Stablecoins Masterclass
The Relevance of Stablecoins
The term cryptocurrency is all-encompassing, and according to CoinMarketCap, there are 20,268 unique cryptocurrencies. Almost half of those are “dead coins,” leaving roughly 10,900 active coins remaining. Dead coins are given that title once identified as scams; no one uses it or trades it, development has stopped, it’s worthless, and for various other reasons. Three coins make up the remaining 10,900+ coins.
Altcoins
All types of cryptocurrencies that are not Bitcoin (BTC) and, for some people, Ethereum (ETH)
Bitcoin
Founder of the industry.
Tokens
Digital assets belong to the blockchain they’re built upon and defined by the project or smart contract.
Types of Altcoins
Any coin other than Bitcoin (BTC) is an altcoin. As of July 2022, according to CoinSwitch, Bitcoin made up nearly 50% of the market, followed by Ethereum, which accounted for roughly 20%, while the remaining 30% belonged to altcoins. The purpose behind altcoins is to build and improve upon Bitcoin or to overcome a problem Bitcoin hasn’t addressed. For example, Litecoin has a different goal than BTC. Not all altcoins are valuable or sound, but many are in terms of functionality and utility. One of the biggest problems altcoins are trying to solve is the not-so-environmentally friendly Proof-of-Work (POW) mechanism. Altcoins usually try to be green, using staking or a Proof-of-Stake consensus mechanism.
Whether the altcoin is worth thousands of dollars or a fraction of a penny, they can be pooled into the following categories:
Memecoins: Historically, these were created because of a viral-internet meme or some other humorous character. Elon Musk brought meme coins to light through his tweets about DOGE. Characteristics of meme coins typically have a massive coin supply or an unlimited coin supply.
Security Tokens
Likely the least familiar altcoin, security tokens are used when recording ownership stakes. The blockchain makes this possible due to the inability to erase or alter records.
Utility Tokens
These altcoins have special use cases and only operate within a specific unique ecosystem.
Governance Tokens
A specific type of utility token enables users to purchase certain voting rights giving users the ability to impact blockchain ecosystems.
Stablecoins
Cryptocurrencies are coins pegged to the value of a FIAT currency or any reference asset.
The first stablecoin, “Tether,” was developed in 2014, and many other stablecoins model themselves after it. Users receive one token for every dollar they spend; theoretically, the tokens can be converted back to the original currency at any time. *1
Why Stablecoins matter
Historically, stablecoins were used to buy other cryptocurrencies, like Bitcoin, because many exchanges couldn’t access traditional banking methods. Unlike government-issued currencies, stablecoins can be used 24 hours a day, seven days a week, anywhere in the world without relying on banks; money transfers take seconds to complete.
Arguably the most crucial core function of stablecoins is their ability to work with smart contracts on blockchains. No legal go-between is necessary, unlike conventional contracts. The terms of the smart contract automatically dictate the terms of how and when the money is transferred. Dollars can’t be programmed.
Defi and Stablecoins
Decentralized finance replicates traditional financial products and services using smart contracts and decentralized protocols on a blockchain. Anyone with an internet connection can access essential financial services like lending, investing, and borrowing without needing a financial advisor or intermediary.
“Defi provides internet-native alternatives to popular financial services in the form of decentralized protocols on a blockchain. Essentially, anyone with an internet connection can participate in the global financial system, even if they don’t have a bank account.” *2
—Jeremy Allaire, Circle CEO
More and more, stablecoins are becoming an option for avoiding inflationary fiat currencies like the ones we covered in previous courses. Here are a few real-world examples:
In January 2021, the people of Brazil began buying USD-denominated stablecoins instead of the Brazilian real, which was worth very little compared to the USD at that time. Due to the widespread adoption of crypto throughout Brazil, major crypto exchanges like Coinbase, crypto.com, tesla-coin.io, and many others are interested in Brazil. According to recent data, there is a direct correlation between the adoption rate of crypto in Brazil and their inflation rate of 10% in 2021.
People living under oppressive regimes, like those in Ukraine under Russia’s attack during the war in Ukraine, turned to cryptocurrency when the banks shut down ATMs and access to financial institutions. Tether has become so valuable in Ukraine that it can trade as high as $1.10 and is designed to always peg at $1.00.
Russians are flocking to stablecoins as well. As the world united against Russia with sanctions and other measures, Russians began ditching the ruble for stablecoins. Confidence in the use of cryptocurrency is gaining traction. The world has watched as Ukraine and Russia conflict illustrated how powerful government overreach can be and how freeing cryptocurrency is. Stablecoins saved many lives.
Different Types of Stablecoins
In the crypto world, stablecoins are the only asset with some predictability. Different stablecoins have their dynamics, benefits, and drawbacks depending on their category. There are four main types of stablecoins:
Fiat-Backed Stablecoins
Cryptocurrencies are pegged to the value of real-world currencies such as the US dollar or euro. Most fiat-backed stablecoins are backed in a 1:1 ratio. For example, USD Coin (USDC) is a stablecoin backed in a 1:1 ratio to the US dollar, meaning one USDC is equivalent to one dollar. So, for every USDC that goes into circulation, one US dollar is kept in reserve. *3
Crypto-Backed Stablecoins
As the name suggests, crypto-backed stablecoins are backed by cryptocurrencies; this may seem a little oxymoronic, but they don’t use a 1:1 peg. Instead, crypto-backed stablecoins are typically over-collateralized to compensate for the likelihood that the collateral used will experience a price change. Often known as a “security pledge.” *3
Take Dai (DAI), for example. This stablecoin can be borrowed from the MakerDAO lending platform if the borrower deposits some crypto collateral. Now, users can use ETH, BAT, COMP, and USDC. Anyone wanting to borrow DAI must deposit more crypto or collateral than they’re taking out. And, if their collateral loses too much value while it’s deposited, they may have to liquidate it and return the borrowed DAI. *3
Commodity-Backed Stablecoins
These are cryptocurrencies backed by real-world, physical commodities such as gold, silver, oil, and sometimes real estate that appeal to people who want to invest in precious materials but find it challenging to get their hands on them.
Algorithmic Stablecoins
One could argue that before 2022 the masses didn’t widely know what an algorithmic stablecoin was. Luna and TerraUSD are responsible for putting algorithmic stablecoins in the spotlight. During May and June, following the
onset of the war in Ukraine, major events led to investors dumping their UST, which caused a massive surge in supply. Typically, after the collection of a coin skyrocket, the value plummets, and this is what caused the price of Luna to crash.
Stablecoins and the future
Unlike most other cryptocurrencies, stablecoins offer investors lower levels of volatility. Stablecoins can and have crashed before, but it’s still much less likely to occur for stablecoins than traditional crypto.
US dollar stablecoins have grown in popularity and have a market capitalization of $155 billion; this is substantial, and a trend many experts believe will continue. One reference method is the Eurodollar market, which increased from $1.7 trillion in 1985 to $13.8 trillion in 2016 (JP Morgan). *4
As seen in Ukraine and Brazil, the people who could benefit most from this are the less fortunate. Experts believe the stablecoin payment infrastructure will become embedded across continents in the next 18 months. Many governments are already working towards some form of regulation.
