What are stablecoins?

What is a stablecoin?

In contrast to well-known cryptos, stablecoins are coupled cryptocurrencies. Coupled because they are firmly tied to an asset and thus hedged. Most stablecoins are pegged 1:1 to the US dollar. So a single stablecoin could have the value of one US dollar. A stablecoin is therefore a link between the digital crypto world and the analog world, where payment is made with US dollars or other Fiat. In crypto, euros, dollars, and co. are also called fiat currencies. Stablecoins allow you to settle the payment at a fiat equivalent using blockchain infrastructure. Stablecoins also be coupled with precious metals such as gold or other assets.

How do stablecoins work?

The quality of a stablecoin is measured by how reliably it represents the value of an asset. For example, a stablecoin representing the euro should have as little deviation as possible from the original to function as a solid unit of currency and calculation. 

To achieve this, there are currently three different methods.

Hedging through classic assets:

With stablecoins of this type, classic assets are deposited for hedging.  If, for example, you want to issue a stablecoin that represents the U.S. dollar at a ratio of 1:1, you have to deposit a physical U.S. dollar with the respective provider for each coin. When reselling, this can be exchanged back accordingly. For stablecoins that replicate other assets such as gold, the corresponding assets (in this case gold) must be deposited. 

Hedging through cryptocurrencies:

Besides hedging with classic assets, there are also Stablecoins that guarantee value stability with cryptocurrencies as collateral. This brings with it the advantage of greater decentralization. Finally, the deposited pledge can be managed using a smart contract - consequently, a middleman as with Tether is optional.

However, investors must hedge the high volatility of cryptocurrencies with disproportionately high collateral. This is because, due to the fluctuation in the value of the collateral itself, situations are conceivable in which the required deposit falls below the value of one US dollar. Investors must compensate for this.

c) Hedging through an algorithm:

Besides hedging by assets such as fiat currencies, gold, or crypto, a third option comes into play to create value parity with the underlying asset. The approach of an algorithmic hedge is not to deposit collateral. Rather, automated buying and selling algorithms are designed to provide price stability. In principle, this "stable cryptocurrency" type works similarly to a central bank - just automatically and decentrally. If the market pushes the price above the targeted base value, such as a U.S. dollar, the algorithm throws more coins on the market, artificially increasing the supply. As a result, the price should fall back to one US dollar.

Differences between stablecoins:

USDT

Tether is the stablecoin with the largest market capitalization. Tether (USDT) is pegged to the US dollar. The stablecoin USDT aims for a fixed exchange rate of 1:1 to the US dollar. USDT is issued by the company Tether Labs. Thereby, each USDT token is supposed to be covered 1:1 by Tether's reserve. If the demand for USDT increases, fresh units are minted. If USDT are exchanged for USD again at Tether Labs, the USDT units are burned. You can learn more about Tether here.

USDC

The USD Coin (USDC) was introduced in 2018 by the Centre Consortium company. The USDC is also pegged to the US dollar at a ratio of 1:1. Each unit of this cryptocurrency in circulation is backed by one US dollar.

BUSD

The largest crypto exchange in the world, Binance, also offers a stablecoin. Launched on September 5, 2019, Binance USD (BUSD) aims to merge US dollar stability with blockchain technology. The BUSD is also physically secured by classic assets. 

UST

TerraUSD (UST) is the stablecoin on Terra's blockchain. The same company also developed this stablecoin.

TUSD

The value of TerraUSD is always equal to the US dollar, although the dollar does not back the value. Instead, the value is kept the same by an algorithm developed by Terra. This algorithm uses LUNA tokens to keep the value of UST stable. TerraUSD is the stablecoin that runs on the Ethereum blockchain and attempts to maintain a value of US$1.00. The supply of TUSD is collateralized by US dollars held in escrow by banks. Tokens can be purchased and redeemed for US dollars on the TrustToken website.