All You Need to Know About Stablecoins

Let’s find out what stabelcoins are, how they work, and which token to choose.

Almost every cryptoinvestor has resorted to using stabelcoins, which are cryptocurrencies tied to an asset, usually the U.S. dollar.

Stablecoins serve as the primary currency for payments because their exchange rate is stable and transactions are fast.

The stabelcoin market is enormous: there are dozens of types of coins to choose from, varying in terms of management system, collateral organization, popularity and so on. Despite this, most of the market is occupied by the 4 largest steblecoins.

Let’s understand what principles should be used to determine which stablcoin is more reliable, convenient, and secure.

Classification of Stablecoins

Basically, stablcoins are divided into two groups:

• Decentralized steablecoins;
• Centralized stablcoins.

Centralized organizations, such as Tether, fully manage the coin issue and the overall infrastructure, while decentralized projects cannot have a single owner and therefore cannot change the way such a stablcoin works in any significant way.

Usually, centralized organizations offer stablcoins tied to fiat currency, which can be the US dollar (USD), euro (EUR), or something else. Decentralized organizations are not able to link to any real-world asset, so only centralized organizations can provide real-world currency to steblycoins.

Centralized Stablecoins

The centralized stablcoin market is represented by giants like Circle (USDC), Tether (USDT) and Binance (BUSD). Let’s take a look at each of them separately.

USDT

USDT appeared in 2014 and was the first stabelcoin. It was originally called Realcoin, but was renamed after rebranding.

USDT is ranked number 3 in the CoinMarketCap cryptocurrency ranking and its trading volume is now ahead of even bitcoin.

USDT was created on the Bitcoin blockchain via the Omni Layer protocol. Now it has been released on other blockchains as well:

• TRON (TRC-20);
• BNB Smart Chain (BEP-2);
• EOS;
• AVAX C-Chain;
• BNB Beacon Chain (BEP-20);
• Algorand;
• Solana;
• Polygon;
• Tezos;
• OMG Network;
• Ethereum (ERC-20);
• and others.

Most of the USDT offering is centered on the TRON blockchain. Stablecoin is also used in other networks. Ethereum is the second most popular and in terms of volume of supply.

How USDT is issued

The issuance of tokens is handled by Tether Limited.

When a user sends fiat money to the company’s bank account, Tether Limited creates a token in the proportion 1:1 with the fiat dollar. That is, for every dollar sent, 1 USDT is issued and sent to the user. This is how tokens are put into circulation.

Withdrawal from circulation occurs in the same way, but in reverse order: USDT is sent to Tether Limited and the fiat money is sent to the user. After that, the token is destroyed.

Tether Limited issues not only USDT tokens, but also stabelcoins tied to other fiat currencies:

• EURT – a Tether coin pegged to the euro;
• CNHT – a Tether coin pegged to the Chinese yuan;
• XAUT – a Tether coin pegged to real gold.

As of December 30, 73 billion USDT have been issued. Token issuance is not limited, as it depends on the number of assets the stabelcoin is backed by. Roughly speaking, USDT can be issued indefinitely, as long as there is something to back it up.

There are 66 billion USDT in circulation.

Collateralization of USDT

Tether backs USDT through U.S. dollars (USD), U.S. Treasury bills, and other securities.

Officially, Tether holds as reserves:

• 82.45% cash and short-term securities;
• 4.69% corporate bonds, funds and precious metals;
• 9.02% secured loans;
• 3.85% of other investments, including tokens.

Unfortunately, there is not a single project that fully backs its stabelcoin with real U.S. dollars right now, but Tether has been around for eight years and has survived more than one economic crisis, and despite scandals, continues to provide a 1:1 peg.

What can you fear if you have USDT

Tether has the ability to freeze and unfreeze USDT accounts in all of the ecosystems in which it operates. It also has the ability to reset a frozen account balance, you can check it yourself.

These features can only be used by Tether. They are usually used to limit the actions of hackers who hack into various projects. No data about your location is recorded in the blockchain, but be aware that data can be collected by wallets, even decentralized ones.

Tether started blockchains back in 2017. The first address was blocked because of an allegation of $30 million in stolen funds.

There are now 810 blocked wallets with 435 million USDT. In early 2022, there were only 560.

Tether also uses these features at the request of law enforcement. For example, 46 million USDT belonging to the FTX exchange were temporarily blocked at such a request.

There is also a benefit of this feature for regular users. If you sent your USDT to the wrong place, you can send a request to restore it.

Requests are accepted from as little as $1,000.

Tether charges a fee of up to 10% of the recovery amount or $1,000 (whichever is greater) for restoring Tether tokens. The fee will be deducted from the recovery amount.

The procedure has many complexities and limitations, so it’s best not to lose your USDTs, as they are very hard to recover.

USDC

USDC appeared in 2018. It was created by Circle together with Coinbase exchange.

USDC ranks 4th in the ranking of cryptocurrencies according to CoinMarketCap. Its market trading volume per day is 9.5 times less than USDT, but despite this, the stabelcoin is popular.

USDC was launched on the Ethereum blockchain as the ERC-20 token, but now it works on other networks as well:

• Algorand;
• Avalanche;
• Flow;
• Hedera;
• Solana;
• Stellar;
• TRON;
• Polygon (via crosschain bridge).

USDC collateral

Circle holds USDC reserves in cash and short-term U.S. bonds. The current proportion is 22.1% cache, 77.9% short-term U.S. Treasuries.

The reserves are managed by large institutions including BlackRock, Bank of New York and BNY Mellon, so there is rarely any question in the market as to whether they have enough reserves.

Reserve reports are now published once a month.

How the USDC is issued

The USDC issuance mechanism is identical to the USDT mechanism, so we won’t go into that topic.

What to be afraid of if you have USDC

Circle can block wallets. An example in 2022 was the blocking of Tornado Cash bitcoin mixer wallets that had over 75,000 USDC in them. Also in 2020, $100,000 in USDC was blocked at the request of law enforcement.

In fact, USDC seeks to become a U.S. state-owned stabelcoin. Circle operates as a regulated company in the U.S., unlike Tether, although Tether also blocks funds at the request of authorities.

BUSD

BUSD was created by Paxos and Binance in 2019. Of the popular major stackablecoins, it is the youngest.

BUSD is ranked #7 in the CoinMarketCap ranking of cryptocurrencies. Its daily trading volume is 4 times less than USDT, but more than USDC by 2.3 times.

The capitalization of BUSD in recent months has shown steady growth amid growing uncertainty in the crypto market and the increasingly clear-cut establishment of Binance as the main centralized crypto exchange. This growth has largely come at the expense of the falling capitalization of USDT, USDC and DAI.

BUSD is issued on the Ethereum blockchain (ERC-20), and Binance issues tokens on the BEP-20 network and stores them on the Ethereum address (ERC-20).

BUSD can be moved between networks via an output on the Binance exchange or via the Binance Bridge.

How BUSD is issued

BUSD (ERC-20) is issued by Paxos using the same mechanism as USDC and USDT.

BUSD (BEP-20) is a token linked to BUSD (ERC-20). It is exactly issued by Binance, it is not connected with Paxos and that is why it is not regulated by the New York State Financial Services Authority, unlike BUSD (ERC-20).

The security of BUSD

The reserves of BUSD (ERC-20) consist of the U.S. debt. Paxos publishes reserve reports on a monthly basis.

Because BUSD (BEP-20) is issued by Binance and is not affiliated with Paxos, the Stablecoin is not backed by dollars, but by BUSD (ERC-20) tokens, which are held in the exchange’s reserves.

What to be afraid of if you have BUSD

In fact, no risks have been identified when using BUSD. BUSD has never been blocked in the wallets of its holders, but that possibility always remains because of the centralized nature of steblecoin.

Decentralized Stablecoins

Such coins maintain their exchange rate through smart contracts, which automatically try to maintain the coin’s exchange rate. Here, stabelcoins can be divided into two other types: algorithmic and those with excess collateral in BTC, ETH or other popular cryptocurrencies.

Usually, the rate of such coins is supported by other fundamental and extremely liquid crypto-assets: ETH, BTC, BNB.

This niche is represented by DAI, USDD, and MIM coins. By and large, they are algorithmic (because management is automatic), but it is not customary to call them as such. Let’s consider the principle of operation by the example of DAI.

DAI

DAI is released by the project MakerDao. It ranks 11th in the ranking of cryptocurrencies, according to CoinMarketCap.

The DAI contract does not include the ability to block accounts, so hackers usually try to transfer all centralized assets to DAI right away. It also means that no one will ever take your DAI coins from you, under any circumstances.

DAI collateral and issuance

Overcollateralization for DAIs can range from 150-200%. This means that if you want to get 100 DAI, you will need to provide another liquid asset in the equivalent of $150 to $200. When the price of your asset falls to the minimum allowable collateral, any blockchain user can liquidate your position by initiating a function in the DAI contract. This is usually handled by bots that operate independently of the DAI. This mechanism concerns token issuance, if you buy DAI on an exchange, you don’t have to worry about that.

There are now 5.7 billion DAIs issued and $7.1 billion of blocked assets used for collateral.

DAI risks

Half of the DAI reserves are held in the USDC. If Circle locks the USDCs that are in DAI collateral, there is a risk that users won’t be able to exchange DAIs back into USDCs. But that only applies to users who didn’t buy from an exchange or wallet, but rather contributed collateral and issued new tokens themselves.

Algorithmic

Algorithmic stackcoins are generally similar to the aforementioned DAI-like coins, but only one crypto-asset representing a blockchain is used as collateral. For example, if the Ethereum network had its own algorithmic stablecoin, it would be backed only by ETH.

For example, the UST stabelcoin was algorithmically secured by the LUNA token through the following manipulation.

When the UST grew in value, Terra would mint and sell new USTs, using the proceeds to buy the native blockchain token, LUNA. Later, Terra would exchange LUNA for other funds, forming a fund to provide LUNA to be used in crisis situations. When UST falls slightly in value, Terra would mint a LUNA token and exchange it for UST.

In order to increase the capitalization of algorithmic stackcoins, projects offer to make deposits in these coins, offering good annual interest. Terra offered up to 20%. In this way, capital flowed from other stablcoins to UST.

The problem with such projects is that they have to use aggressive strategies to raise funds, sacrificing security guarantees. Also, the collateral of such coins is usually 1:1, and with the promise of high annual interest rates, insufficient collateral even in a stable market was possible.

Now algorithmic stabelcoins do not inspire confidence because of the history with the collapse of UST and loss of USDN, so few people dare to keep their savings with such coins.

The U.S. is planning to ban algorithmic stablcoins for 2 years.

What kind of steablecoins to use?

Stablecoins are usually used to preserve capital before a crisis or if you just don’t want to have a floating balance.

Stablecoins are also often used for cryptocurrency settlements because transactions with them are fast, cheap, and there is no rate volatility.

USDT is the most popular USD-linked crypto-asset and time-tested.

BUSD and USDC are less popular U.S. dollar-linked steblecoins.

The other stablecoins, including DAI, are heavily inferior to them.

There is no way to say which is the best stablcoin, as all have their advantages. The best way is to diversify your portfolio if you are intimidated by holding assets in one cryptocurrency.