Fast settlement

Again, it depends on the chain you’re using, but no more settlement banks or T+2 (trade plus two days) or opening hours since blockchain networks run 24/7.?

?? Interoperable

Think of ‘Money Legos’ - building blocks that can be used together to build new applications or services. This is also often referred to as composability.?

Well in a world that is becoming increasingly digital and global, given these characteristics, it seems quite obvious why we need stablecoins afterall.

That was quite the list, huh? Well, there’s another one coming your way.

Not all Stablecoins are created equal

There are three main different types of stablecoins, which can be roughly categorized by the asset collateralizing them - as always with complex topics, lines tend to blur between categories. For the sake of simplicity, let’s however roll with these. Again, Patty McCormick provides a useful overview of the categories, which we’ll touch upon briefly:

1. Fiat-backed (e.g. USDC)

As the name suggests, these stablecoins are backed by Fiat currency such as the USD or the EUR. The issuing entity promises to have 1 USD (in the form of cash or US Treasury Bills) in its’ reserve for every 1 USDC it issues into circulation.

2. Crypto-backed (e.g. DAI)

These stablecoins are backed by a basket of cryptocurrencies. The most prominent one is DAI by MakerDAO (which was DeFi before DeFi even existed). In most cases, these stablecoins are overcollateralized, which means that for every 1 USD in circulation, a higher amount needs to be in the reserve. It has to be noted that DAI is most often referred to an algorithmic stablecoin due to how its’ peg is maintained (s. below)

3. Algorithmic

The peg of the stablecoin or rather its’ stability (e.g. liquidations for borrowers) is most often done automatically through smart contracts. The main differentiator between e.g. DAI and UST really boils down to whether the collateral is exogenous (DAI) or endogenous (e.g. LUNA/UST) to the protocol.

Reading the above, one could argue that there actually are only two types of stables: the ones backed by exogenous collateral (no matter if fiat, crypto, or baseball cards) and the ones backed by endogenous collateral. These can then be further categorized by whether the protocol or issuing party is governed centralized or decentralized.

The team behind a16z put together a nice, brief piece that dissects algorithmic stablecoins even further. You can check it out here.

Too good to be true?

Before we end this post, we need to talk about some risks too:

• No middlemen, no customer support: if you send your assets to the wrong address, they are gone unless that party willingly sends it back or you know for whatever crazy reason who’s behind the respective address and can reach out to them.
• Forgotten, lost, or stolen seed phrase: assets are gone. Your mnemonic seed phrase (usually 12 to 24 words) is the most important thing as they are used to create your private key - whoever has access to the mnemonic, ultimately has access to your funds. Unfortunately, some folks had to learn this the hard way during a recent wallet breach on Solana (more on this here).

As the great Ben Parker said:

With great power comes great responsibility.

Crypto/blockchain gives you that power. Use it wisely - best use a non-custodial hardware/cold wallet for everything you do. You can learn more about that on our blog.

Now while this sounds all bad and scary, solutions to these risks are being worked on as you read this post (e.g. social recovery or multi-sigs, etc.)

Now it’s up to you - what’s your take?

?? Would you be willing to have all your ‘credit card’ history on-chain, hence fully transparent and publicly accessible?

?? Do you think that big players such as Circle will integrate some privacy mechanisms - at least for smaller payments?

?? What type of stablecoin do you think will prevail and why?

Speaking of privacy tokens, Tornado Cash has recently been sanctioned by the US - interesting to see how that unfolds, what’s your take here?

While Circles’ & its’ founders’ background story, as well as their path forward to becoming a global platform, are very interesting, to say the least, we leave it up to you to go read through the entire post - we highly recommend to do so as there is a lot to unpack!