Stablecoin

Last updated

A stablecoin is a type of cryptocurrency where the value of the digital asset is supposed to be pegged to a reference asset, which is either fiat money, exchange-traded commodities (such as precious metals or industrial metals), or another cryptocurrency. [1]

Contents

In theory, 1:1 backing by a reference asset could make a stablecoin value track the value of the peg and not be subject to the radical changes in value common in the market for many digital assets. [2] In practice, however, stablecoin issuers have yet to be proven to maintain adequate reserves to support a stable value and there have been a number of failures with investors losing the entirety of the (fiat currency) value of their holdings.

Background

Stablecoins have several purported purposes. They can be used for payments and are more likely to retain value than highly volatile cryptocurrencies. In practice, many stablecoins have failed to retain their "stable" value.[ citation needed ]

Stablecoins are typically non-interest bearing and therefore do not provide interest returns to the holder.[ citation needed ]

Reserve-backed stablecoins

Reserve-backed stablecoins are digital assets that are stabilized by other assets. [2] Furthermore, such coins, assuming they are managed in good faith and have a mechanism for redeeming the asset(s) backing them, are unlikely to drop below the value of the underlying physical asset, due to arbitrage. However, in practice, few, if any, stablecoins meet these assumptions.

Backed stablecoins are subject to the same volatility and risk associated with the backing asset. If the backed stablecoin is backed in a decentralized manner, they are relatively safe from predation, but if there is a central vault, it may be robbed or suffer loss of confidence.

Fiat-backed

The value of stablecoins of this type is based on the value of the backing currency, which is held by a third party–regulated financial entity. Fiat-backed stablecoins can be traded on exchanges and are redeemable from the issuer. The stability of the stablecoin is equivalent to the cost of maintaining the backing reserve and the cost of legal compliance, licenses, auditors, and the business infrastructure required by the regulator.

In this setting, the trust in the custodian of the backing asset is crucial for the stability of the stablecoin's price. If the issuer of the stablecoin does not actually possess the fiat necessary to make exchanges, the stablecoin can quickly lose value and become worthless.

The most popular stablecoin, Tether, initially claimed to be fully backed by fiat currency; this was proven to be untrue, and Tether was fined $41 million by the Commodity Futures Trading Commission for deceiving consumers. [3] Instead, Tether only had enough fiat reserve to guarantee 27.6% of their stablecoin. Nevertheless, Tether still remains widely used.

Cryptocurrencies backed by fiat currency are the most common and were the first type of stablecoins on the market.[ citation needed ] Their characteristics are:

Examples: TrueUSD (TUSD), [4] USD Tether (USDT), [5] USD Coin,[ citation needed ] Monerium EURe. [6]

In January 2023, National Australia Bank (not Australia's central bank) announced that it would create by mid-2023 an Australian Dollar fiat-backed stablecoin called the AUDN, for streamlining cross-border banking transactions and trading carbon credits. [7]

Commodity-backed

The main characteristics of commodity-backed stablecoins are:

Holders of commodity-backed stablecoins can redeem their stablecoins at the conversion rate to take possession of the backing assets under whatever rules as to timing and amount are in place at the time of redemption. Maintaining the stability of the stablecoin is the cost of storing and protecting the commodity backing.[ citation needed ]

Cryptocurrency-backed

Cryptocurrency-backed stablecoins are issued with cryptocurrencies as collateral, conceptually similar to fiat-backed stablecoins. However, the significant difference between the two designs is that while fiat collateralization typically happens off the blockchain, the cryptocurrency or crypto asset used to back this type of stablecoins is done on the blockchain, using smart contracts in a more decentralized fashion. In many cases, these allow users to take out a loan against a smart contract via locking up collateral, making it more worthwhile to pay off their debt should the stablecoin ever decrease in value. In addition, to prevent sudden crashes, a user who takes out a loan may be liquidated by the smart contract should their collateral decrease too close to the value of their withdrawal.

Significant features of crypto backed stablecoins are:

The technical implementation of this type of stablecoins is more complex and varied than that of the fiat-collateralized kind, which introduces a greater risk of exploits due to bugs in the smart contract code. With the tethering done on-chain, it is not subject to third-party regulation creating a decentralized solution. The potentially problematic aspect of this type of stablecoins is the change in the value of the collateral and the reliance on supplementary instruments. The complexity and non-direct backing of the stablecoin may deter usage, as it may take time to comprehend how the price is ensured. Due to the highly volatile and convergent cryptocurrency market, substantial collateral must also be maintained to ensure stability.

Live stablecoins projects of this type are Havven (the pair: nUSD – stablecoin and HAV – the collateral-backed nUSD), [8] DAI (pair: CDP – Collateralized Debt Position and MKR – governance token used to control the supply) [9] and others. There is also Wrapped Bitcoin (WBTC), see BitGo.

Seigniorage-style/algorithmic stablecoins (not backed)

Seigniorage-style coins, also known as algorithmic stablecoins, utilize algorithms to control the stablecoin's money supply, similar to a central bank's approach to printing and destroying currency. Seigniorage-based stablecoins are a less popular form of stablecoin. [10]

Algorithmic stablecoins are a type of stablecoin intended to hold a stable value over the long term because of particular computer algorithms and game theory rather than a peg to a reserve asset. [11] In practice, some algorithmic stablecoins have yet to maintain price stability. For example, the "UST" asset on the Terra blockchain was theoretically supported by a reserve asset called "Luna", and plummeted in value in May 2022. Wired magazine said, "The Ponzinomics were just too obvious: When you pay money for nothing, and stash your nothing in a protocol with the expectation that it will give you a 20 percent yield—all you end up with is 20 percent of nothing." [11]

Significant features of seigniorage-style stablecoins are: [10]

Basis was one example of a seigniorage-style coin. [10]

TerraUSD (UST), created by Do Kwon, was meant to maintain a 1:1 peg with the United States dollar. [12] Instead of being backed by dollars, UST was designed to keep its peg through a complex system connected with another Terra network token, Terra (LUNA). [13] In May 2022 UST broke its peg with its price plunging to 10 cents, [14] while LUNA fell to "virtually zero", down from an all-time high of $119.51. [15] The collapse wiped out almost $45 billion of market capitalization over the course of a week. [16]

On 13 June 2022, Tron's algorithmic stablecoin, USDD, lost its peg to the US Dollar. [17]

Possible advantages

The Bank of International Settlements lists the possible merits of the subject as enhancement of anti-money laundering efforts, operational resilience, customer data protection, financial inclusion, tax compliance, and cybersecurity. [18]

Risks and criticisms

Lack of regulation

Nellie Liang, Under Secretary of the Treasury for Domestic Finance reported to the Senate banking committee that the rapid growth of the stablecoin market capitalization and its potential for financial services innovation require urgent congressional regulation. [19]

Lack of transparency

Tether is currently the world's largest market capitalization stablecoin. It has been accused of failing to produce audits for reserves used to collateralize the quantity of minted USDT stablecoin. [20] Tether has since issued assurance reports on USDT backing, although some speculation persists. [21]

De-pegging

Many projects can advance a product and call it a stablecoin. Thus, despite the name, many stablecoins have historically needed more stability because digital assets can be built to many different standards. Stablecoins such as TerraUSD, USDD, DEI and others crashed to zero in 2022 alone.[ citation needed ]

Other concerns

Griffin and Shams' research attributed the creation of unbacked USDT to the rise in Bitcoin's price in 2017. [22] Following that, research indicated little to no evidence that Tether USD minting events influenced Bitcoin values unless they were publicized to the public by Whale Alert. [23] [24] [25]

Failed and abandoned stablecoin projects

A number of stablecoins have crashed or lost their peg. For example:

Related Research Articles

<span class="mw-page-title-main">Digital currency</span> Currency stored on electronic systems

Digital currency is any currency, money, or money-like asset that is primarily managed, stored or exchanged on digital computer systems, especially over the internet. Types of digital currencies include cryptocurrency, virtual currency and central bank digital currency. Digital currency may be recorded on a distributed database on the internet, a centralized electronic computer database owned by a company or bank, within digital files or even on a stored-value card.

<span class="mw-page-title-main">Cryptocurrency</span> Digital currency not reliant on a central authority

A cryptocurrency, crypto-currency, or crypto is a digital currency designed to work as a medium of exchange through a computer network that is not reliant on any central authority, such as a government or bank, to uphold or maintain it.

Circle is a peer-to-peer payments technology company that now manages stablecoin USDC, a cryptocurrency the value of which is pegged to the U.S. dollar. It was founded by Jeremy Allaire and Sean Neville in October 2013. Circle is headquartered in Boston, Massachusetts. USDC, the second largest stablecoin worldwide, is designed to hold at or near a stable price of $1. The majority of its stablecoin collateral is held in short-term U.S. government securities.

Gemini Trust Company, LLC (Gemini) is an American cryptocurrency exchange and custodian bank. It was founded in 2014 by Cameron and Tyler Winklevoss.

Bitfinex is a cryptocurrency exchange owned and operated by iFinex Inc, and is registered in the British Virgin Islands. Bitfinex was founded in 2012. It was originally a peer-to-peer Bitcoin exchange, and later added support for other cryptocurrencies.

Tether is a cryptocurrency stablecoin, launched by the company Tether Limited Inc. in 2014. As of January 2024, Tether's website lists fourteen protocols and blockchains on which Tether has been minted.

A cryptocurrency bubble is a phenomenon where the market increasingly considers the going price of cryptocurrency assets to be inflated against their hypothetical value. The history of cryptocurrency has been marked by several speculative bubbles.

Binance Holdings Ltd., branded Binance, is a global company that operates the largest cryptocurrency exchange in terms of daily trading volume of cryptocurrencies. Binance was founded in 2017 by Changpeng Zhao, a developer who had previously created high-frequency trading software. Binance was initially based in China, then moved to Japan shortly before the Chinese government restricted cryptocurrency companies. Binance subsequently left Japan for Malta and currently has no official company headquarters.

USD Coin (USDC) is a digital stablecoin pegged to the United States dollar. USD Coin is managed by Circle. USDC is issued by a private entity and should not be confused with a central bank digital currency (CBDC).

Paxos Trust Company is a New York–based financial institution and technology company specializing in blockchain. The company's product offerings include a cryptocurrency brokerage service, asset tokenization services, and settlement services. ItBit, a bitcoin exchange run by Paxos, was the first bitcoin exchange to be licensed by the New York State Department of Financial Services, granting the company the ability to be the custodian and exchange for customers in the United States.

Decentralized finance offers financial instruments without relying on intermediaries such as brokerages, exchanges, or banks by using smart contracts on a blockchain, mainly Ethereum. DeFi platforms allow people to lend or borrow funds from others, speculate on price movements on assets using derivatives, trade cryptocurrencies, insure against risks, and earn interest in savings-like accounts. DeFi uses a layered architecture and highly composable building blocks. Some applications promote high-interest rates but are subject to high risk. Coding errors and hacks have been common in DeFi.

<span class="mw-page-title-main">Dai (cryptocurrency)</span> Stablecoin cryptocurrency

Dai is a stablecoin token on the Ethereum blockchain whose value is kept as close to one United States dollar as possible by decentralized parties incentivized by smart contracts to perform actions that affect the token's supply and therefore its price. Dai is maintained and regulated by MakerDAO, a decentralized autonomous organization composed of the owners of its governance token, MKR, who may propose and vote on changes to certain parameters in its smart contracts.

Hodlnaut is a Singapore-based cryptocurrency lending and borrowing platform that lost 69% of the cryptocurrencies that users deposited onto the platform.

<span class="mw-page-title-main">Solana (blockchain platform)</span> Public blockchain platform

Solana is a blockchain platform which uses a proof-of-stake mechanism to provide smart contract functionality. Its native cryptocurrency is SOL.

The general notion of cryptocurrencies in Europe denotes the processes of legislative regulation, distribution, circulation, and storage of cryptocurrencies in Europe. In April 2023, the EU Parliament passed the Markets in Crypto Act (MiCA) unified legal framework for crypto-assets within the European Union.

<span class="mw-page-title-main">Do Kwon</span> South Korean cryptocurrency fraudster (born 1991)

Kwon Do-Hyung, more commonly known as Do Kwon, is a South Korean former businessman and software engineer. He was the co-founder and CEO of Terraform Labs, the parent company of crashed stablecoin TerraUSD and cryptocurrency Luna. TerraUSD and Luna collapsed in May 2022, wiping out almost $45 billion market capitalization in one week and causing hundreds of billions in losses in the larger crypto market. Kwon faces legal and social pressure regarding his role in the Terra crash. Citizens from various jurisdictions — including South Korea, Singapore, and the United States — are taking legal action against Kwon. On 23 March 2023, Kwon was arrested in Montenegro, while attempting to travel to Dubai using falsified documents. Following his arrest, he was charged by a US federal grand jury of eight counts, including securities fraud, commodities fraud, wire fraud, and conspiracy.

Terra is a blockchain protocol and payment platform used for algorithmic stablecoins. The project was created in 2018 by Terraform Labs, a startup co-founded by Do Kwon and Daniel Shin. It was best known for its Terra stablecoin and the associated Luna reserve asset cryptocurrency.

Three Arrows Capital was a Singapore-based cryptocurrency hedge fund which was ordered to liquidate on 27 June 2022 by a court in the British Virgin Islands. It was founded in 2012 by Kyle Davies and Su Zhu. The company borrowed billions of dollars to fund its trading, and according to July 2022 bankruptcy filings, faces $3.5 billion in creditors' claims. The fund appears to have lost in excess of $3 billion over 2021 and 2022, making its collapse one of the largest hedge-fund trading losses of all time.

The Aave Protocol is an open-source, decentralized finance (DeFi) protocol built on the Ethereum blockchain and released in 2020. It is one of the largest cryptocurrency liquidity protocols. The Aave Protocol uses smart contracts to automate processes, including distributing funds and handling collateral.

References

  1. ↑ "Rise of Crypto Market's Quiet Giants Has Big Market Implications". Bloomberg.com. 19 March 2021. Archived from the original on 2021-11-26. Retrieved 2021-04-18.
  2. 1 2 "Stable Coin Backed by Circle, Coinbase Draws Most Early Demand". Bloomberg.com. 29 October 2018. Archived from the original on 2020-06-06. Retrieved 2021-04-18.
  3. ↑ "CFTC Orders Tether and Bitfinex to Pay Fines Totaling $42.5 Million | CFTC".
  4. ↑ "Why Facebook Chose Stablecoins as Its Path to Crypto". Bloomberg. January 27, 2019. Archived from the original on November 27, 2021. Retrieved August 30, 2019.
  5. ↑ Tether. "Tether: Fiat currencies on the Bitcoin blockchain" (PDF). Tether: Fiat Currencies on the Bitcoin Blockchain: 7. Archived (PDF) from the original on 2022-01-26. Retrieved 2018-10-23.
  6. ↑ Liao, Rita (2023-07-17). "Gnosis launches Visa card that lets you spend self-custody crypto in Europe, soon US and Hong Kong". TechCrunch. Retrieved 2023-08-27.
  7. ↑ "National Australia Bank joins stablecoin bandwagon, to launch fiat-backed digital currency by mid-2023". India Today . 19 January 2023. Archived from the original on 20 January 2023. Retrieved 20 January 2023.
  8. ↑ Brooks, Samuel; Jurisevic, Anton; Spain, Michael; Warwick, Kain (2018-06-11). "A decentralised payment network and stablecoin" (PDF). A Decentralised Payment Network and Stablecoin V0.8: 6–9. Archived from the original (PDF) on 2018-11-19. Retrieved 2018-10-23.
  9. ↑ "The Dai Stablecoin System". Archived from the original on 2018-10-24. Retrieved 2018-10-23.
  10. 1 2 3 Memon, Bilal (23 August 2018). "Guide to Stablecoin: Types of Stablecoins & Its Importance". Archived from the original on 23 October 2018. Retrieved 22 Oct 2018.
  11. 1 2 Volpicelli, Gian M. (12 May 2022). "Terra's Crypto Meltdown Was Inevitable". Wired. Archived from the original on 1 January 2023. Retrieved 19 January 2023.
  12. ↑ "Controversial stablecoin UST — which is meant to be pegged to the dollar — plummets below 50 cents". CNBC . 11 May 2022. Archived from the original on 11 May 2022. Retrieved 11 May 2022.
  13. ↑ "Yellen cites UST stablecoin risk after it loses its dollar peg". Protocol. 10 May 2022. Archived from the original on 13 May 2022. Retrieved 11 May 2022.
  14. ↑ "The crypto crash rivals both the internet bubble burst and the Great Financial Crisis, Bank of America says". Fortune . Archived from the original on 16 May 2022. Retrieved 16 May 2022.
  15. ↑ "Terraform Again Halts Blockchain Behind UST Stablecoin, Luna". Bloomberg News . 13 May 2022. Archived from the original on 13 May 2022. Retrieved 13 May 2022.
  16. ↑ "Terra $45 Billion Face Plant Creates Crowd of Crypto Losers". Bloomberg News . 14 May 2022. Archived from the original on 16 May 2022. Retrieved 15 May 2022.
  17. ↑ "Another algorithmic stablecoin loses its peg as Tron's USDD falls, with founder Justin Sun vowing to deploy $2 billion". Fortune. Archived from the original on 2022-06-15. Retrieved 2022-06-14.
  18. ↑ G7Working Group on Stablecoins. Committee on Payments and Market Infrastructure. (18 October 2019). "CPMI Papers: Investigating the impact of global stablecoins". Bank of International Settlements website Archived 2021-01-16 at the Wayback Machine Retrieved 23 January 2021.
  19. ↑ Allyson Versprille and Jesse Hamilton. (8 February 2022). "Treasury Official Says the Need for Stablecoin Legislation Is ‘Urgent’". Bloomberg website Archived 2022-02-21 at the Wayback Machine Retrieved 21 February 2022.
  20. ↑ Faux, Zeke (7 October 2021). "Anyone Seen Tether's Billions?". Bloomberg . Archived from the original on 7 October 2021. Retrieved 9 August 2021.
  21. ↑ Emily, Nicolle (27 July 2022). "Tether Says There Is No Chinese Commercial Paper Among Its Reserves". Bloomberg . Archived from the original on 21 January 2023. Retrieved 9 August 2022.
  22. ↑ Griffin, John M.; Shams, Amin (15 June 2020). "Is Bitcoin Really Untethered?". The Journal of Finance. 75 (4): 1913–1964. doi: 10.1111/jofi.12903 . ISSN   0022-1082. S2CID   229576274.
  23. ↑ Saggu, A (1 October 2022). "The Intraday Bitcoin Response to Tether Minting and Burning Events: Asymmetry, Investor Sentiment, and "Whale Alerts" on Twitter". Finance Research Letters. 49: 103096. doi:10.1016/j.frl.2022.103096. ISSN   1544-6123. S2CID   250082279.
  24. ↑ Lyons, Richard K.; Viswanath-Natraj, Ganesh (17 April 2020). "Stable coins don't inflate crypto markets". VoxEU.org. Archived from the original on 14 May 2022. Retrieved 2022-07-04.
  25. ↑ Cai, Justin (18 November 2019). "Data Analysis: Tether Manipulation Did Not Cause Bitcoin's 2017 Bull Run". Longhash Research. Archived from the original on 24 January 2021. Retrieved 18 July 2022.
  26. ↑ "Cryptocurrency project Basis to shut down and return funding to investors". Reuters . 13 Dec 2018. Archived from the original on 30 December 2018. Retrieved 30 Dec 2018.
  27. ↑ Denton, Jack. "How a Digital Token Designed to be Stable Fueled a Crypto Crash". www.barrons.com. Archived from the original on 12 May 2022. Retrieved 12 May 2022.
  28. ↑ "Turmoil and panic in crypto market as 'stablecoin' slump prompts wider collapse". the Guardian. 12 May 2022. Archived from the original on 12 May 2022. Retrieved 12 May 2022.
  29. ↑ "South Korean founder of failed cryptocurrency Terra denies he is 'on the run'". the Guardian. Agence France-Presse. 18 September 2022. Archived from the original on 19 September 2022. Retrieved 19 September 2022.
  30. ↑ "South Korean prosecutors ask Interpol to issue red notice for Do Kwon". Financial Times. 19 September 2022. Archived from the original on 19 September 2022. Retrieved 19 September 2022.
This page is based on this Wikipedia article
Text is available under the CC BY-SA 4.0 license; additional terms may apply.
Images, videos and audio are available under their respective licenses.