A stablecoin is a kind of cryptocurrency that is pegged to the value of an external asset. This “peg” ensures a stablecoin stably expresses the value of its associated external asset, which in the vast majority of cases is a major fiat currency issued by a central bank.
Since these major currencies are non-volatile compared to traditional cryptocurrencies like bitcoin (BTC) and ether (ETH), stablecoins use their pegs to offer users value-stability in their payments, trading, and investing around and beyond the decentralized finance (DeFi) ecosystem.
As the U.S. dollar is the world’s reigning reserve currency, the most popular kinds of stablecoins so far have unsurprisingly been ones pegged to the value of USD.
Yet there are stablecoins that have been pegged to other fiat currencies and even commodities. For example, there’s sEUR, Synthetix’s euro-pegged stablecoin, and PAXG, Paxos’s gold-pegged stablecoin. The activity around these alternative stablecoins simply pales in comparison to USD-pegged stablecoin activity to date.
Zooming in, stablecoins are notably issued on smart contract blockchains like Ethereum. They exist per specialized token standards, with Ethereum’s ERC-721 fungible token standard easily being the most popular stablecoin implementation style around crypto as of Summer 2021.
Why use stablecoins?
Stablecoins’ ability to function as crypto-native versions of fiat currency have made them increasingly popular among cryptocurrency users in recent years. That said, some of stablecoin’s most in-demand utilities today include offering:
- crypto-native, tamper-resistant savings avenues
- affordable, low-friction international transfers
- ways to make money via borrowing, lending, and providing liquidity in DeFi
- non-volatile payments on NFT marketplaces
Types of stablecoins
There are three main types of stablecoins: custodial, collateralized, and fractional-algorithmic. A stablecoin project’s type is fundamentally determined by the way it maintains its price peg.
Custodial
A custodial stablecoin is one whose peg is underpinned by assets held in custody by a third party, like a company or group of companies.
One of the most popular custodial stablecoins in contemporary DeFi is USDC, which is issued by the Circle- and Coinbase-backed Centre organization. For all the USDC that exists on Ethereum today, a corresponding sum of USD paper notes has been custodied via Centre in the real world. This sort of custodial setup offers unique advantages, like Coinbase’s ability to offer 1:1 USDC-to-USD redemptions on an ongoing basis.
On the flip side, custodial stablecoins are ultimately permissioned since they depend on a third party allowing you access to tokens associated with the funds in their custody. Although programmable blacklistings have been rare to date, custodial stablecoin projects like Tether (USDT) have been known to freeze tokens held by crypto hackers from time to time.
Collateralized
A collateralized stablecoin is one whose peg is underpinned by deposits of cryptocurrency in specialized smart contracts.
So far the most widely recognized collateralized stablecoin project has been DAI, which is issued by the decentralized credit protocol MakerDAO. Users can deposit an approved collateral type, e.g. ETH, into a Maker Vault to mint a lesser amount of DAI.
The automated and decentralized nature of collateralized stablecoin projects thus makes them effectively permissionless in contrast to their custodial-styled peers.
Fractional-Algorithmic
A fractional-algorithmic stablecoin is one whose peg is partly maintained by deposits of collateral and partly by a specialized algorithm-based stability mechanism.
There are many more custodial and collateralized stablecoin projects in existence today than fractional-algorithmic projects, but one leading contemporary example is Frax Finance’s FRAX stablecoin. FRAX sees its reliance on collateralization and its algorithm system fluctuate depending on the stablecoins’ market price at any given time.
Related: the RAI stable asset
The Reflexer project’s Rai is a stable cryptocurrency that functions somewhat like the aforementioned stablecoins, but in contrast it’s not pegged to any external asset.
In this sense, Rai’s value continuously “floats” depending on market conditions rather than oscillating around an arbitrary price point, e.g. $1 USD, and it does this floating slowly and steadily. The result is a crypto-native unit of account (UoA) and medium of exchange (MoE) that is extremely stable in value and is good for most, if not all, of the utilities that pegged stablecoins are.
Rai, which is now trading around the $3.01 mark, is backed by over $74M worth of ETH collateral currently.
Examples of top stablecoins
The most popular stablecoins are underpinned by hundreds of millions, even billions, worth of fiat currency deposits and/or other top cryptocurrencies. Some of the largest of these stablecoins per total value locked (TVL), essentially DeFi’s name for AUM, include the following projects.
- USDT
- Type: custodial
- Current TVL: $30.9B
- USDC
- Type: custodial
- Current TVL: $24.9B
- BUSD
- Type: custodial
- Current TVL: $10.74B
- DAI
- Type: collateralized
- Current TVL: $5.23B
- LUSD
- Type: collateralized
- Current TVL: $763M
- sUSD
- Type: collateralized
- Current TVL: $233M
- FRAX
- Type: fractional-algorithmic
- Current TVL: $217M
- DSU
- Type: collateralized
- Current TVL: N/A
How to make money with stablecoins
To make money with stablecoins, you can use them to lend, borrow, and provide liquidity in DeFi.
Lending
Lenders can lend stablecoins to earn interest from borrowers via decentralized lending protocols. Taking popular lending protocol Aave as an example, users can deposit stablecoins like DAI, USDC, and USDT into the project’s smart contract-powered lending pools. Right now, these lenders are earning between 0.7% and 22.5% interest on their Aave deposits depending on which asset they’ve supplied.
Borrowing
Borrowers can use stablecoins as collateral in decentralized credit platforms like MakerDAO to borrow cryptocurrency, e.g. more ETH or more DAI. It’s up to you what you do with your borrowed funds, but one possibility is reinvesting your borrowings into DeFi platforms to earn further yields.
Providing liquidity with stablecoins
Liquidity providers (LPs) can supply stablecoins to the liquidity pools of decentralized exchanges like Uniswap to earn a portion of the trading fees generated atop their deposits. LPs earn these fees on a pro-rata basis, so in proportion to the amount of liquidity they’ve supplied to a particular liquidity pool.
How to buy stablecoins
When it comes to acquiring stablecoins, you can trade for them on a centralized crypto exchange like Coinbase, you can swap for them on a decentralized exchange like Uniswap, or you can mint them from existing stablecoins via stablecoin protocols like mStable.
Here, some things to keep in mind:
- If you want to use a centralized exchange to buy stablecoins, you’ll have to create an account on that exchange, supply your personal info, and link your bank account.
- No sign-up is required to use decentralized exchanges, but you will need some ETH in your wallet to pay for the gas fees associated with your swap or swaps.
- You can mint mStable’s mUSD stablecoin out of other stablecoins like DAI, USDC, USDT, and so forth. The idea with this “meta-stablecoin,” then, is optimized stability.
The inspiration for central bank digital currencies
The rise in the popularity of stablecoins in recent years has given rise to the development of central bank digital currencies.
These CBDCs, which in effect would be fiat currencies issued as stablecoins by central banks, offer new avenues for programmable monetary policy and could be used in both retail and wholesale, interbank contexts.
Lately, these realities have led to a boom in CBDC research by central banks around the globe. The Bank of International Settlements (BIS), the “central bank for central banks,” noted that over 70% of the world’s central banking institutions were exploring CBDC tech as of Jan. 2019. That figure is undoubtedly higher now.
Learn more
If you’re interested in learning more about stablecoins and keeping up to date with important stablecoin data, check out the DeFi Pulse Cryptodollars page. The analytics dashboard tracks the individual and aggregate TVL of stablecoins, stablecoin types, the dominance rate of the largest project at the time, and more!
