The way of the stablecoin: A journey toward stability, trust and decentralization

The way of the stablecoin: A journey toward stability, trust and decentralization

Bitcoin (BTC) and other cryptocurrencies have opened the doors to a whole new world of finance. In their most basic form, cryptocurrencies allow people to transact in a fully trustless, transparent and efficient manner, cutting out the centralized intermediaries and counterparty risk previously associated with digital money transfers.

Thanks to blockchain technology, value can now be transferred on a worldwide scale within seconds/minutes and with relatively low fees — but that’s not all. However, Bitcoin and Ether (ETH) are still too volatile to be used as currency, a factor that has hindered their mass adoption.

Although Bitcoin and blockchain technology are still in their infancy, volatility is still predominant in the industry, which has led to the creation of something that takes the best of both worlds — stablecoins. Popular examples include Tether (USDT) and USD Coin (USDC).

While cryptocurrencies themselves are volatile, their underlying technology can be leveraged to create assets pegged to and backed by more stable assets, such as fiat currencies, precious metals and others. These stablecoins are mostly used for common payments and exchange settlements. Certain stablecoins have become extremely popular since they are pegged to the United States dollar and have attained a market capitalization of over $51 billion for USDT and around $14 billion for Coinbase-backed USDC.

Stablecoins have become a new asset class of their own, seeing popularity grow among both retail and institutional demographics alike for their unique properties. Now, decentralized finance and nonfungible tokens are the new game-changers of the industry and, together with stablecoins, provide new and exciting possibilities for financial inclusion.

Centralized and decentralized stablecoins

The concept of coins like USDT is simple. In theory, companies backing these stable cryptocurrencies keep a reserve of the underlying asset — in this case, the U.S. dollar — and issue the corresponding amount of blockchain-based tokens.

However, stablecoins have issues of their own. The most prevalent is the fear that stablecoin issuers can manipulate their reserves and audits to issue unbacked tokens. While iFinex — the parent company of crypto exchange Bitfinex and a USDT issuer — is adamant that USDT is always 100% backed by reserves, some in the industry remain skeptical as seen by the recently settled court case between the New York Attorney General’s office and Tether.

The aforementioned issues have prompted developers and entrepreneurs in the space to create decentralized stablecoin systems, the most popular of which is MakerDAO and its USD pegged token, the Dai. MakerDAO uses Ether (ETH) to create a decentralized and verifiable reserve for stablecoin issuance.

Other options are also available. Kava has leveraged a similar system to create crypto-backed stablecoins that are pegged to the USD, allowing users to provide liquidity with multiple assets such as Bitcoin and XRP in order to issue USD-pegged stablecoins. John Wu, president of Ava Labs — the team supporting the development of Avalanche — told Cointelegraph:

“Decentralized stablecoins have played a vital role in the growth of DeFi. Without the innovation of MakerDAO to create synthetic U.S. dollars backed by crypto, the ecosystem would not be nearly as mature as it is today.”

While it is a novel concept, it can also be dangerous for those providing liquidity to the system. Given that Dai is backed by Ether, a high collateralization ratio must be provided by participants who are also exposed to the risk of being fully liquidated should the price of Ether drop drastically.

When speaking about the launch of new concepts like the hybrid stablecoin, Wu mentioned a recently launched FRAX stablecoin that combines collateral and algorithmic supply controls, adding: “The innovations provided by the likes of MakerDAO and Kava come, however, at a high risk, which is intensified by the high congestion rates of the Ethereum blockchain.”

The issue with the underlying asset

Decentralized stablecoins are an alternative to simple stablecoins like USDT, but the volatility of cryptocurrencies also makes them dangerous for liquidity providers, holders and users of the stablecoin. Now several companies are attempting to find a solution that allows decentralized and centralized stablecoins to “meet in the middle.”

For example, Five5Five has created and will soon launch a new stablecoin model where a stablecoin can be pegged to the U.S. dollar while removing the danger associated with volatile cryptocurrency reserves. The USD Reserve (USDR) is a gold-backed cryptocurrency that can maintain a one-to-one ratio with the dollar.

This solution protects against the potential liquidation and price fluctuations associated with decentralized stablecoins. At the same time, such a coin can be backed with a high collateralization rate that will allow it to balance volatility or a sudden change in market situations. In this example, the company has chosen to issue the stablecoin on the Bitcoin Ultimatum blockchain — a decentralized ecosystem with smart contracts, leased-proof-of-stake mining algorithm in conjunction with proof-of-authority, private transactions, and leasing and staking solutions. Eric Ma, CEO of Bitcoin Ultimatum, told Cointelegraph:

“The BTCU blockchain was particularly selected for the development of the USD Reserve (USDR) stablecoin because of its capabilities, such as high-speed transactions, ability to conduct anonymous transactions, improved scalability, smart contract capabilities and multi-chain interoperability.”

While other projects have also tried to tackle the issue of protecting users against the volatility of the underlying asset by using “baskets” of fiat currencies instead of one single currency, to issue a stablecoin that is pegged to various assets, most have so far failed to achieve this feat — most notably, the Libra project by Facebook, which has been stopped on its heels by regulators, much like Sogur.

USDR will allow holders to hedge against the inflation of a single fiat currency — USD — given that the coin is backed by gold and not fiat or a volatile cryptocurrency. Jeremy Harbour, CEO and founder of Five5Five, told Cointelegraph: “The internet needs a reserve currency. The sheer demand for stablecoins demonstrates that the challenge is always what sits behind these stablecoins.” He added that the gold reserves were obtained by the company “in partnership with artisanal gold miners and so brings much-needed capital into some of the poorest places in the world to provide much needed direct investment into their communities.”

Metal-based stablecoins

While USDR aims to create a stablecoin for the U.S. dollar that protects users against inflation and downward price swings, and MakerDAO and Kava have tried to use cryptocurrencies to provide a trustless solution, other projects have gone for a simpler approach.

Projects like DigixDAO and Paxos issue stablecoins pegged and backed by precious metals such as gold. However, they still rely on centralized reserves, raising the same issues that plague USDT, USDC and, to a degree, even USDR.

In a bid to solve this issue and provide users with a semi-decentralized solution for precious-metal backed stablecoins, Aurus has issued precious-metal-based coins for gold, silver and platinum that are backed and pegged to these assets.

However, instead of using centralized reserves, Aurus works with multiple metal producers and foundries to create precious-metal-backed tokens that have distributed reserves, ensuring that users are always protected against single points of failure. Guido van Stijn, CEO of Aurus, told Cointelegraph:

“We could have built a centralized solution, but if we want mass adoption for products like AurusGOLD and AurusSILVER, we need the acceptance of the precious metals industry itself while making our system open and beneficial for everyone.”

The road ahead

While none of the solutions mentioned above are 100% perfect, the thought process behind the continued development of stablecoins is a quite noticeable one. So much so that governments are also working on their own version of stablecoins, known as central bank digital currencies, and countries such as China have already begun testing these systems.

Related: Rolling up the sleeves: China’s tech giants drive digital yuan adoption

However, many worry that CBDCs will be nothing more than virtual versions of fiat currencies that will leverage centralized blockchains, offering no real innovation. As such, it’s interesting to see how the cryptocurrency community will continue to invent and develop new solutions for stablecoins, while Bitcoin continues on its path to fulfilling its ultimate goal of replacing fiat currencies completely — something that may or may not happen.

Stablecoin Rush Breaks Out; JPMorgan, DBS and Temasek Launch Partior

As the Coinbase public listing approached, many analysts were looking for a $100 billion valuation. The cryptocurrency exchange, founded by Brian Armstrong and Fred Ehrsam, hit that mark briefly after listing, but COIN has settled down to a less-rarified valuation.

Meanwhile, CoinGecko calculates a total market capitalization of $128 billion for decentralized finance (DeFi), the corner of the cryptocurrency industry that represents a wide range of lending, trading and betting activities carried out almost entirely on blockchain networks using tokens as proceeds and collateral. The top five tokens on CoinGecko’s list are UNI, LINK, LUNA, AAVE and CAKE.

The following chart is from a CoinGecko page that tracks the combined market cap of all DeFi tokens:

Related: Stablecoin Rush Breaks Out; JPMorgan, DBS and Temasek Launch Partior

Coinbase, it should be noted, listed DeFi as a potential competitor when it filed for a public listing, but for whatever reason, market caps aren’t how we usually talk about the DeFi market. We usually talk about the value of assets people have deposited in DeFi apps to earn yield.

But that measure gives a similar reading: There is now more than $100 billion worth of assets locked up in DeFi.

These get to be very large numbers, numbers that are worth reviewing to illuminate a story that somehow continues to be missed even as cryptocurrency has started going mainstream.

Here at CoinDesk we have focused on DeFi on Ethereum because DeFi originated on Ethereum, and it is where the best-known entrepreneurs have committed to operating.

Related: Paxos Joins Crypto Unicorn Club After Latest $300M Funding Raise

Those aforementioned deposited assets are referred to as total value locked (TVL). TVL on Ethereum, using the most widely cited data site, DeFi Pulse, is $66 billion as of this writing, more than quadrupling since Jan. 1 when it was $15 billion.

Meanwhile, DeFi has taken off in a big way on Binance Smart Chain (BSC). According to Defistation, the current TVL on there is $38 billion, led by PancakeSwap but also including money markets filling a similar role to Aave and derivative solutions that fill a similar role to dydx.

Story continues

DeFi on BSC has grown much faster than on Ethereum; it first hit $1 billion in TVL only at the end of January.

DeFi vs. ICOs

Here’s a chart that compares funds entrusted to Ethereum’s many DeFi smart contracts in the last year or so to funds that went to founders in initial coin offerings during the 2017-2018 boom (an updated version of one published here):

It should be noted that DeFi Pulse was in the midst of updating how it tracks the TVL for the robo-adviser for yield, Yearn Finance, when this was made, and so those numbers aren’t in this graph. According to Yearn itself, though, it has had several billion dollars tied up.

Read more: DeFi reshapes the CoinDesk 20

While the 2020 surge was known as “DeFi Summer,” it’s already evident the market is much bigger now.

For example, TVL first broke $1 billion in February 2020. It broke $10 billion in September, on Ethereum. Earlier this month, the money market platform Compound broke $10 billion in TVL all on its own.

Tuesday night, the original DeFi protocol, stablecoin minter MakerDAO, also broke $10 billion for the first time.

1 million users? Maybe 2 million?

Richard Chen, at the venture firm 1confirmation, has been assembling on-chain data about users using Dune Analytics. One chart is worth citing here in particular.

This shows there are at least 2 million wallets that have interacted with DeFi protocols. So that probably means something like more than a million individuals, maybe even close to two? It’s very hard to say, but it is also worth noting that sometimes individuals participate in DeFi via third parties. So while some users hold many wallets, it’s also true that some wallets represent many users.

Whatever the real count of users, the amount of money changing hands shows these applications are real businesses. The site Crypto Fees has been tracking usage fees charged on different DeFi applications. The top DeFi applications it lists (Uniswap, SushiSwap and Compound) show a seven-day average of daily fees collected ranging from $1 million to $4 million.

If there’s one kind of finance that everyone understands, it is lending. The blockchain software company ConsenSys just released a first-quarter report on DeFi on Ethereum, showing a growing market for loans:

DeFi represents a much more credible narrative with more substantive businesses because it shows products with genuine returns and provides a way for people to earn impressive yields on deposits rather than making wild bets and hoping.

Wild bets are the best way to describe much (though certainly not all) of the investing that took place in the initial coin offering boom of 2017 to 2018. That boom drove the prior bull run, and the public appeared capable of making that connection.

Four years later, the cryptocurrency industry is in a bull run again, but the public appears incapable of connecting it to these billion-dollar deposits into this new iteration on finance. For whatever reason, the main topics are, again, bitcoin’s price and, somehow, non-fungible tokens and dogecoin.

Related Stories

USDT Stablecoin Market Cap of $51B+ Now Exceeds Insured Deposits at Most US Banks, Quarterly Report of Tether Reserves Expected Soon

Tether (USDT), the world’s largest stablecoin (or digital asset that’s supposed to be backed 1-to-1 with major fiat currencies like USD and cash equivalents) now claims a market cap of over $51.7 billion at the time of writing (according to available data).

Notably, Tether (USDT) market capitalization has now exceeded the insured deposits at most of the thousands of US banks (except for 44 of the major ones).

This is a very significant milestone for a so-called stablecoin that’s increasingly being used as part of large cryptocurrency transactions. USDT is also used as a method of payment or as part of transactions on peer-to-peer exchanges like Paxful.

iFinex, Tether, and crypto exchange Bitfinex‘s parent company that issues USDT, has received multiple warnings from regulators such as the New York Attorney General’s (NYAG) office. The company has also paid heavy fines due to alleged non-compliance by offering its products or services to New York residents who may not be permitted to engage in these types of transactions.

As its market cap surpasses the $50 billion mark for the first time, Tether is also getting ready to share its first quarterly statement that would provide details of its reserves. The report will be submitted to the New York Attorney General at some point this month. This disclosure comes as part of a settlement of a controversial dispute with US regulators regarding whether the company has the reserves needed to issue USDT (and concerns about why it’s been offering services to consumers in jurisdictions where these transactions are not allowed).

Despite concerns about whether there are enough assets in reserve to back Tether (USDT), the stablecoin continues to rise in popularity. USDT is the most traded crypto in the world (even more than Bitcoin). Tether has mainly used a way to carry out crypto-to-crypto transactions on major digital currency exchanges like Binance. Tether is also used to park crypto-assets during periods of very high market volatility.

As reported by Bloomberg, Nic Carter, Co-founder of Coin Metrics, stated:

“At those offshore exchanges Tether is the main collateral and margin type. Exchange volumes are way up and Binance volume is way up. For traders to get access to these crypto-only exchanges they often prefer a stablecoin like Tether. You can think of the supply of Tether as a transparent proxy for the balance sheet of both the crypto-only exchanges as well as the funds trading crypto on those exchanges.”

Approximately 66% of BTC is purchased by using USDT, according to CryptoCompare data. The leading stablecoin’s use is expected to growh further given that digital assets firm Coinbase Global Inc., the largest US-based crypto exchange, intends to permit trading of Tether on Coinbase Pro .

Tether’s quarterly report will be shared with New York regulators this month, Stuart Hoegner, General Counsel for Bitfinex and Tether, confirmed. The firms, which are headquartered in the British Virgin Islands, had recently settled their lawsuit (brought by the NYAG) without actually admitting or denying involvement in unlawful activities.

At the time when the settlement was reached, New York Attorney General Letitia James stated that both Bitfinex and Tether “recklessly and unlawfully covered-up massive financial losses to keep their scheme going and protect their bottom lines. Tether’s claims that its virtual currency as fully backed by U.S. dollars at all times was a lie.”

The crypto community did not have much of a reaction to this development, with many prominent industry participants claiming that it’s safe to conduct transactions with USDT.

Kyle Samani, Co-founder at Multicoin Capital, has argued that since Coinbase added USDT, it “tells you everything you need to know.”