Crypto101: What are stablecoins?

The obvious advantage of stablecoins over other cryptocurrencies remains their stability, in this article, we will explain what stablecoins are.

What are stablecoins?

A stablecoin is any cryptocurrency designed to have a relatively stable price, typically through being pegged to a commodity or currency or having its supply regulated by an algorithm.

There are, broadly speaking, two ways to set the value of a coin to a public currency (or "fiat", according to Latin anglicism). The first is similar to the management of a monetary fund: the operator puts in reserve as many dollars (or euros, etc.) as he issues tokens. This is the system announced by Tether, the first and most contested stablecoin.

Regulations are very strict in traditional finance, but these rules do not apply in cryptos.

One can hear in their speeches the echo of the "true competition of currencies", theorized by Friedrich-Augustus von Hayek in the 1970s and one can see in their stablecoins the technological incarnation of the "self-declared private currencies" imagined by the great liberal economist. But while he imagined banks free to issue money, the structures behind decentralized finance are more ghostly. "Many entities in cryptos still lack legal personality," notes lawyer Hubert de Vauplane.

What are the main types of stablecoins?

The main stablecoins are based on fiat currencies or metals, but there are also other types. Here is a list of the main stablecoins:

Dollar-indexed stablecoins

Tether (USDT),

USD Coin (USDC),

TrueUSD (TUSD),

Binance USD (BUSD),

Gemini Dollar (GUSD),

Paxos Standard (PAX).

Stablecoins indexed to other fiat currencies

Stasis Euro (EURS), indexed to the euro,

Tether Euro (EURT), pegged to the euro

Binance GBP Stable Coin (BGBP), indexed to the British pound.

Stablecoins indexed to metals

CACHE Gold (CACHE), indexed to gold,

Tether Gold (XAUT), indexed to gold,

Paxos Gold (PAXG), indexed to gold.

Also noteworthy is the case of Petro (PRT), issued by Venezuela and indexed to the country's oil reserves.

Stablecoins based on the most popular algorithms are:

Ampleforth (AMPL),

Celo Dollars (CUSD),

and Terra (UST).

How do stablecoins work?

Stablecoins, despite being indexed to external assets, are still classic cryptocurrencies. They are backed by blockchains, be it Binance's, Ethereum's or their own chain.

They can be used in the same transactions as other crypto-currencies - stablecoins are particularly popular for their stability and by investors in DeFi (decentralized finance) projects. They can be more easily converted back into fiat currency, or gold.

The case of stablecoins indexed to cryptocurrencies is peculiar and may seem counterintuitive, given that their success is largely due to their stability. The mechanism to counter their volatility is therefore different from others. For example, the price of DAI is constantly monitored by smart contracts. If the price of DAI fluctuates too much, corners are destroyed in order to stabilize its price.

Algorithm-indexed stablecoins are still a special case, as they have no collateral, contrary to what one might think. Instead of a dollar or a gram of gold, the stability of the value of these coins is guaranteed by an algorithm and by smart contracts. The latter manages the number of tokens in circulation. For example, if "marke t prices are falling, the algorithm will remove tokens from circulation, explains the specialized site Cryptopedia. Conversely, if prices are rising, the algorithm will decide to produce new tokens to dilute their value." Thus, it is possible that the number of tokens owned by a person will change, but the total value will remain stable, says the ethereum site.

There is no need to mine stablecoins to get them. In the case of Tether, you only need to deposit one dollar to get one USDT. The same goes for CACHE Gold: 1g of gold is equivalent to one coin. For other stablecoins, there are different situations. For example, new IADs are created by users, in exchange for collateral of their choice.

Governments want to regulate these assets

In the draft European Mica regulation, an electronic money institution status will be required to issue stablecoins, placing issuers under the authority of the European Central Bank. "Even before it came into force, the banking regulations deterred many stablecoin creators," observes Pierre Noizat. In fact, these are quite rare: neither the EurB of the German bank BVDH, nor the EurS of Stasis, nor the Par of Mimo Capital have really broken through. In France, the Casino Group has been testing a stablecoin euro, Lugh, since last year, developed with Société Générale and designed to facilitate crypto payments in its stores.

It is indeed through e-commerce that the links between the real economy and crypto-currencies are developing the fastest, rather than through savings. "Crypto assets are mainly held by individuals," Stéphane Reverre reminds us, "because the necessary conditions of liquidity and transparency have not yet been reached." In China, on the other hand, the reserves allocated to financial services that accompany transactions on Tencent and Alipay had reached some $300 billion last year. Financial authorities have imposed stricter regulations, which has led to an all-out crackdown on cryptos. Payments were also at the heart of Facebook's Libra project, which was to be based on a set of stablecoins and then, renamed Diem, a dollar stablecoin. Opposition from regulators in Europe and the United States led Meta to abandon the idea.

Triple problem

The development of stablecoins poses, in short, a triple problem for financial authorities. Since private money creation is potentially unlimited, if pseudo-banks tie it to fiat currencies, this tsunami could aggravate inflation, destabilize trade and, above all, threaten the monopoly of issuing money, a central point of sovereignty. So, for example, when Great Britain says it wants to allow payments in stablecoins, it is actually surrounding them with extremely strict conditions.

The general response of the financial system is to prepare central bank digital currencies (CBDs). "This is a real geostrategic issue," analyzes Hubert de Vauplane: "Pass that El Salvador and the Central African Republic adopt bitcoin, but how should we react if Serbia adopts the e-yuan?" A hypothesis far from being theoretical, considering the scale of Chinese investments in the world, the Digital Silk Road could be doubled with a monetary Silk Road.

China and Europe seem to be ahead of the game. Although the Biden administration beat the rap with an executive order late last year, the U.S. market seems more accommodating and could make room for regulated stablecoins. "An MNBC is a solution waiting for a problem," said Dante Disparte, a former Libra executive who became Circle's chief strategy officer, at a London conference.

Digital currencies of central banks

In the French world of innovation, the deployment of MNBCs is still being debated. For venture capitalist Alban de La Bretèche, a partner at Ring Capital, there is no doubt: "In a few years, MNBCs will replace stablecoins," he says. But there are still many problems, especially regarding the programmability of the currency. "Thanks to NFTs, DAOs have become hotspots of creativity, both from a technological and artistic point of view," observes consultant Xavier Dalloz, for example: "Stablecoins are absolutely necessary for their financing, because it is hard to imagine a central bank digital currency presenting the flexibility needed to foster innovation in smart contracts." MakerDAO's DAI, a decentralized organization on Ethereum, relies directly on bitcoins and ethers, for example. One wonders what would happen if bitcoin and ether, which have lost 30% of their value this week, continue their downward slide. MakerDAO would plan to ask, in that case, to update this collateral. These would likely be the first margin calls in the history of cryptocurrencies. A prospect that has in any case allowed DAI to weather the storm. Until now.

Are stablecoins decentralized?

This is one of the biggest criticisms of stablecoins: they are in some cases centralized. In practical terms, this means that an intermediary is needed during a transaction. This is particularly the case for Tether, because it is the company that issues tokens in exchange for dollars. This is also the case for stablecoins indexed to metals.

This is the exact opposite of the spirit of cryptocurrencies, which were developed to be decentralized and not require third parties to trade. And this is why these stablecoins are highly criticized in the crypto community.

Some stablecoins are however decentralized: this is notably the case of those indexed on other cryptocurrencies, or those backed by algorithms.

Conclusion

They enjoy many of the advantages of classic crypt exchanges are faster than with traditional banks, and they can be used for decentralized finance projects.

Some stablecoins do have one major problem: their centralized nature, which makes them less secure, less independent and less transparent. And it's not just that: since their values remain stable, stablecoins are not a very lucrative investment for stock market bettors. Some still have new protocols, such as algorithm-based stablecoins, which can make them unstable, and they remain quite complex to understand.

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