Have you ever heard of Tether, USD Coin, DAI, AMPL or other asset that claims to have a target price? I am sure yes, but if not, this post will make you understand how tokens, offering the possibility to accept crypto without worrying much about the market volatility, work.
Crypto in general, has a very high volatility. For instance, Bitcoin kept rising since the beginning of this year up to its all time-high, then it recently dropped down to almost half of it, taking the all crypto market with it.
For long term use, if you are a holder or hodler, you know that its price will go much higher, so this is not a problem for you. But, for people looking for an asset for everyday use with a value staying relatively stable, this will not work. Therefore, Stablecoins are here for this purpose. Stablecoins offer the possibility to accept crypto without worrying much about the market volatility.
Types of Stablecoins
It exists different types of Stablecoins, but at the end they all have the same purpose: achieving a price relatively stable, around a pre-defined target price, with as low fluctuation as possible.
Centralized Stablecoins Tied To FIAT
FIAT is the currency issued by the governments, that the people mostly use every day, for instance U.S.Dollar $, Euro €, Pound Sterling £. These FIAT currencies are centralized, managed by central organizations and tend to stay relatively stable.
For Centralized Stablecoins, having a price relatively stable is done by tying/linking the assets to these FIAT stable currencies. For that purpose, a reserve stock is gathered/set up by the central organization governing the tying, serving as collateral, pledged as a guarantee to be repaid, backing the Stablecoins. The final objective is having the Stablecoins value equal to the FIAT assets backing them.
Tether (USDT)
One of the leaders in Stablecoins market is Tether (USDT). This asset, operated by Tether Limited, was created in 2014 for the purpose of converting FIAT into digital currency, crypto. This swap is targeting a 1:1 ratio with the U.S.Dollar.
This Stablecoin asset claims to have a reserve stock 100% backed for its coin.
Every Tether token is always 100% backed by our reserves, which include traditional currency and cash equivalents [...] Every Tether token is also 1-to-1 pegged to the dollar, so 1 USD₮ Token is always valued by Tether at 1 USD. - Tether official website
USDT is mostly used on exchanges as a bridge between FIAT and crypto, but it is also minted on several networks such as Ethereum as an ERC-20 token, Tron as an TRC-20, EOS and others...
Useful links:
USD Coin (USDC)
Another asset leader in the Stablecoins market is USD Coin (USDC). This asset, created by Coinbase in 2018 has also the purpose of converting FIAT into digital cryptocurrency, with a target ratio of 1:1 with the U.S. dollar.
This Stablecoin asset claims to have each of its USDC backed by 1 $ (USD), with reserve stocks located in bank accounts.
USDC is issued by regulated financial institutions, backed by fully reserved assets, redeemable on a 1:1 basis for US dollars, and governed by Centre, a membership-based consortium that sets technical, policy and financial standards for stablecoins. - USD Coin official website
This crypto asset is also minted on the Ethereum blockchain, as an ERC-20 token.
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Decentralized Stablecoins Tied To Crypto
These Stablecoins do not have central organizations governing the assets, but are governed by users taking part in the networks, who have weight when voting according to the percentage of governance tokens they hold.
Most of the time, when buying/borrowing the decentralized Stablecoins, a certain amount of other crypto asset is required as collateral, representing the reserve stock.
Dai (DAI)
Maker Protocol’s stablecoin, DAI, requires its users to lend/lock up an amount of crypto asset for buying/borrowing. This collateral comes as Ethereum ETH, the native token of the Ethereum network or more recently with other assets through the multi-collateral possibility. Once the borrowed DAI, plus a little fee characterized as stability fee, are returned, the overcollateralized asset is given back. At the end, DAI aims to be worth a ratio of 1:1 with the U.S.Dollar currency.
Moreover, DAI is governed by MKR token holders.
These holders form a decentralized community, in which governance is given according to the percentage of tokens held by members. This governance is a gateway to enable changes to the network by having vote according to the number of MKR tokens held, for governing the risk management and the market logic of the Maker system coming for instance as the stability fee or what type of assets to allow as collateral.
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Decentralized Coins Relying On Algorithm
This type of tokens tries to look like as much as Stablecoins as possible, but may not be considered by such term because of having volatility. These assets rely on algorithm to stay as stable as possible near their target price and are not dependent on centralized collateral or lenders because of using an elastic supply mechanism.
For instance, one way is by changing the percentage of tokens supply by either burning or creating coins, according to the market volume, to make the value of the assets converging to the final target price. Indeed, when the value of the assets drops below the target price, the algorithm burns a percentage of the supply of the coins leading to scarcity, in order to make the price of the assets rise to achieve the target price again. On the other hand, when the value of the assets pumps over the target price, the algorithm creates a percentage of supply of the coins, in order to make its price decrease to achieve the target price again. All of that in order to converge to the final target price. For example, Ampleforth AMPL uses this method.
The target price of the AMPL asset is 1.033$. Every day at 02:00 AM UTC, a rebase takes place in order to make the price of the token converge to its target price. When the value of the asset is over the target price, the rebase is positive, creating a certain amount of tokens given back to holders according to the percentage of rebase and the amount they hold. In contrary, when the value of the asset is under the target price, the rebase is negative, burning/deleting tokens of holders according to the percentage of rebase and the amount they hold.
Nevertheless, you have to be careful with the AMPL token market volatility! Indeed, AMPL provides the same function as Stablecoins do, by being near a target price of 1.033$, but it does not eliminate volatility.
The Ampleforth team highlighted the reasons why on their website:
Often we're asked: "If the number of tokens in my wallet can change, then isn’t AMPL still speculative and volatile? Why not use a stablecoin like Tether or DAI for contract denomination?" Our Answer: "Because the goal of the decentralized finance movement, is to create an alternative financial ecosystem, beyond the reach of politics." Stablecoins today either rely on 1) traditional banks, or 2) lenders of last resort. AMPL is an independent financial primitive that does not rely on centralized collateral or lenders of last resort. It's like Bitcoin, except it can be used in contracts. - AMPL official website
Changing the token supply based on the market conditions is a good way to reach the final target price, by not being dependent on centralized collateral or lenders, but it still brings volatility...
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Some Stablecoins Usage Examples
Stablecoins can be used for swapping. On many exchange websites, when traders or simple holders feel like their portfolio is going to take a serious hit in the face, because of a sharp drop of the market, they may swap a certain percentage of their assets into Stablecoins. Like that, they apply a common rule that you may have heard: "Buy Low, Sell High!". For instance, let us say that someone invested 35,000$ in Bitcoin at a price rate around 35,000$, leading to 1 BTC. After a couple of weeks after holding the asset on the exchange, the market tends to turn bearish because of someone popular saying Bitcoin is not green enough...
Consequently, the "holder" decides to sell 60% of his Bitcoin, representing 0.6 BTC, at a price rate of 56,000$ per BTC, leading to an amount of 33,600$. Taking in consideration about 1% fee, the final amount would be around 33,264$. Generally, because of not withdrawing the money into FIAT to the banking account, but by keeping it on the exchange, this amount is swapped into a worthy amount of a stablecoin, most of the time into USDT. As seen previously, this stablecoin is worth ~1 $.
So the swap is from 0.6 BTC to around 33,264 USDT. Then the market crash a bit, leading Bitcoin down to -37.5%, achieving 35,000$ again. The previous person decides at this point to buy BTC again, with all his UDST earned from the previous swap. So the 33,264 USDT with about 1% fee charged are invested again, representing 32,931 USDT of investment. This amount leads to around 0.94 BTC.
At the end 1.34 BTC is in his portfolio, rather than if the person had not done the previous swap during the drop, his BTC amount would have still been 1 BTC. Therefore, 34% profits were made thanks to the swap to a crypto that had not been disturbed by the market volatility during the drop with its value staying relatively stable around 1$.
Another usage of Stablecoins on exchanges would be by taking part in leverage trading. For instance with these positions on Stormgain:
By the way do not hesitate to join Stormgain through my referral link, Stormgain offers free USDT to trade when reaching 10$ worth of BTC on their free BTC cloud mining. I made a post on it.
Other use, with the AMPL asset (once again, careful for what you want to do with the AMPL token, it brings volatility because of not being a true Stablecoin, but volatility reaching at the end the final target price). The target price, around 1.033$ is reached by adjusting the supply of the coin. So lots of people take this at their advantage. When the price is super low in comparison to the target price, for them this is the time to accumulate as much of the asset as possible, to make the percentage of supply value owned high. Therefore, when the price will be upper than the target price, a percentage in the supply will be added to holders to reach, once again, the target price according to its rebase. Then, selling a part of the asset owned is done to be in profit.
Other use, when you want to buy crypto, you may buy it directly with credit card, but if you have Stablecoins, you can swap them directly into the crypto you want to buy, according to their price rate. Generally acting with a ratio of 1:1 with U.S.Dollar, it offers a bridge between FIAT and crypto.
Some Stablecoins Cons
Although Stablecoins tend to have no volatility, to reach the objective of being as stable as possible, we could say that they are as stable/volatile as the asset that they are linked/tied to. In fact, any fluctuations in the FIAT value would have an impact on the Stablecoins value.
Another drawback when relying on Centralized Stablecoins, is that you have to trust the organization governing the assets and so as the amount claimed to be as collateral. Sometimes, these organizations do not provide any proofs about their reserve, but just the numbers.
The parole is yours
So, among all you read, what do you think of Stablecoins providing a bridge between FIAT and crypto? Do you have some for sending and receiving funds thanks to its price relatively stable? Or do you use them more for borrowing/swapping/trading? Feel free to share your use or any other feedbacks in the commentary section!
