#3HOUSE Campfire #Stablecoins

Author: 3HOUSE user @MsTwr

The rise of digital currencies has changed the financial landscape, with cryptocurrencies like Bitcoin and Ethereum garnering significant attention. However, the volatility of these cryptocurrencies has limited their wide adoption for everyday transactions. Stablecoins have emerged as an alternative solution that provides the benefits of digital currencies while maintaining a stable value. This article delves into the concept, advantages, and potential impact of stablecoins on the financial industry.

Understanding Stablecoins

Stablecoins are digital currencies designed to maintain a stable value by anchoring them to asset reserves such as fiat currencies, commodities, or other cryptocurrencies. This approach addresses the issue of price volatility, which is a major obstacle to the widespread adoption of cryptocurrencies. There are three main types of stablecoins:

1. Fiat-collateralized stablecoins: These stablecoins are backed by a trusted third party holding reserve of fiat currency (such as US dollars or Euros). Each stablecoin unit represents a claim on the underlying asset and can be redeemed at any time. Examples include Tether (USDT) and USD Coin (USDC). However, these types of stablecoins are often subject to strict regulation and scrutiny due to the centralization of the issuer. In multiple hacking incidents, the USDC issuer Circle froze the USDC assets in the hacker's address, which means that we do not have control over our assets and the regulator can take them away at will. Furthermore, there are many risks associated with the reserves held by centralized stablecoin issuers. Stablecoin issuers may use reserve funds to purchase US Treasury bonds or deposit them in centralized banks. In the event of a run, a liquidity crisis may occur, as seen in the recent failure of Silicon Valley Bank, resulting in the USDC being unanchored from the US dollar and the price of USDC deviating significantly from its $1 peg. This has had a huge impact on on-chain DeFi systems and has even caused the collapse of collateralized stablecoins DAI and Frax, as both rely heavily on USDC as collateral.

2. Cryptocurrency-collateralized stablecoins: These stablecoins are backed by other cryptocurrencies and are typically issued through smart contracts. To account for the volatility of the underlying collateral, they are typically over-collateralized, meaning that the value of the collateral exceeds the value of the stablecoins issued. MakerDAO's DAI is a famous example of a cryptocurrency-collateralized stablecoin. Generally, collateralized stablecoins use the method of over-collateralization, in which users borrow stablecoins at a collateral rate of 150%-200%. When the value of the collateral reaches the liquidation line, a liquidator will come in to specially settle the stablecoins to repay the borrowed stablecoins. In the process of decline, the better the liquidity, the lower the liquidation line will be. However, if the liquidity of the asset is poor, bad debts may occur before the liquidation, which means more collateral is needed, the collateral rate will be higher, and the utilization rate of the asset will also decrease.

3. Algorithmic stablecoins: These stablecoins are not backed by any collateral but rely on algorithms and smart contracts to control the supply and demand of the currency to maintain a stable value. Examples include Ampleforth (AMPL) and Basis Cash (BAC). The most famous case of algorithmic stablecoins is Luna/UST. In the early bull market, Luna's market value was low, and users minted a large amount of Luna into UST to participate in the 20% annualized mining on Anchor. A large amount of Luna was minted into UST, driving up the market value of Luna, and pushing up the market value of UST through a spiral effect. UST even rose to the top three stablecoins in terms of market capitalization. When the market entered a bear market, the price of Luna fell, and the UST mechanism could not maintain the market value of UST. The entire stablecoin was in a state of insolvency, resulting in a large amount of UST being exchanged for Luna and other stablecoins. The demand for UST disappeared, and the risk increased significantly. At this time, a death spiral was formed, resulting in the unanchoring and collapse of UST, which directly affected other institutions and protocols in the industry, dragging the cryptocurrency market value into the abyss and causing a series of subsequent explosions such as 3AC and FTX. Algorithmic stablecoins have undergone a series of innovations, but have still not been successful, and each collapse has caused huge irreversible damage to the industry. Despite many failed cases, the exploration of algorithmic stablecoins is still ongoing, and stablecoins will be a persistent narrative in the cryptocurrency field.

Advantages of Stablecoins

Stablecoins have several advantages over traditional cryptocurrencies and fiat currencies:

1. Price stability: As the name suggests, stablecoins maintain a stable value, making them suitable for daily transactions and as a reliable store of value.

2. Faster and cheaper transactions: Stablecoins use blockchain technology to enable faster and cheaper transactions, making them more advantageous compared to traditional banking systems. Traditional cross-border payment systems are not only expensive but also slow and cumbersome, making them difficult for ordinary people to use. However, stablecoins can achieve real-time cross-border transfers with negligible transaction fees.

3. Financial inclusivity: Stablecoins provide access to digital financial services without requiring traditional bank accounts, especially in developing countries, promoting financial inclusivity. Obtaining a credit card in traditional finance is difficult, and many people cannot afford low-cost financial accounts. However, with blockchain systems, anyone can easily have their wallet and seamlessly participate in the global financial system, making it attractive to people in the third world and developing countries.

4. Transparency and security: Blockchain technology ensures transparency and security, reducing the risk of fraud and counterfeit transactions. Since blockchain is a decentralized account system, all public transactions are traceable on the chain, and users do not have to worry about their transactions being fraudulent. Therefore, stablecoins are inherently more trustworthy.

Future of Stablecoins

Stablecoins may have a significant impact on the financial industry. They can facilitate cross-border transactions, remittances, and micro-payments, reducing transaction costs. Additionally, stablecoins can serve as a bridge between traditional finance and decentralized finance (DeFi) ecosystems, promoting new financial products and services.

However, the growth of stablecoins has raised regulatory concerns. Central banks and regulatory authorities are closely monitoring the development of stablecoins, assessing their potential risks and rewards. Some countries are also exploring the idea of central bank digital currencies (CBDC) as a response to the rise of stablecoins. Centralized third-party stablecoins still face significant challenges, and the future trend is towards decentralized stablecoins. Although this path is full of failures and obstacles, it will benefit everyone worldwide once it succeeds.

Conclusion

Stablecoins are a promising solution to the volatility of traditional cryptocurrencies and have many advantages over traditional financial systems. As the stablecoin market continues to grow, regulatory issues must be addressed to ensure a safe and transparent ecosystem. By doing so, stablecoins can pave the way for a more inclusive and efficient global financial system.

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