You might have seen headlines and articles stating how the US has printed almost 80% of all its USD in existence since January 2020, and how much the total USD circulation has increased since then.
Many experts speculate this act is to increase prices of all goods in a matter of time, in spite of any deflationary roles in play. However, it is not that the government is directly printing money; they issue bonds at lower costs and at high-interest rates. Central banks hold the nation’s reserves that are mostly backed for printing money and pumping it into the economy.
Central bank-issued currency serves as a stable and standard unit of account that offers purchasing power at any given time. This is also how most people store savings for retirement.
Central banks control interest rates and are given authority to take any unconventional approaches to “stabilize” the economy at any given time. However, it is evident that they are doing a poor job over the past two decades, causing millions of taxpayers to lose faith in central banks.
“In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value.”
— Alan Greenspan
Moreover, since the currency issued is regulated and controlled solely by one body, officials possess the authority to impose constraints on how the currency can be used and where it can be moved. In a democratic nation, the central authority is trusted to store fiat currency within banks.
However, on many occasions, banks took advantage of this faith and misused money by loaning it to other banks, not sharing the generated yield fairly. On past occasions of crisis, they have also frozen many accounts to avoid the public doing bank runs in the name of preventing economic collapse.
Compared to developed democratic nations, countries that are undergoing heavy resistance, corruption, authoritarianism, communism, and internal conflicts, are prone to economic crises which can have a high impact on currency value on a global scale.
Countries such as Myanmar, Afghanistan, Sudan, and Somalia, among other similar nations which are presently under authoritarian rule, have seen high inflation rates which caused the prices of goods to go sky high in a matter of few days. Many South American and African nations have also seen such unimaginable spikes in the inflation rates which led to economic collapses and people suffering.
Creation of free markets
With goals to overcome the central authority’s control over the economy and bring an efficient and fair economic system that is global in nature and faster than the traditional finance system, a decentralized cryptocurrency called Bitcoin was introduced in 2009 by Satoshi Nakamoto (a pseudo name). It is run on a distributed ledger (account book), by different nodes (or computers that are connected to the internet) in any part of the world. Any person can set up a node and become a validator for the transactions that are happening on their nodes, which encourages them to own the network, secure it, and validate actively; for which they are also incentivized by fees paid by users transacting on the network.
Since it was launched, the price of one Bitcoin has grown from $0 to nearly $68,000 in 2021. In that same year, Bitcoin was adopted as legal tender by El Salvador, making it a mode of payment. But so far this has failed to live up to expectations due to Bitcoin’s volatility in prices and limits on scalability.
The user interface has also proved to be confusing for beginners who are getting into crypto markets for the first time. High speculation meant that the cryptocurrency market was more representative of an investment opportunity or a risky asset, rather than a means for citizens to make payments. Hence the store of value may have been resolved by Bitcoin because of its tokenomics and adoption, but the issues of legal tender, price volatility, and scalability to suit mass adoption are still unanswered.
Stablecoins- an answer to address volatility
In 2014, the first stablecoin Tether (USDT) was introduced. Originally called Realcoin, Tether is a USD-backed crypto token. This means that every 1 USDT in circulation is backed by 1 US Dollar. This reduced volatility compared to other cryptocurrencies.
This also changed the game for crypto traders. By pairing their trading tokens to USDT or similar stablecoins, they can always hold liquidity within the exchange and prevent liquidating into banks. USDT, being the first fiat-backed token, was widely disbursed into the majority of crypto exchanges and grew to be the leading stablecoin in terms of market cap. As use cases for stablecoins grew, the entire stablecoin ecosystem has also grown to almost 7–8% of the $2.4 trillion crypto world (at the time of this writing).
Types of stablecoins
Stablecoins entered the market as fiat-backed, mainly USD-backed. However, the organizations which introduced these tokens are centralized institutions with full power of attorney over tokens. To make stablecoins more decentralized, other stablecoins were designed and introduced into the market, which eventually became favorites for the DeFi hardcore.
There are four different types of stablecoins widely in use:
- Fiat-backed: These are mostly centralized and backed with fiat USD. The parent company of these tokens holds the central authority to hold reserved assets to back tokens that are in the market supply.
- Crypto-backed: These are backed by crypto-assets in order to maintain the peg of each stablecoin. To maintain the peg, the risk of crypto volatility is taken into account and introduces an overcollateralizing lending mechanism. For example, by depositing $100 worth of crypto assets into the platform, you can borrow $50 worth of stablecoin, which will be newly minted. Once you pay back the loan of $50 worth of stablecoin, the stablecoins are burned (removed from the system) and unlock your deposited collateral. Meanwhile, if your collateral falls in value below the amount you have borrowed, your losses are incurred from the collateral and the rest in your account will be liquidated.
- Algorithmic-backed: Algorithmic stablecoins rely on complex build algorithms to balance funds on blockchains through a supply and demand mechanism. Similar to central banks which peg fiat currencies in the market, the peg is maintained and stable by supplying more tokens if the price exceeds the peg, and removing tokens from circulation if the price falls below the peg.
- Asset/commodity-backed: These are backed by reserves held in a central entity which are in the form of physical assets such as gold, oil, and minerals, among others. When the value of these assets varies, the token price varies. Hence this pegging mechanism may not always be viable unless they are also algorithmically stabilized.
Top 10 stablecoins and their market cap
There are almost 70 different stablecoins. The table below showcases the top 10 in terms of market cap. As you can see, USD-backed type stablecoins that are centralized captured a vast majority of the market. However, algorithmic and crypto-backed tokens such as DAI and UST are DeFi crowd favorites because they are fully decentralized and governed by Decentralized Autonomous Organizations (DAO).
USDT occupies almost 50% of the stablecoin market. It is a low-cost fast way to transfer from one wallet address to another. USDT is available on almost 450 different platforms, which makes it the most widely available stablecoin.
Different platforms charge different withdrawal fees that begin from 0.05–0.5% per transaction. However, by using Tron (TRC20) network, any amount of USDT can be moved with only a network fee of $1 USDT, whereas the other ERC20 based tokens must pay a hefty gas fee for the Ethereum network.
This has an impact on real-world applications such as cross-border payments and international remittances. Regardless of using USDT as a substitute for USD to solve USD liquidity issues, or a temporary store of value while exchanging currencies, such transactions can now be effectively done at a fast rate and at the lowest costs.
Blockchain fintech platforms like Taipei-based XREX capitalizes on the dependability of stablecoins and enables users to conduct cross-border transactions and transfers. Low network fees and world-class security allow these services to be provided at extremely low fees, compared to traditional methods of transacting.
However, USD-backed tokens are held by a central authority that has all access to tokens in spite of any wallet on any platform. This central authority holds the right and authority to freeze and reverse any transactions if necessary. In contrast to USDT and USDC, DAI and UST are fully decentralized and no one body nor institution can freeze assets or reverse transactions.
Both types of stablecoins have their pros and cons, which you must be fully aware of before deciding to dip your toes.