Stablecoins are cryptocurrencies that attempt to peg their market value to some external reference. They can be useful than more volatile cryptocurrencies as a medium of exchange. Stablecoins may be pegged to a currency like the U.S. dollar or to the price of a commodity such as gold. Stablecoins pursue price stability by maintaining reserve assets as collateral or through algorithmic formulas that are supposed to control supply.

Fiat-Collateralized Stablecoins

• Fiat-collateralized stablecoins maintain a reserve of a fiat currency (or currencies) such as the U.S. dollar, as collateral assuring the stablecoin's value.
• Other forms of collateral can include precious metals like gold or silver as well as commodities like crude oil, but most fiat-collateralized stablecoins have reserves of U.S. dollars.

Examples

USDT - Tether

Tether (USDT) is a cryptocurrency stablecoin pegged to the U.S. dollar and backed "100% by Tether's reserves," according its website. Tether is owned by iFinex, the Hong Kong-registered company that also owns the crypto exchange BitFinex.

As of the latest Tether assurance report, the company had a total assets amount of at least $78.6 billion, around $4 billion or 5% of which was cash.

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How It Works

• USDT is available on ETH, Tron, Solana, Omni, Avalanche, Algorand, EOS, Liquid, SLP.
• Individuals, merchants, and exchanges can purchase USDT directly after going through a KYC process.
• Similarly, such individuals can also cash in their USDT directly as well.
• Third party trading is available on many exchanges.

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Risks

• All of Tether's reports are made by an offshore Cayman island company.
• If more than 5% of the USDT supply is withdrawn at any time, liquidation of assets must occur.
• Relies on one centralized body to remain solvent in order to cash out the stablecoins.
• Cashing out requires human labour and fixed opening hours.

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USDC - USDCoin

USDCoin is a cryptocurrency stablecoin pegged to the U.S. dollar created by Circle and Coinbase. They claim that USDC is fully backed by cash and short-dated U.S. government obligations, so that it is always redeemable 1:1 for U.S. dollars.

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How It Works

• USDC is available as an Ethereum ERC-20, Algorand ASA, Avalanche ERC-20, Flow FT,  Hedera SDK, Solana SPL, Stellar asset, and TRON TRC-20.
• Businesses can access and use USDC by creating a free circle account.
• Similarly, such businesses can also cash in their USDC directly as well.
• Third party trading is available on many exchanges.

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Risks

• Relies on one centralized body to remain solvent in order to cash out the stablecoins.
• Cashing out requires human labour and fixed opening hours.

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USDP - Pax Dollar

USDP is a regulated stablecoin, subject to strict regulatory oversight by the New York State Department of Financial Services. USDP reserves are held in cash and cash equivalents, meaning that customer funds are always kept safe and available for redemption.

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How It Works

• USDP is available as an Ethereum ERC-20.
• Businesses can access and use USDP by creating a free Paxos account.
• Similarly, such businesses can also cash in their USDP directly as well.
• Third party trading is available on many exchanges.

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Risks

• Relies on one centralized body to remain solvent in order to cash out the stablecoins.
• Cashing out requires human labour and fixed opening hours.

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Crypto-Collateralized Stablecoins

• Crypto-collateralized stablecoins are backed by other cryptocurrencies. Because the reserve cryptocurrency may also be prone to high volatility, such stablecoins are over-collateralized—that is, the value of cryptocurrency held in reserves exceeds the value of the stablecoins issued.
• A cryptocurrency worth $2 million might be held as reserve to issue $1 million in a crypto-backed stablecoin, insuring against a 50% decline in the price of the reserve cryptocurrency.

Example

DAI - MakerDAO

DAI is an algorithmic stablecoin issued by MakerDAO, an Ethereum-based protocol, that seeks to maintain an exact ratio of one-to-one with the U.S. dollar. It is primarily used as a means of lending and borrowing crypto assets without the need for an intermediary. Creating a permissionless system with transparency and minimal restrictions.

DAI is pegged to the U.S. dollar but backed by Ethereum (ETH) and other cryptocurrencies worth 150% of the DAI stablecoin in circulation.

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How It Works

• Users submit Ethereum-based assets into a smart contract and borrows DAI (with a fee).
• If the value of the collateral falls below the value of the issued DAI tokens, your collateral will be liquidated.
• Users can get back their collateral by returning DAI.
• DAI token holders earn interest on their DAI if deposited into a MakerDao smart contract.
• Those who hold MKR, MakerDao’s native governance token, set the DAI Savings Rate (DSR) and act as guarantors for DAI — meaning, their MKR tokens can be liquidated if the system were to crash.

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Risks

• If the entire crypto market is falling, DAI may lose its peg as there is little fiat value backing the token.
• Governance risk allows 51% attacks for proposals voting from MKR holders.
• Smart contract risks - programs can be vulnerable to potential vulnerabilities and exploits.

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Algorithmic Stablecoins

Algorithmic stablecoins may or may not hold reserve assets. Their primary distinction is the strategy of keeping the stablecoin's value stable by controlling its supply through an algorithm, essentially a computer program running a preset formula.

Example

UST - TerraUSD

Terra is a Cosmos-based protocol that powers a suite of algorithmic stablecoins, which aim to maintain their pegs using a coin called LUNA developed by Korean firm Terraform Labs. To maintain its stablecoins' equilibrium, Terra mints and burns tokens while also incentivizing arbitrage. The Terra blockchain has officially halted and UST has remained de-pegged from the US dollar since 9th May 2022. We are simply illustrating an example to help you understand the different types of stablecoins.

How It Works

• LUNA holders can exchange 1 LUNA to mint $1 of UST. During this exchange, LUNA is burnt, causing LUNA's value to go up slightly.
• UST holders can exchange 1 UST to mint $1 of LUNA. During this exchange, UST is burnt, causing UST's value to go up slightly.
• The arbitrage opportunity theoretically means that when UST drops below the peg, UST holders can arbitrage it back to LUNA, gaining the difference in the peg.
• Conversely, when UST rises above the peg, LUNA holders can buy UST and gain the difference.

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Risks

• The Luna Foundation Guard (LFG) was set up to protect the peg in the case of a death spiral. However, the protection is limited to the amount of assets it can inject.
• In May 2022, UST depegged admist a wider crypto market crashed and has never recovered.

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Hybrids

FEI - Fei Protocol

The Fei protocol is a fully decentralized stablecoin project developed by Fei Labs Inc. The team innovated Protocol Controlled Value, which is different from collateral because it is owned and controlled by the DAO. The original design attempted to pair this PCV with an algorithmic design, using direct incentives to manage the peg with the PCV as a backstop. Despite being an innovative design and highly touted project, it did not function as desired. Fortunately, Fei was able to pivot and use 1:1 minting and redeemability of PCV for FEI within a band to maintain the peg, the design it currently uses.

How It Works

• FEI uses ETH as value collateral.
• It has two mechanism to stabilize this stablecoin: PCV + Direct Incentives.
• Direct incentive is where rewards and penalties drive the price towards the peg via arbitrage.
• PCV activate the buyback function when the price is less than $1 and when the direct incentive fails.
• Is uses a bonding curve to manage supply and demand based upon its collateralization levels.
• Bonding curves and other incentives fund a PCV pool that is approximately as large as the entire user circulating amount of FEI.

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Risks

• Smart contract risks - Hacked In April

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PAYD

PAYD is a crypto-collateralized algorithmic stablecoin pegged 1:1 to USD developed by FintruX Network to unlock liquidity from their ETH and generate an organic return from ETH2.0 staking validators and liquidation returns.

How It Works

• Individuals and businesses can sign up on staked.finance to stake ETH as collateral and issue PAYD up to 86.9% of their ETH value interest free.
• If the value of the collateral falls below the above threshold, your collateral will be liquidated.
• Liquidated collateral is used to reward the users who stake PAYD into the rewards pool, burning their PAYD in exchange.
• Redemptions for PAYD are offered on the platform for staked.finance users.

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Risks

• ETH withdrawals may be locked until ETH2.0 is out.
• Smart contract risks - programs can be vulnerable to potential vulnerabilities and exploits.