DOMANI Concept Explainer Series - Stablecoins
(DOMANI is an oracle-less Digital Asset Management platform that enables users to create, mint and manage ETF-style tokenized funds. The views expressed in the article below should not be taken as investment advice. Always do your own research.)
Stablecoins have recently been extensively debated after Terra’s UST was deppegged from the dollar, causing it to free fall well below the $1 intended peg. At the time of writing this, UST is currently trading at ~$0.07. In the first ever installment of the DOMANI Concept Explainer series we will take a look at what stablecoins are and analyze how different stablecoins can be fundamentally different.
UST/USD (-93%, 1 month)
What are stablecoins?
Stablecoins is a digital currency whose value is designed to maintain price parity to another asset or currency. In most cases, stablecoins choose to be pegged against the US dollar as an alternative to high volatility assets in crypto, which can make cryptocurrencies less suited as a medium of exchange.
What are the benefits of using Stablecoins?
The benefits of stablecoins in crypto are clear, they offer a low volatility safe haven in a market riddled with highly volatile assets. Moreover, due to the lower volatility associated with stablecoins, they are ideal as an on-chain payments solution and are often favored by traders wishing to place profits from high-volatility crypto assets into more stable assets without exiting to fiat. Stablecoins also serve a great purpose within decentralized finance (DeFi) and their decentralized applications (dApps). Stablecoins can be used as collateral to loan other assets and earn yield, or they can be provided as liquidity within decentralized exchanges (DEX) where liquidity providers (LPs) will be rewarded in tokens, otherwise stablecoins can simply be swapped for other assets directly on-chain.
What are the different types of Stablecoins?
As the DeFi and crypto ecosystems have developed over time, stablecoins have become an integral part of how the system operates, however we must not assume that just because a stablecoin labels itself as such, it will always be “stable” and retain its peg. All stables are not built the same, the main differences lie in how the stablecoins retain their peg. The value of stablecoins can be maintained through various mechanisms. Namely, there are two main ways a stablecoin can maintain its value, through collateralization or through algorithmic mechanisms and smart contracts that contract and expand the supply of the stablecoin, driving the price of the asset back to its peg. Stablecoins can also be issued by centralized institutions or be collateralised in a decentralized way.
Centralized stablecoins are issued by centralized institutions. Examples include collateralised stablecoins like USDC and USDT, which have off-chain dollar reserves held by regulated financial institutions. Also includes PAXG, which is a gold stablecoin backed by real gold reserves. These examples of centralized stablecoins, holders can redeem their stablecoins for the underlying assets at any point by burning their stablecoin and receiving fiat by the centralized institution that issued the tokens. In the case of USDC, the tokens are issued by Circle, USDT is issued by Tether and PAXG is issued by Paxos Gold.
Decentralized stablecoins are issued by decentralized institutions. This includes algorithmic stablecoins like UST and USDD, which contrary to USDC and USDT are not collateralized and cannot directly be redeemed for fiat. FRAX is another decentralized algorithmic stablecoin, however, FRAX is partially collateralized and can be redeemed for USDC and FXS. DAI is an example of a fully collateralized and decentralized stablecoin, issued by Maker DAO.