Understanding Stablecoins

This is the BEST application of tokenization.

This is already a $125,176B market

The stablecoin EMPIRE (and WAR) keeps growing.

The world's largest stablecoin Tether made $1B operational profit in Q2.

The 2nd biggest stablecoin issuer Circle is considering an IPO in 2024.

One of the world's most valuable fintech company PayPal recently launched its stablecoin PYUSD.

There's over 120 stablecoins available in the market.

But how many are really relevant ?

Is stablecoin a SCAM ?

  1. What Is a Stablecoin

  2. How It Works

  3. The Stablecoin Trilemma

  4. The BIGGEST Threat

  5. 11 Risks to Know

  6. 12 Questions to Ask

  7. 4 Most Popular Stablecoins

  8. The Future of Stablecoin

What Is a Stablecoin

A representation of a $ on the blockchain.

The best application of tokenization (bringing a real world asset on chain)?

How It Works

A stablecoin $ must have enough reserves (collateral) at least equal to the value of each stablecoin $ (ratio 1:1) to keep its price steady at one dollar.

The Stablecoin Trilemma

The stablecoin trilemma is a concept that suggests it is difficult for a stablecoin to achieve stability, decentralization, and capital efficiency at the same time. Each stablecoin approach tends to achieve two of these at the expense of the third.

Stability: The ability of a stablecoin to maintain its value (1$ for 1 stablecoin $)

Decentralization: The stablecoin is distributed among many different parties rather than a central authority.

Capital Efficiency: The stablecoin does not require a large amount of excess collateral to maintain its stability.

Here’s how the trilemma comes to life:

  • A stablecoin can be stable and decentralized, but then it might require over-collateralization, making it capital inefficient (LUSD)

  • A stablecoin can be stable and capital efficient by being backed one-to-one with fiat or other assets, but this often requires centralization (USDT)

  • A stablecoin can be decentralized and capital efficient, which often involves complex algorithms to maintain the stability without excess collateral, but this can lead to issues with maintaining stability (UST)

The Biggest Threat

The peg of a stablecoin is the stable value it is set to maintain. The biggest threat stablecoins $ face is peg loss.

11 Risks to Know

  1. Collateral Risks:

    • Fiat-Backed: Risks of bank failure or seizure of assets by government authorities; if the reserves are not regularly audited, there might be doubts about whether the stablecoin is fully backed. This is the reason USDC recently deppegged.

    • Crypto-Backed: Subject to the volatility of the underlying crypto; if the value of the collateral plummets rapidly, it may not sufficiently cover the value of the stablecoins.

    • Algorithmic: They may fail to maintain their peg if the algorithm does not function as intended, especially during extreme market conditions, as seen in various historical "de-pegging" events. That’s why UST failed.

  2. Regulatory Risks:

    • Changes in regulations can have significant impacts on the operation and stability of stablecoins.

    • Governments may impose restrictions or outright bans on the use of stablecoins.

  3. Operational Risks:

    • Smart contract vulnerabilities can lead to hacking incidents or unintended issuance of coins.

    • Poor operational security can result in theft or loss of reserves.

  4. Liquidity Risks:

    • In times of market stress, there may be a "bank run" on the stablecoin, with many users trying to redeem their coins at once, potentially overwhelming the reserves. It also happened during USDC depeg

    • Liquidity issues can also arise if a significant portion of the stablecoin is held by a small number of investors.

  5. Market Risks:

    • A loss of confidence can lead to a decrease in the use of the stablecoin, impacting its value.

    • Market manipulation can also occur, especially if the market for the stablecoin is not very liquid.

  6. Legal and Compliance Risks:

    • There could be legal uncertainties about the rights of stablecoin holders.

    • Compliance with international AML/KYC requirements can be complex and costly.

  7. Systemic Risks:

    • Large-scale adoption of a particular stablecoin could create systemic risk within the broader financial system.

    • Interconnectedness with the traditional financial system can transmit shocks across systems.

  8. Pegging Mechanism Risks:

    • Maintaining a stable peg is challenging, and mechanisms may fail, especially for algorithmic stablecoins that rely on maintaining balance through supply and demand.
  9. Counterparty Risks:

    • There are risks associated with the entities that hold the collateral or manage the reserve funds, including trustworthiness and solvency.
  10. Scaling Risks:

    • As the stablecoin grows in popularity, the ability to scale operations and maintain a stable peg becomes more challenging.
  11. Censorship Risks: Centralized stablecoin issuers can freeze the assets of their holders

12 Questions to Ask

To assess the relevance of a stablecoin, you need to analyze its risks but you should also ask yourself the following questions:

4 Popular Stablecoins

The future of Stablecoin

Stablecoin is a juicy business for issuers.

Tether, Circle & MakerDAO are making a lot of money.

That’s why the stablecoin war is fierce.

To stand out, the next gen of stablecoins will need to offer unique utilities that will truly empower holders.

Some new projects are doing it relatively well.

$GHO, stablecoin launched this year by AAVE, allows its holders to have reduced fees on their loans by staking $AAVE

$eUSD, stablecoin launched this year by Libra Finance, is pioneering the concept of interest-bearing stablecoin allowing its holders to generate yield with their stablecoin by just holding it (no staking required)

We’ll keep following this space very carefully

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