Stablecoins are cryptocurrencies specifically designed to minimize volatility and maintain a stable value. To achieve this, they use a traditional financial asset as a reference and establish a “target value” – denominated in the units of the latter – which usually corresponds to a 1:1 ratio.
The traditional financial asset used as a reference by stablecoins can be a single fiat currency, a combination or basket of different currencies, or even a physical commodity traded on exchanges, such as gold and other precious metals. Thus, a stablecoin that uses the US$ as a reference asset and emulates its price based on a 1:1 ratio will aim to maintain a constant value of $1.
The main objective of stablecoins is to escape the speculative nature of most cryptocurrencies, to generate a more predictable and consistent market environment. To this day, Bitcoin remains the most popular asset and the one that generates the highest trading volume, but its high volatility prevents it from being adopted for certain use cases – everyone remembers the anecdote of Laszlo Hanyecz, who would once pay 10,000 BTC for two pizzas, which is currently equivalent to $70 million. Precedents of this kind are palpable proof that conventional cryptocurrencies are not ready – at least in the short term, as long as such extreme volatility is not attenuated – to be used outside the realm of trading and financial investments.
And this is because, if we look at the example of legal tender currencies, they usually act as a medium of exchange, the unit of account, and store of value – which implies that their price should be relatively stable in the long term. It is not surprising, therefore, that citizens who lose confidence in their national currency – because they believe it will not be able to retain its purchasing power in the future – tend to seek refuge in the currencies of other countries with stronger economies – or monetary policies.
Cryptocurrencies will only start to be used on a day-to-day basis if they can act as a store of value and are accompanied by a minimal level of inflation – albeit high enough to promote spending rather than accumulation encouraged by potential future appreciation. Stablecoins are ideal in this regard because they achieve both in an organic way.
We could say that part of the success that stablecoins have enjoyed lately is because they combine the best of both worlds: on the one hand, they preserve the privacy, immediacy, and global reach of cryptocurrencies; and on the other, the lack of volatility -the stability- of fiat currencies.
By far the stablecoins that have experienced the highest level of demand are those pegged to the dollar – not surprising, given the scarcity of the US currency in off-shore markets, which has led many to believe that Ethereum could end up becoming a real hub for shadow banking.
History of stablecoins
Since 2014, different types of stablecoins have been launched on the market, each with its particularities -especially, regarding the collateralization system and the anchoring mechanism they employ. The first of these -BitUSD and NuBits- would be based on a collateralization system using other cryptocurrencies -instead of using, for example, fiat currency deposits in a bank.
BitUSD launched on July 21, 2014, on the BitShares blockchain, would be the pioneer. Conceived by two leading figures in the crypto arena – Dan Larimer, later founder of EOS, and Charles Hoskinson, who would eventually launch the Cardano platform – BitUSD was offered as a potential hedge against the wild volatility characteristic of conventional cryptocurrencies.
BitUSD was backed and collateralized by crypto – specifically by BTS, Bitshares’ native token, deposited in a smart contract. The project would enjoy some predictability, but by the end of 2018 it would fall out of favor as it lost its anchor to the US$ – currently, the coin fluctuates around 80 cents to the dollar.
Shortly after the launch of BitUSD, in September 2014, NuBits – the first algorithmic stablecoin – would appear. NuBits had its hybrid Proof of Work/Proof of Stake blockchain – a fork of Peercoin – and would use an elastic bidding model along with a controversial governance system called Seigniorage Shares – what we could translate as seigniorage shares.
This would translate into a dual system: with a governance token called NuShares – with a fixed monetary mass – and NuBits – the stablecoin itself. NuShares holders would be in charge of deciding the number of new NuBits to be minted and delivered to custodians -who would place long sell orders when the price exceeded $1-, as well as setting the interest rate to be received by those willing to hold the coin when it fell below $1.
Since its conception, NuBits would suffer two serious crashes – the first in 2016 and the last in 2018. That wouldn’t stop NuBits during the ICO bubble of 2017 when Bitcoin hit a price of $20,000, NuBits was trading at $1.2 – the 20 cent premium would be the result of voracious demand from BTC “holders” trying to sell their funds, to protect them from a more than likely correction after a historic rally. Currently, NuBits is trading at less than 6 cents on the dollar and its market capitalization barely reaches 1 million.
October 2014 would see the launch of RealCoin, a stablecoin collateralized through bank deposits, on the OMNI blockchain -formerly Mastercoin. The project would be conceived by Brock Pierce, Reeve Collins, and Craig Sellars, and would have as alleged headquarters the Isle of Man and Hong Kong. In November of that same year, a month after its launch, RealCoin would decide to change its name to Tether and would assume the ticker USDT -denominations by which it has been known ever since, and which have become true totems in the cryptocurrency sector.
With Tether, the concept of off-chain collateralized stablecoins – i.e., backed by bank deposits and not by other cryptocurrencies, as was the case with BitUSD – would take off. In 2015, Tether would disembark in Bitfinex -one of the most important exchanges in the world-, although at that time the corporate network that had been established between the two institutions was kept secret. Said entanglement would come to light in 2017, as a result of a lawsuit against Wells Fargo that would involve both Bitfinex and Tether.
Since then, the fact that Tether’s issuance is dependent on Bitfinex has been normalized, and both entities are considered part of the same business structure. However, controversy would never entirely leave them: in 2017, Bitfinex would suffer a $31 million hack, and to this would be added accusations of market manipulation – according to which, much of Bitcoin’s rally during the ICO bubble would be supported by an irregular issuance of Tethers.
The worst would come later that year, when rumors began to spread that Tether (USDT) was not 100% backed, i.e. on a 1:1 basis against the dollar, by bank deposits. After months of uncertainty, the stablecoin’s managers would admit that $850 million had been lost – representing 74% collateralization and making Tether, technically, a fractional reserve asset. To address the problem, Bitfinex would release a cryptocurrency called UNUS SED LEO, and use the funds raised to cover the hole in Tether’s accounts.
Despite all these scandals, and having sometimes fallen as low as $0.88 or revalued above $1.05, Tether has played a very prominent role in the popularization of stablecoins and, to this day, remains the reference asset for all those traders or investors who want to protect their portfolio during periods of high volatility. In March 2018, it was the only stablecoin in the top 30 cryptocurrency ranking by market capitalization.
Since then, many candidates to steal the podium from it have appeared, but as of today none of them overshadow it – at the moment Tether is the fourth-largest cryptocurrency by market cap, 9 times larger than USDC, the second-largest cryptocurrency. One of the most interesting aspects of Tether in recent times has been its migration process from the OMNI blockchain to Ethereum – currently, most of the USDT in circulation is hosted on the latter platform.
After the launch of RealCoin/Tether, in 2016, SteemUSD (SBD) would appear – a stablecoin linked to the dollar and intended to establish the rewards system of the blockchain-based social network Seemit. Steem Dollars or SBD would be subject to enormous volatility, reaching a price of $13.81 in December 2017 and eventually dropping below 60 cents in early 2020 – meaning that as far as “stability” is concerned, it has been rather a failure.
DAI, the MakerDAO stablecoin – one of the first Ethereum projects, founded by Rune Christensen in late 2014 and announced in 2015 – would not be launched until December 2017. But thanks to its features, it wouldn’t take long for it to become the cornerstone of the Defi ecosystem – which at the time, was still a very nascent phenomenon.
Christensen would draw inspiration for its creation from BitUSD and rescue the idea of using cryptocurrencies as collateral. Unlike Tether – which relied on opaque bank deposits that were subject to regulatory friction, threats of seizure, and blacklisting – DAI embodied the promise of a truly decentralized stablecoin – governed by a DAO – “trustless” – as it could be issued without the need for intermediaries or custodians – and resistant to censorship – by using unseizable assets as collateral.
The issuance of DAI would be based on the opening of collateralized debt positions -the famous CDPs-, which is the first version that would only admit ETH -with the launch of the Multicollateral DAI (MCD) in 2019, other assets such as BAT, USDC and wBTC would be incorporated. The primary users of CDPs would be those traders or investors eager to achieve long exposure to ETH – or one of the other forms of collateral supported in MCD. In other words, the IAD issued after opening the CDP would quickly go into circulation, being used primarily to buy new units of the same collateral that had been deposited to create it – which, in essence, would be like opening a long position on margin. One of the criticisms of this system is that the supply of IADs is decoupled from the effective demand for the currency – since it depends entirely on whether users are willing to open long positions with margin in any of the forms of collateral allowed.
These problems in terms of scalability have not prevented DAI from consolidating its position as a benchmark stablecoin in the Defi ecosystem, thanks to its enormous resilience, its large community of enthusiasts, and its ethos.
The next stage in the history of stablecoins would be marked by the emergence of numerous proposals based on the Tether model -collateralization through fiat deposits in banks-, which would be promoted mainly by exchanges. This would be the case of USD Coin -a stablecoin promoted by Circle and Coinbase, which has reached a market capitalization of more than 700 million dollars-, BUSD -the stablecoin of the Binance and Paxos exchange, with a capitalization of close to 200 million dollars-, and other smaller proposals such as those of OKCoin (USDK) and Huobi Group (HUSD). All these stablecoins have followed in the wake of Tether and have ended up deployed on the Ethereum blockchain as ERC20 tokens linked to the US dollar exchange rate – for obvious reasons, given that most of the Defi ecosystem is hosted on that platform.
Currently, there are more than 200 stablecoins on the market, although only a dozen of them show consistent transaction volumes and keep their code repositories up to date. Soon, Facebook is expected to launch its payment system based on the Libra cryptocurrency, and numerous central banks are expected to launch a new type of centralized stablecoins called CBDCs -Central Bank Digital Currencies-, which would be crypto versions of their national currencies. To this, we must add a whole batch of DAI competitors on the side of the more decentralized and censorship-resistant stablecoins. The latter include Liquality and MetaCoin – which is based on the concept of “reflex bonds” developed by Nikolai Mushegian, one of the original architects of MakerDAO.
Operation and use cases of stablecoins
To understand how stablecoins work, it is important to first look at the architecture of fiat money systems. These manage to stabilize their legal tender currencies through the use of bank reserves that act as a backstop, as well as interventions by the authorities in charge of designing and executing monetary policy – central banks. Central bank reserves act as a kind of collateral, meaning that fiat currencies are protected from volatility by being pegged to an underlying asset – usually other forex currencies or commodities such as gold.
Central bank intervention is essential when bank reserves fall or for whatever reason, the official currency is radically weakened or strengthened – as such volatility is detrimental to the country’s economy. To re-establish the stability of the currency, these authorities try to balance the supply and demand of the currency.
In previous articles, we have explained that most cryptocurrencies wield the scarcity of their money supply as one of their main attractions. The fact that the issuance rate cannot be manipulated -or at least not arbitrarily and expeditiously as in the case of fiat money-, and that these cryptocurrencies do not have reserves to act as collateral and support their value, means that they lack the two main tools that central banks have at their disposal to minimize volatility.
Stablecoins could be understood as a compromise between both worlds. On the one hand, they have a flexible money supply – capable of adjusting to market supply and demand – and have reserves that act as collateral and support their value; and on the other hand, they are decentralized, resistant to censorship, and – to a greater or lesser degree – “trustless” – i.e., they do not require intermediaries. The degree of “trustlessness” of a stablecoin will depend, however, on its typology: off-chain collateralized, on-chain collateralized, and algorithmic.
But before delving into the differences between these categories, let’s look at some use cases.
We have seen how many countries, with extremely weak national currencies or uncontrolled monetary stimulus policies, end up falling into hyperinflationary spirals – the most famous cases, in recent times, are probably those of Venezuela and Zimbabwe, although recently we have also seen the collapse of the national currencies of Lebanon and Iran. Often, citizens of these countries seeking to protect their savings choose to take refuge in the dollar – the de facto international reserve currency. The problem is that access to this off-shore dollar, in the places where it is most needed, is usually complicated – given that governments apply different types of exchange controls and restrictions to prevent their currencies from collapsing even further.
Given this scenario, the wide range of stablecoins that anchor their value to the U.S. currency – some have started calling them “crypto dollar” – could act as a very interesting alternative hedge. This would make Ethereum – the platform on which most of these stablecoins are deployed – the main international shadow banking hub. If the currency that ends up collapsing as a result of an unbridled expansionary policy is the dollar, alternatives to crypto dollars would have to be sought – a stablecoin linked to a basket of currencies? Or better yet, to an index?
Solutions for remittances and other international payments
While there are conventional cryptocurrency projects such as Ripple (XRP) specifically designed to address the issues of remittances and other types of international payments, more and more corporations – such as JP Morgan, Wells Fargo, and most recently Facebook with its Libra project – see stablecoins as a lucrative opportunity for the cross-border money transfer sector.
Sending cryptocurrencies has always been much faster, cheaper, and more efficient than using fiat alternatives such as the SWIFT system – in which the clearing and settlement process takes days, and involves numerous intermediaries who charge their respective fees. If the use of cryptocurrencies for international payments had not been widespread to date, it was mainly due to the considerable volatility to which they are subject – a problem that disappears with the emergence of stablecoins.
Sending remittances through conventional banks, payment applications such as PayPal or Venmo, or historical entities such as Western Union, suffers from the same problems mentioned above – costs, long processing times, the intervention of intermediaries. The use of stablecoins for transfers of this type eliminates the only problem associated with cryptocurrencies that until then represented a disadvantage compared to traditional alternatives – greater volatility, which entails a potential loss of value of the transferred asset.
Trading and lending instrument
One of the first areas in which a massive use of stablecoins would occur would be in cryptocurrency trading. For those traders who execute trades on exchanges daily trying to generate a profit, it is more useful to park their funds in a stable currency – once the trading day is over – than in volatile assets such as ETH or BTC.
In addition, stablecoins are ideal in scenarios where you want to preserve your position in an asset for the long term, but you think it is going to fall soon due to some negative news or event. Moving your funds into a stablecoin allows you to buy back the asset in question at a lower price – the crypto community often uses the expression “BTFD”, Buy the Fucking Dip – and thus expand your position.
It is no coincidence, then, that various stablecoins have become the most popular base pairs in numerous cryptocurrency exchanges – both in traditional centralized exchanges and in the DEXs of the Defi ecosystem.
And it is also not uncommon that in the numerous lending platforms that have emerged in the last couple of years – both centralized and Defi-like – stablecoins have become the most demanded assets – being the ones that pay a higher APR to depositors.
Decentralized applications (dApps) and other use cases
Among many other things, Ethereum is a blockchain platform that enables the deployment of decentralized applications – dApps – based on smart contracts. Such applications often require the execution of transactions, thus triggering the smart contracts that are responsible for providing the service. A stablecoin will always be, by its very nature stable, a much more practical payment method than a utility token with lower market capitalization/liquidity and higher volatility.
Another workhorse for Ethereum in general, and the Defi ecosystem in particular, is the tokenization of real-world assets – that is, representing them as NFT tokens – non-fungible tokens – on a blockchain. Real estate and works of art are two of the main categories of assets that can be tokenized. However, for such NFT token markets to become popular, it is much more useful to use a stablecoin as a unit of account or peer – as the high volatility of cryptocurrencies such as ETH or BTC does not make them ideal for this type of transaction.
Stablecoins could also become useful for recurring payments -such as salaries of workers in companies or organizations with workers spread across different countries, rents, subscriptions to services-, as well as for one-off payments for services that can be contacted over the Internet -immersed as we are in a “gig economy” that knows no borders.
Types of stablecoins
Off-chain collateralized stablecoins
Off-chain collateralized stablecoins are those whose value is backed by bank reserves of fiat money -mainly dollars- on a 1:1 ratio; or commodity deposits -crude oil, silver, gold- in institutions that act as custodians. Hence the off-chain concept, because real-world assets and, therefore, intermediaries intervene as collateral.
This type of stablecoins, therefore, will be less resistant to censorship and “trustless” than those that do not depend on custodians – the bank or commodity deposits that act as collateral can be seized, or certain addresses, together with their balances, can be blacklisted.
Despite this, such off-chain collateralized stablecoins have many advantages overpayment services such as Paypal, Venmo, or other digital banking applications – where dollars are still IOUs. For starters, the user has full control of his assets, so he can send them anywhere in the world without restrictions, quickly and very cheaply. No less important, many of the institutions issuing this type of tokens allow auditing in real-time the monetary mass of the tokens -which provides a series of extra guarantees.
Among the stablecoins of this type, we find such outstanding examples as Tether (USDT), USD Coin (USDC) -official stablecoin of Coinbase and Circle-, Binance USD (BUSD) -issued by Binance in association with Paxos-, True USD (TUSD), Paxos Standard (PAX) and Gemini Dollar (GUSD).
On-chain collateralized stablecoins
On-chain collateralized stablecoins are those that back their value using other cryptocurrencies. Since the cryptocurrency that functions as a reserve or collateral is likely to be highly volatile, these types of stablecoins require some degree of over-collateralization.
If each unit of a given stablecoin represents one dollar, and the level of over-collateralization that the stablecoin requires is 150%, this will mean that for every dollar in circulation there will be 1.5 dollars -at least- backing them. In short, this type of stablecoins will be issued as debt – or to be more precise, from collateralized debt positions.
The advantage of these stablecoins over the previous ones is that they have a high degree of resistance to censorship – since they do not depend on asset deposits in the real world, they cannot be seized -, decentralization and trustlessness – instead of intermediaries acting as custodians and managing the issue, the entire operation falls on smart contracts and governance processes via DAO.
The most prominent example of such stable currencies is DAI, from the MakerDAO protocol. To issue DAI, a user must open a 150% collateralized debt position -CDP- with ETH. The operation is automatically managed by smart contracts, while the parameters of collateralization, settlement, interest rates, and other fees are decided by the holders of the MKR governance token. One of the problems with these types of stablecoins is that they are not easily scalable models – they depend on there being significant demand for CDPs, which are generally used to open long positions in the underlying with leverage.
DAI is not the only on-chain collateralized stablecoin. Among those that implement a similar issuance mechanism we find BitUSD -it would be the dean stablecoin of this type, which DAI would take as a source of inspiration-, sUSD -stablecoin of the Synthetix protocol-, and some newer proposals that are not yet in production such as Liquidity (LQTY) and MetaCoin -which is based on a system called “reflex bonds”.
Uncollateralized stablecoins are those that do not use other assets -whether fiat money bank deposits, commodities, or other cryptocurrencies- as reserves to back their value. Instead, they adopt an algorithmic governance system programmed in the base code of the protocol -called Seigniorage Shares-, which is responsible, through increases or decreases in the money supply, for guaranteeing the anchor with the reference asset -for example the US$-, to stabilize the value.
In this sense, they use a strategy similar to that of central banks, with the difference that changes in the money supply are programmatic – they depend on a series of pre-established and self-executing parameters through smart contracts, and not on the discretion of central monetary authorities – and auditable in real-time – through the block explorer of the blockchain.
Among the most prominent projects of this type, we could highlight the stablecoin Basis -originally, Basecoin. The project would describe its monetary policy – governed by the protocol itself – like that of an “algorithmic central bank.” Basis’ approach to Seigniorage Shares would, however, be very particular, with three elements that, together, would be in charge of governing the protocol: basis tokens – the stablecoin itself -, bond tokens – created when the price falls below the anchor and redeemed when the anchor recovers – and share tokens – which receive new basis tokens if, after bonds are redeemed, the stablecoin continues to trade above par.
Basis would never launch, citing regulatory pressures, so it would return to investors the more than $130 million it had raised in its financing rounds.
List of Top Stablecoins
Dai is an ERC20-compliant stablecoin, issued on the Ethereum blockchain by the MakerDAO protocol. It falls into the category of on-chain collateralized -originally, only ETH was used as a reserve asset, although in recent months, with the upgrade to the MCD system, BAT, USDC and WBTC have been added as forms of collateral.
DAI uses US$ as a reference asset on a 1:1 ratio basis – and relies on an oracular system to determine the value of reserve assets and thus the level of debt over-collateralization. And we say debt because the way DAI is created is by opening collateralized debt positions – or CDPs. This means that the MakerDAO system allows users to deposit any of the supported forms of collateral and get a loan – debt – in the form of stable currency – DAI.
MakerDAO would be founded by Rune Christensen, with the idea of achieving a decentralized stablecoin, resistant to censorship and accessible to everyone. As an ERC20 token, DAI can be used in most financial applications in the Defi ecosystem, as well as to pay for services offered by all kinds of Dapps – decentralized applications.
The original version of DAI – called Single Collateral DAI – only supported ETH as a reserve asset to back the security. When the MakerDAO system was upgraded to MCD -MultiCollateral DAI-, new assets were adopted as a reserve -currently, BAT, USDC, and WBTC-, and two cryptocurrencies coexisted for a time: SAI -the original DAI, backed only by ETH- and DAI -the MCD version, backed by ETH and the other assets mentioned above.
The MCDs function in MakerDAO as dynamic response systems that help stabilize the value of DAI. The money supply of DAI is completely dependent on the demand for CDPs – which, in general, are opened by investors who want to open a long position in Ethereum with self-leverage.
The way it would work would be as follows:
- A user opens a CDP by depositing $200 in ETH and withdraws $100 in DAI.
- With that $100 in DAI, the user buys more ETH.
- Let’s imagine that the price of ETH doubles.
- The user will be able to sell the ETH that has appreciated, pay off his $100 of debt in DAI – plus the stability fee paid as interest – and still have ~$100 in ETH left over.
This practice is not without risk, since if the collateral deposited falls below a debt collateralization threshold of 150%, the position will be liquidated – the user will recover part of his collateral but will have to pay a penalty.
Another problem with this system is that it relies on demand for CDPs to issue more IADs-that is, the supply of IADs is not a product of demand for the stablecoin itself, but of demand for a service that allows investors to open long positions with leverage. For this reason, many critics believe that the MakerDAO system is not scalable.
Another problem with the protocol is that it depends on a whole series of parameters – stability fee, collateralization threshold, collateral types – that have to be decided through a governance process by the MKR token holders. There are skeptical voices regarding the possibility that a system that depends on governance processes -susceptible to capture- can be scaled effectively to meet global demand.
Tether (₮) is a stablecoin collateralized off-chain through bank reserves of different fiat currencies – although by far the most popular version is the one linked to the US$ exchange rate on a 1:1 basis and known under the ticker USDT. Among the versions of Tether backed by other international currencies, EURT – linked to the euro exchange rate – and CNHT – linked to the yuan exchange rate – stand out. Lately, XAUT – a version of Tether backed by troy ounces of gold – has also attracted enormous interest.
Although Tether originally launched on the OMNI blockchain -formerly MasterCoin-, as of today the vast majority of its units exist as ERC20 tokens on the Ethereum platform -although alternative versions also exist on Tron and EOS.
Unlike DAI, off-chain collateralized stablecoins such as Tether are much easier to scale – to meet existing market demand, it will only be necessary to deposit in a bank account or vault the corresponding amount in dollars, euros, yuan, or troy ounces of gold. In this case, there are no CDPs or smart contracts to settle positions, Tether is not issued as debt, but is a tokenized version of the underlying asset. This means that, as long as the collateralization ratio is maintained at 1:1 as stipulated by the issuer, the anchor to the value of the reference asset – e.g. the dollar – should be maintained with relative ease. Thus, the only theoretical risk an investor who chooses to use Tether as a store of value would face is that the price of the reference or reserve asset collapses – imagine a scenario where the price of the dollar, for whatever reason, collapses. If you have your funds locked up in USDT, your loss of purchasing power would be equivalent to the drop in the dollar’s value.
We just said that the only risk is that “theoretically” – because the reality is that Tether’s collateralization ratio has not always been 1:1. To understand why this situation of under-collateralization was reached, it is important to take into account the special relationship that, from the beginning, has linked Tether with Bitfinex – one of the main cryptocurrency exchanges. Bitfinex was one of the first exchanges to integrate Tether into its marketplaces, and at first, people believed that the only thing linking the two projects was a simple business relationship.
However, in 2017 a lawsuit against Wells Fargo would reveal that both entities were part of the same business structure. This would be followed by accusations of market manipulation during the crypto bull rally in the wake of the crypto rush and would culminate with the recognition in 2019 that Tether was only 74% backed by bank reserves – which would force Bitfinex to put a token, called UNUS SED LEO, up for sale to cover the financial hole. Despite all this, and perhaps because of its rebellious ethos and ties to tax havens, Tether remains the most popular stablecoin – with a market cap of over $7 billion.
Like Tether, USD Coin (USDC) is a stablecoin collateralized off-chain through bank reserves and linked to the US$ exchange rate on a 1:1 basis. The project would be launched in late 2018 jointly by Circle – a p2p payments company – and Coinbase – one of the world’s leading cryptocurrency exchanges.
USDC is issued and redeemed as an ERC20 token on the Ethereum blockchain via smart contracts – however, we cannot consider it a decentralized and “trustless” model like MakerDAO, because custodians of bank reserves are involved in the process.
However, unlike Tether, the Centre consortium – the issuer of USDC – is not based in a tax haven, but in the USA. -This means that it is a stable currency fully regulated by FinCen. This has some advantages – being under the focus of such a financial supervisor makes it difficult to reach situations of under collateralization like the one USDT found itself in – but it also entails some dangers in terms of censorship – such as certain accounts being blacklisted and USDC funds being frozen.
Thus, the policies of Tether and USDC couldn’t be further apart in terms of compliance – which couldn’t be otherwise given the vast differences between the issuers of the two tokens.
Circle, founded in 2013 by Jeremy Allaire and Sean Neville, is a U.S. payments company that complies with all federal laws and regulations. Coinbase, meanwhile, is an exchange founded by Brian Armstrong in 2012, which has based part of its success on an efficient banking gateway that allows users to buy crypto with fiat. Therefore, launching a stablecoin like USDC represented for both companies a logical step.
It is important to understand the process of issuing the currency, as it is not created out of thin air. Each time new USDC units are put into circulation, an equivalent dollar amount must be deposited with one of the Centre’s accredited custodians. The steps that are followed throughout the process are as follows:
- The user sends a given amount of US$ to the issuer’s bank account.
- The issuer uses the USD Coin smart contracts to issue an equivalent amount of USDC – if the user has deposited $1000, ~1000 USDC would be minted.
- The newly minted USDCs are sent to the user’s Ethereum account, and their original deposit remains as a reserve – or collateral – at the bank.
The redemption process is the same, but in reverse:
- The user requests the issuer to redeem a given amount of USDC tokens for US$.
- The issuer requests the USD Coin smart contract to exchange the user’s USDCs – which will be withdrawn from circulation – for an equivalent amount of US$ – if 1000 USDCs have been sent, ~1000US$ will be received.
- The issuer sends the requested amount of US$ from its reserves to the user’s bank account.
The Centre ensures that it does not charge any fees for either issuing or redeeming USDC tokens. The issuer’s business, therefore, revolves around earning interest and other returns from the bank reserves backing the stablecoin.
Among the off-chain collateralized stablecoins issued by exchanges following the USDC model we can highlight a:
- Binance USD: launched in late 2019 by Binance – the world’s largest cryptocurrency exchange – and Paxos – a custody service provider. BUSD is a stablecoin that complies with all NYDFS regulations, and whose reserves are audited once a month. Like USDC, it is an ERC20-compliant token issued on Ethereum blockchain-although it also exists as BEP2 on Binance Chain.
- Gemini USD: official stablecoin of the Gemini exchange, founded in 2015 by the Winlevoss brothers.
- HUSD: official stablecoin of the Huobi exchange, founded in 2013 and one of the largest in China – although based in Singapore.
Libra is a payment system using stablecoins, based on blockchain technology, but permissioned – that is, it does not use a public network like Ethereum as infrastructure.
The project, promoted by Facebook, would be announced in June 2019 – although there were rumors about it since the end of 2018. David Marcus, vice president of Facebook, would leave the direction of the messenger service to focus on the Menlo Park giant’s blockchain division.
Although the initiative would be led by Facebook, the project would be presented as a partnership based in Switzerland and governed by its members – which included companies such as Visa, Mastercard, Stripe, eBay, PayPal, Coinbase, Vodafone – each of which would have to invest $10 million to become validators of the network. Regulatory pressure from the U.S. authorities, however, would cause many of the original members of the association to abandon the project.
The original idea was to launch Libra in early 2020 as a stablecoin backed by a basket of international currencies and other financial assets. But financial and banking regulators around the world quickly raised alarm bells, expressing concerns about the implications of a system like the one Facebook was proposing for user privacy and the monetary sovereignty of states. As a result, Facebook would issue a statement announcing that it was halting the project pending regulatory approval.
Mark Zuckerberg would go on to testify up to twice in front of the Congressional Financial Services Committee, and in September 2019, Facebook would reveal the percentage weight of each of the different financial assets that would act as Libra collateral, placing special emphasis on the leading role of the official US currency. -$US 50%, €EUR 18%, ¥YEN 14%, £GBP 11% and $SGD 7%. But nothing would serve to reassure regulators, so, in early 2020, a change of strategy would be announced: the approach of a single currency -Libra Coin or LBR-, backed by a basket of currencies, would coexist with a system based on multiple stablecoins -each of them collateralized and linked to the price of a specific fiat currency. The launch would be delayed until the end of 2020.
As for the type of blockchain platform that Libra will implement, as of today there are no certainties, but four possible scenarios are being considered:
- Private blockchain with a central authority: this would mean that all nodes would be controlled by Facebook and the members of the association, so it would not be an immutable, censorship-resistant network – the blockchain technology would simply act here as an accounting system to avoid “double-spending” problems.
- Private blockchain without central authority: it would be immutable but would contain a litigation system to resolve disputes in case of potential fraud.
- Public blockchain with central authority: would not be immutable or censorship-resistant but all activity would be public – i.e., auditable.
- Public blockchain without central authority: it would be immutable and censorship-resistant and all activity would be public – i.e., auditable.
Although there is no certainty, it is most likely that the Libra network will eventually opt for a private or semi-private model, with members of the association exercising some degree of control.
What is certain, however, is that if the project finally comes to fruition by the end of 2020, it will be a milestone for the cryptocurrency industry as a whole – and stablecoins in particular. Making such technology available to the billions of users of the social network Facebook will represent a giant step towards eliminating bank intermediation within payment systems.
Stablecoins issued by private and central banks (CBDCs)
As a result of the enormous growth that the cryptocurrency sector has experienced – especially within the Ethereum platform and, more specifically, in the Defi ecosystem – numerous players in the private banking sector have started to launch their initiatives. One of the first would be JPMorgan Bank, which would launch the JPM Coin stablecoin on Quorum – a permissioned platform based on Ethereum. The coin would be presented as a solution to improve the settlement process in international payments – through JPM Coin, the bank’s large institutional clients would be able to send large sums of money faster, cheaper, and safer.
The other major emerging trend in stablecoins is that of state-owned central banks exploring the technology as an official payment gateway. This is a logical initiative considering the prevailing trend towards cashless societies.
To this must be added the suspicion that cryptocurrencies based on public blockchain networks – first Bitcoin and Ethereum, and currently, a whole series of cryptocurrencies linked to the dollar and freely accessible – arouse in the monetary and fiscal authorities of most countries. The popularity gained in recent times by these assets represents a threat to the monopoly of banking – supervised by the central bank authority – in terms of payment systems and current or savings accounts. Likewise, there is also an honest concern for a certain type of unsophisticated consumer who may not be prepared to deal with the enormous volatility of traditional cryptocurrencies, and who may fall victim to fraud or be exposed to scenarios of under collateralization of stablecoins such as Tether.
“If you can’t beat the enemy, join him,” goes the proverb. Something like that must have been thought by the numerous central banks that, unable to control the ferocious shockwave of cryptocurrencies, have decided to launch their stablecoins on the market. These are a type of regulated cryptocurrency called Central Bank Digital Currencies – better known by their acronym CBDCs – which are nothing more than a digital representation of the national fiat currency, on a blockchain permitted and controlled by the regulator. Predictably, and like their 100% fiat counterparts, CBDCs will to some extent be backed by the forex monetary reserves and gold of each central bank – although obviously, and as with cash, they will not be redeemable.
Therefore, each unit of a CBDC will still be a virtual representation of a national currency bill or coin and can be used as a unit of account, a means of payment, and a store of value. The idea of central banks is to offer the comfort and usability of cryptocurrencies, together with the security and convenience of operating through a financial instrument fully regulated and backed by the banking authority – which will be solely responsible for the system.
Central banks that have launched stablecoin initiatives
- The Riksbank, Sweden’s central bank, is studying a crypto version of the krona.
- The Central Bank of England
- The People’s Bank of China, which has been exploring a crypto version of the yuan since 2014.
- That of the Republic of the Marshall Islands – which has advanced the launch of Sovereign (SOV), a currency that is presented as an official government payment solution.
- And the central banks of many other countries such as Uruguay, Thailand, Venezuela, and Singapore.