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What are stablecoins: Different types and top coins explained

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Stablecoins have been around for nearly a decade and have become crucial to crypto – how have they changed and what's yet to come?

Disclaimer: This information should not be interpreted as an endorsement of cryptocurrency or any specific provider, service or offering. It is not a recommendation to trade.

Bitcoin's boom as a digital currency led to the inevitable need to trade against a consistently priced asset – without converting to and from fiat (government-issued) currency. This gap in the market opened the door to what we now know as stablecoins.

The primary purpose of stablecoins is to act as a bridge between traditional financial and blockchain-based currency representing the value of a real-world asset.

US dollar stablecoins are the most common digital currency used for trading against the price of cryptos on both centralised and decentralised exchanges.

While their intended purpose is often much the same, not all stablecoins are built equally. There are many factors to consider, including blockchain compatibility, collaterallisation and cryptographic algorithms.

Let's look at some of the most popular crypto stablecoins, how they work and what to expect for the future.

Comparing stablecoins

Stablecoins – the vast majority of which are pegged to the US dollar – account for approximately 18% of the total crypto market cap, or US $149 billion.

Of the top 11 projects listed on CoinMarketCap, 4 are stablecoins: Tether, USD Coin, Binance USD and Dai.

This high market share demonstrates the necessity of these projects and highlights the need for a trusted, digital US-dollar alternative.

So how do these projects differ?

Tether (USDT)

Known initially as Realcoin, Tether was released in 2014, making it one of the oldest and most popular stablecoins. Although it was originally built on the Bitcoin blockchain, it's now supported by many networks, including Ethereum, EOS, Tron and Algorand.

How it's backed: According to Tether, USDT is backed by "traditional currency and cash equivalents and may include other assets and receivables from loans made by Tether to third parties."

Although Tether claims that all USDT is backed 1:1, concerns have been raised regarding the transparency of collateral and its real-world value.

Stablecoin growth rate: 2020 - Current

Reserves Breakdown: USDT: Tether

USD Coin (USDC)

USD Coin is a relatively new digital currency. It was released in 2018 by the founding partners of the Centre Consortium, Circle and Coinbase.

How it's backed: USDC has fast grown in popularity thanks to its transparent nature, regulatory compliance and verified 1:1 backing consisting of cash reserves and US Treasury bonds – according to Circle. In addition, USDC is compatible with a wide range of blockchains, including Ethereum, Algorand, Avalanche and Solana.

Since its launch, USDC has maintained ranks as the second-largest stablecoin by market cap, while USDT dominance has steadily decreased.

Stablecoin growth rate: 2020 - Current

Stablecoin growth rate: 2020 - Current Image: Glassnode

Dai (DAI)
Developed by Maker Protocol and the MakerDAO (decentralised autonomous organisation), DAI is an Ethereum-based, decentralised stablecoin.

How it's backed: DAI differs from USDT and USDC in that it's not fiat-backed but instead backed by the value of cryptocurrencies deposited into Vaults. DAI uses an over-collateralised and decentralised minting model to maintain its peg to the US dollar.

To mint DAI, users must deposit a higher value of collateral than the amount of DAI they receive. If the value of this collateral drops and a liquidation threshold is reached, Dai Keepers will sell the collateral to cover the debt.

This process is known as over-collateralised minting and ensures that the total value of DAI in circulation is lower than that of crypto held in the Vaults. This over-collateralisation model makes DAI one of the most trusted and utilised decentralised stablecoins.

Commodity stablecoins

Commodity stablecoins are blockchain-based assets whose value is pegged directly to a tangible asset such as gold. PAX Gold (PAXG) is a commodity-backed stablecoin that has become popular in crypto.

Investors often use it to help diversify their crypto portfolios into traditional markets. Gold is typically a more stable asset than many cryptos and can be used to mitigate some risk during market downturns or periods of price uncertainty.

Algorithmic and hybrid stablecoins

Throughout the bull market of 2020 and 2021, known as DeFi summer, many crypto projects offered investors high annual percentage yields (APYs) that often stretched well into the double digits.

One of the most notorious projects to do so was TerraUSD (UST). UST was an algorithmically backed stablecoin minted by locking up Terra (LUNA) and receiving its equivalent value in UST.

UST could then be deposited into a protocol known as Anchor, which at the time offered up to 20% APY to depositors. Although appealing, these high-yield rates proved unsustainable.

As the bear market dawned and the total crypto market cap fell, investors rushed to burn their UST and cash out of LUNA. This major sell-off caused the algorithm to lose its peg to the dollar, and both LUNA and UST dropped towards 0.

This sell-off caused a string of liquidations across the crypto market and sparked concerns and speculation about any projects claiming to offer what now seem like unsustainable APYs.

Reward and yield earning potential

Following the collapse of many major crypto lenders and yield-generating platforms in 2022, the market has taken a step back and reconsidered what constitutes a sustainable APY.

Exchanges and platforms such as Coinbase are now looking for long-term ways to help investors earn passive returns while reducing the risk associated with crypto lending and unproven yield-generating products.

Coinbase offers customers 1% APY on USDC held on the platform. These rewards are funded with the company's own assets, which means there is no lending involved.

By holding USDC on Coinbase, investors will, by default, earn this fixed-rate yield. These returns can be used to soften the effects of inflation without needing to lock-up funds in a lengthy term deposit.

Disclaimer: This information should not be interpreted as an endorsement of cryptocurrency or any specific provider, service or offering. It is not a recommendation to trade. Cryptocurrencies are speculative, complex and involve significant risks – they are highly volatile and sensitive to secondary activity. Performance is unpredictable and past performance is no guarantee of future performance. Consider your own circumstances, and obtain your own advice, before relying on this information. You should also verify the nature of any product or service (including its legal status and relevant regulatory requirements) and consult the relevant Regulators' websites before making any decision. Finder, or the author, may have holdings in the cryptocurrencies discussed.

The future of stablecoins

Stablecoins have grown significantly over the past decade. At the time of writing, they account for roughly 18% of the total crypto market cap and are used to facilitate billions of dollars worth of trades daily.

However, transacting on the blockchain is relatively new for many investors. Using private and public addresses and Web3 wallets can be confusing and risky if not properly managed.

The industry is working hard to help solve these issues and make crypto more user-friendly and accessible for everyday users. Stablecoins will likely play a prominent role in this mainstream integration due to their practical use cases, including borderless transactions and fast settlement times.

Central Bank Digital Currencies (CBDCs) have been a hot topic throughout 2022. The Australian government even announced a stablecoin research project to explore potential use cases of an Australian dollar stablecoin.

Headway is also being made in the DeFi space. Popular crypto lending protocol Aave is developing an algorithmically backed stablecoin, GHO, that's set to launch in the coming months.

Although 2022 has been a testing year for the broader crypto space, many development advancements are on the horizon, and the industry's future is looking bright.

Disclosure: The author owns a range of cryptocurrencies at the time of writing

Trade with Coinbase

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