Stablecoins are supposed to provide a safety net for the average investor amid the rollercoaster ride of cryptocurrencies. In the wake of the LUNA/UST collapse, we want to dive into the world of stablecoins to gain some more insights into what they really are and how they are designed to work
Stablecoins are cryptocurrencies used to minimize or stabilize the price volatility of cryptos. Generally, cryptocurrencies are very unstable, so rather than compare a volatile asset against another, stablecoins are utilized to ensure a level playing ground in Crypto.
These coins are usually pegged to the price of the US dollar or Gold. Stablecoins like USDT, DAI, and USDC are pretty popular today.
Stablecoins are in high demand by Exchanges and DeFI protocols as they can be used to provide liquidity and facilitate the easy buying and selling of digital assets. They may be utilized as collateral for DeFi protocols and provide investors with a soft landing during periods of high market volatility.
The major types of stablecoins include;
1. Fiat-backed stablecoin
2. Crypto-backed stablecoins
3. Algorithmic stablecoins
These cryptos are backed by the fiat US dollar, deposited in the reserves as collateral. USDT, BUSD, and USDC are typical examples
Tether(USDT); USDT was launched in 2014 by Tether, a Hongkong-based private company. It was initially called Realcoin, renamed UStether, and finally Tether.
The total supply of Tether is about 74.21 billion according to Coinmarketcap; its price is pegged to that of the US dollar and is often used as a hedge against inflation. They are fully backed by the fiat US dollar deposited in the external reserves.
USDT is one of the most popular coins and a top three cryptocurrency by market capitalization. They are built on leading blockchains like Ethereum, BSC, Tron, etc.
USDC made the headlines when Visa announced it would adopt the stablecoin for use on its platform. Like its fiat-backed counterparts, USDC is collateralized by a dollar equivalent on a 1:1 basis, launched in 2018 by Circle on its native chain Ethereum.
Coinmarketcap has verified its circulating supply to be about 52.16 billion. The unique thing about USDC is the transparency surrounding its operations, as its parent company, Circle, is registered in the US and audited by Grant Thornton.
Crypto-backed cryptocurrencies are collateralized by another cryptocurrency, often held in excess of the stablecoin to provide some hedge against inflation. For example, a 100 or 150% reserve can be held to create a crypto-backed stablecoin. DAI is a typical example of a crypto-backed stablecoin collateralized with Ethereum.
DAI is a Crypto-backed stablecoin built on the Ethereum chain. It was launched by MakerDAO, a Decentralized autonomous organization, in 2017. The token is generated when users lock other Cryptos like ETH on MakerDOA’s vault as collateral to be able to borrow DAI using a defined ratio.
DAI enjoys more transparency because it is managed by a DAO, which utilizes smart contracts, and implements decisions only when they are approved by the votes of members. The circulating supply of DAI is determined by the amount staked by users on the protocol.
Algorithmic stablecoins utilize algorithms or computer codes to control the supply of a stablecoin; these stablecoins usually consist of two coins. The algorithm or computer code maintains the relationship between them, buying and burning tokens to keep the value of the stablecoin equal to $1.
They may or may not be backed by any reserve currency, so algorithmic stablecoins may not have a good reserve to fall back on in a crisis. UST, USDD, and USN are typical algorithmic stablecoins.
UST, also known as Terra USD, is an algorithmic stablecoin that relies on its reserve currency, LUNA. The protocol is used to maintain the relationship between them; when the price of UST decreases below the $1 peg, UST is burnt to buy LUNA and vice versa.
UST was launched in April 2019 and managed by the Luna Foundation Guard. Its circulating supply, according to Coinmarketcap, is 11.28 billion UST. The stablecoin depegged in May 2022, with UST and LUNA prices plunging more than 99%.
USN was launched in April 2022 on Layer 1 blockchain, Near Protocol by Decentral bank(a DAO). The stablecoin was designed to use the Near token as collateral so users can deposit the Near token to mint USN. The objective was to create liquidity for Defi protocols on the Near blockchain.
To protect the value of the dollar peg, the DAO planned to make some Near and USDT token reserves available to its treasury, which could be more than 100% of the initial USN issued. They also planned to deploy an arbitrage system that allows arbitragers to feed off the price difference when USN loses its peg.
Algorithmic stablecoins appear to be leading the charts for the highest yield offering by stablecoins with TRON’s USDD, which was launched in April 2022, already boasting of a superior APR of 40%- the highest yield right now.
USN offers holders a minimum of 11% APY, and first lenders will likely get a 20% APY. Before its collapse in May 2022, Terra USD, through its protocol, Anchor, had launched a similar 20% APY, which helped its tokens, UST, and LUNA, to grow very fast.
Terra project Anchor had offered users about 20% in APY when they stake their UST. This move drew many holders and, as expected, created a massive demand and use case for the UST token.
The initial traction waned as Anchor later admitted that the strategy was not sustainable, announcing that it would decrease its yield. Afterward, Anchor gradually dropped its APY and users found less motivation to stake their UST, so they began to leave. Before the collapse of the stablecoin, LUNA was the 10th largest coin by market cap.
In response to the Terra USD crash, Tron’s founder, Justin Sun, pointed out that APYs should depend on how long someone has staked tokens with the protocol, pointing out that UST also fell because people were allowed to pull their money instantly.
USN may look to use the same playbook now that UST is out of the way to compete with a new opponent ‘’USDD’’ and try to draw significant capital to its platform. Decentral bank had revealed that USN’s yield would subsequently change depending on the market value of the tokens and the NEAR staking percentage.
The failure of UST has raised a lot of dust around the world of stablecoins, particularly the algorithmic stablecoins, amid an already panicked market. Time will tell if USDD and USN strategies will succeed or not.