Not All Stablecoins Are Created Equal: Part 2

By Michael @ CryptoEQ | CryptoEQ | 9 Feb 2024

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Stablecoin Types and Market Overview

The landscape of stablecoins presents a complex web of designs each vying for market dominance. Within this spectrum, fiat-collateralized stablecoins serve as the bedrock for stability in the cryptocurrency markets. These stablecoins, such as USDT (Tether), USDC (USD Coin), and BUSD (Binance USD), are backed by fiat currencies and are considered the closest digital equivalent to traditional money.

Fiat-Collateralized Stablecoins: USDT, USDC, BUSD

  • USDT: The pioneering fiat-collateralized stablecoin operates on multiple blockchains and has maintained its position as a leader in transaction volume. Its value proposition lies in providing a bridge between fiat currencies and cryptocurrencies, enabling users to transact and transfer across borders without the volatility commonly associated with digital assets.
  • USDC: This stablecoin has emerged as a contender for market leadership due to its adherence to regulatory standards and transparent operations. Managed by a consortium that includes Circle and Coinbase, USDC offers a level of trust that appeals to institutional investors seeking entry into the cryptocurrency space.
  • BUSD: Regulated by the New York State Department of Financial Services, BUSD adds an additional layer of credibility for users concerned with compliance. As with other fiat-collateralized offerings, BUSD aims to combine the efficiency of blockchain technology with the stability of the US dollar.

Resources for Understanding Stablecoins

For those seeking detailed explanations or definitions around stablecoins and their inherent stability mechanisms can find valuable insights at CryptoEQ's dictionary on stablecoins.

The Impact of Regulatory Changes on Stablecoin Operations

Navigating the complex and evolving landscape of cryptocurrency, particularly in the realm of stablecoin issuance in the United States, has become increasingly challenging. The past couple of years have seen a significant shift in how US federal regulators approach the crypto banking sector, making it difficult for entities to establish essential banking relationships. This shift has particularly impacted centralized stablecoins, such as USDC, which rely on a variety of foundational elements including banking and custodial relationships, regulatory compliance, and broad distribution within the crypto space. These developments underscore the intertwined nature of cryptocurrency transactions and traditional banking systems, highlighting the difficulties that arise when access to fiat-to-crypto gateways is restricted.

The emergence of stablecoins as a potential solution to liquidity issues illustrates the ongoing struggle for balance in the crypto sector. For example, users could theoretically deposit funds with a stablecoin issuer, receive stablecoins, and then transfer these to exchanges for trading. However, this solution is not without its challenges, as stablecoin issuers themselves depend on banking access, which is increasingly under threat.

The situation is particularly stark for new entrants in the crypto market, who face significant hurdles in establishing operational banking relationships, a necessity for conducting complex financial transactions. Meanwhile, New York’s regulatory framework for stablecoins stands out for its thoroughness, mandating prompt redemption, asset-backed reserves, and transparent reporting, potentially serving as a model for federal regulation.

On a broader scale, the federal regulatory environment remains mired in ambiguity, with agencies like the FDIC and the OCC sending mixed signals about banks' participation in crypto activities. Despite this uncertainty, some private institutions have embraced stablecoins, with notable examples including Signature Bank's adoption of stablecoins for payments and the formation of the USDF Consortium, marking significant milestones in private sector adoption.

The regulatory scrutiny of stablecoins intensified following their rapid growth from 2020 to 2022, culminating in proposed legislation such as the STABLE Act, aimed at curbing potential abuses and opacity in the stablecoin market. This legislation would impose stringent requirements on stablecoin issuers, including obtaining a federal banking charter and approval from federal bodies prior to issuance.

Recent regulatory actions, such as the SEC's Wells Notice to Paxos regarding the issuance of the fiat-backed stablecoin BUSD, highlight the ongoing challenges and uncertainties in the stablecoin sector. Despite these challenges, legislative efforts continue, with proposals aimed at clarifying the regulatory framework for stablecoins and distinguishing the roles of different regulatory bodies in overseeing this emerging asset class.

The shifting political landscape, with Republicans gaining control of the House of Representatives, could influence the future of stablecoin regulation. With the party's generally pro-business stance, there may be resistance to stringent regulations, affecting the pace and nature of future regulatory developments in the stablecoin space.

Crypto Asset-Collateralized Stablecoins

In the evolving stablecoin arena, crypto asset-collateralized stablecoins represent a significant stride towards harnessing blockchain's capabilities for creating stable value stores.

DAI: An Example of Crypto Asset-Collateralized Stablecoin

DAI, a brainchild of MakerDAO, remains one of the most recognized stablecoins in this category, backed by a surplus of cryptocurrency assets rather than fiat currency. It operates on trustless machinery that locks collateral in smart contracts, generating DAI against it.

Other Examples of Crypto Asset-Collateralized Stablecoins

Entities like Magic Internet Money (MIM) and Liquity's LUSD follow similar paradigms, offering stablecoins collateralized by crypto assets with an emphasis on maintaining a value pegged to conventional currencies.

Challenges and Benefits

As these platforms strive for stability and trust in a decentralized framework, they grapple with the dual challenge of maintaining solvency and fostering efficient capital use. Investors and users alike are drawn to these instruments as they provide an anchorage point in the tumultuous sea of cryptocurrency markets, increasing their appeal among institutions seeking fixed-value crypto assets.

Fractional Stablecoins

The stablecoin ecosystem keeps evolving, and one interesting development is the rise of fractional stablecoins. These are a mix of fiat-collateralized and algorithmic stablecoins, combining the best of both worlds.

What are Fractional Stablecoins?

Fractional stablecoins are designed to maintain their peg to traditional currencies while also using algorithmic mechanisms to optimize collateralization ratios and capital efficiency. They offer a balance between stability and flexibility.

Examples of Fractional Stablecoins

Here are some notable examples of fractional stablecoins:

  1. FRAX: FRAX stands out for its dynamic collateral ratio. It adjusts this ratio in real-time based on demand, ensuring price stability by changing the balance between collateralized assets and algorithmically stabilized tokens (FXS).
  2. FEI: FEI had a challenging start with its bonding curve mechanism causing market volatility. However, it has since made improvements and now focuses on a more stabilized approach to maintain its peg.
  3. USN: USN is backed by a combination of NEAR tokens and USDT reserves, targeting a collateral ratio of 100% or higher. Its goal is to provide dollar liquidity within the NEAR ecosystem while building trust through strict collateral requirements.

The Importance of Stablecoins

Stablecoins, including fractional stablecoins, play a crucial role in the cryptocurrency market for several reasons:

  • They provide stability: While cryptocurrencies can be highly volatile, stablecoins aim to maintain a fixed value, making them useful for everyday transactions.
  • They offer liquidity: Stablecoins make it easier to move funds between different exchanges or platforms without relying on traditional banking systems.
  • They bridge the gap between traditional finance and crypto: By pegging their value to familiar currencies like the US dollar, stablecoins make it more accessible for people to enter the world of cryptocurrencies.
  • They enable decentralized finance (DeFi) applications: Stablecoins are widely used in various DeFi protocols, allowing users to earn interest, borrow funds, and participate in other financial activities in a decentralized manner.

As the demand for stablecoins continues to grow, we can expect further innovation and advancements in this space.

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Michael @ CryptoEQ
Michael @ CryptoEQ

I am a Co-Founder and Lead Analyst at CryptoEQ. Gain the market insights you need to grow your cryptocurrency portfolio. Our team's supportive and interactive approach helps you refine your crypto investing and trading strategies.


Gain the market insights you need to grow your cryptocurrency portfolio. Our team's supportive and interactive approach helps you refine your crypto investing and trading strategies.

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