During the past decade, several new innovative products have been created in an effort to disrupt the financial services industry. Arguably, the product that has unleashed the most disruption is stablecoins. The first stablecoin was Tether (USDT), officially launched in October 2014.
Immediately upon its introduction to the crypto industry, Tether became incredibly popular and quite useful. Since the release of Tether, over 200 stablecoins have been announced. However, the majority of these coins are still lingering in the phase of research and development (R&D). Additionally, 10% have been discontinued. Currently, 36 stablecoins are in existence with a market capitalization of $75.7 billion. Let’s examine a list of the top 5 stablecoins.
- Tether (USDT) – $48.7 billion
- USD Coin (USDC) – $11.3 billion
- Binance USD (BUSD) – $5.4 billion
- Dai – (DAI) $3.6 billion
- TerraUSD (UST) – $1.8 billion
As you can see, Tether is clearly the leader within the stablecoin universe. In fact, Tether’s market capitalization comprises 64% of the entire industry. The top five coins represent 94% of all stablecoins. Essentially, five coins dominate the entire space.
Stablecoins Versus Traditional Cryptocurrencies
Although stablecoins share many of the same features and characteristics of cryptocurrencies, they were designed to solve some of the problems inherently rooted in cryptocurrencies. Let’s discuss the details.
When Satoshi Nakamoto launched the world’s first cryptocurrency on a decentralized ledger in January 2009, Nakamoto could not possibly have forecasted the substantial price appreciation that would transpire during the first decade of its existence. Of course, the cryptocurrency we are referring to is Bitcoin (BTC).
The dramatic increase in the value of BTC in the years following its release was both a benefit and a curse within the global crypto community. Obviously, Bitcoin’s price increase was a huge benefit because a substantial number of investors enjoyed historic rates of return. However, the extraordinary price appreciation was also a major detriment to Bitcoin investors because these price advances also included a great deal of volatility.
Many people in the crypto community were unaware that Nakamoto’s original concept for Bitcoin was a peer-to-peer payment system. In fact, the initial paragraph of the Bitcoin white paper describes “A purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution.”
As you can clearly see from the white paper, Nakamoto was enamored with the idea of an electronic P2P payment system without the need for a third-party intermediary. From 2009 through 2017, the vast majority of the crypto community supported Nakamoto’s belief that Bitcoin was designed to be a payment system that would ultimately replace Visa, Mastercard, PayPal, and other payment forms as the preferred method for daily transactions.
Following the historic rally in 2017 and subsequent collapse in early-2018, Bitcoiners came to the realization that BTC was much too volatile to be used as a method of payment for daily transactions. Beginning in 2018, the Bitcoin narrative began to change from “method of payment” to “store of value.” Based on the fact that BTC had substantially outperformed gold and all other major asset classes since its inception in 2009, the best use case for Bitcoin going forward was a store of value.
Although the Bitcoin community had successfully changed the BTC narrative in 2018, they still had to deal with the fact that cryptocurrencies were inherently volatile. In order to solve this problem, stablecoins were rolled out on a large-scale basis. Stablecoins are an excellent vehicle for performing day-to-day transactions because they are simplistic, stable, scalable, and secure. Stablecoins fulfilled the role of Nakamoto’s original intent for Bitcoin, which was a peer-to-peer payment system.
Unlike cryptocurrencies, stablecoins are not prone to dramatic price fluctuations because each stablecoin is linked to a fiat currency like the US Dollar or Euro. It is collateralized by the value of the underlying asset. Additionally, each stablecoin is pegged at a 1:1 ratio with the underlying asset. This explains how stablecoins are able to maintain price stability even if other cryptocurrencies are experiencing dramatic volatility.
Types of Stablecoins
Stablecoins can be placed in four different categories. Let’s briefly review each category.
Fiat-collateralized – The vast majority of stablecoins are fiat-collateralized. This means that the stablecoins are backed by fiat currencies like US Dollar, Euro, British Pound and other fiat currencies. As we previously mentioned, stablecoins are linked at a 1:1 ratio with the underlying fiat currency. For each stablecoin in existence, fiat currency is held in a bank account as collateral. When a trader initiates a stablecoin withdrawal, the crypto exchange transfers fiat currency to the trader’s bank account and the corresponding stablecoin is taken out of the trader’s crypto account and removed from circulation.
Commodity-collateralized – As the name implies, commodity-collateralized stablecoins are supported by interchangeable assets such as commodities. The most popular asset in this category is precious metals, specifically gold. In addition to gold, other assets include silver, crude oil and even real estate. The most attractive feature of commodity-collateralized stablecoins is that the owners of these coins hold a tangible asset with real value. This is in stark contrast to other cryptocurrencies, which typically have no tangible value.
Crypto-collateralized – These stablecoins are backed 100% by other cryptocurrencies. Many crypto investors don’t support fiat-collateralized stablecoins because they are linked to the legacy financial services industry through fiat money. Instead, these investors prefer 100% decentralized stablecoins, with all transactions conducted on the blockchain. Even though crypto-collateralized stablecoins are inherently more volatile, there is a growing list of supporters who are willing to tolerate the volatility in exchange for a purely decentralized transaction.
Non-collateralized – Even though stablecoins have been in existence since 2014, very few non-collateralized stablecoins have been issued. The demand for such a coin is relatively small because it carries the greatest amount of risk among all stablecoins. Despite its inherent risk, there is a small group of crypto investors who prefer this type of stablecoin because it is the most decentralized and independent form of stablecoin. Its decentralization stems from the fact that the coin is not collateralized to any other asset. Therefore, it avoids dealing with centralized assets such as fiat money and commodities.
Use Cases for Stablecoins
Even though stablecoins have only been in existence for six years, crypto experts have discovered several different use cases. Let’s review a few of the ways stablecoins are being used within the cryptocurrency ecosystem.
Without question, the most common use case for stablecoins is the ability of crypto traders to easily transfer their funds between various crypto assets. Prior to the introduction of stablecoins, traders were unable to move their crypto assets to a safe and secure coin. Instead, they were forced to liquidate their cryptocurrencies, convert the proceeds back to a fiat currency and also remove their funds from the crypto exchange. Thanks to the introduction of stablecoins, traders have the option of liquidating their cryptocurrencies and parking the proceeds in a stablecoin. This allows all funds to remain in the cryptocurrency ecosystem. Thanks to stablecoins, traders and investors can completely avoid the fiat system.
As stablecoins continue to gain widespread acceptance, the retail community could ultimately become the biggest beneficiary. As we previously discussed, Satoshi Nakamoto’s original use case for Bitcoin was a medium of exchange for day-to-day transactions. However, the daily use of BTC never gained widespread adoption because Bitcoin was simply too volatile. Stablecoins have solved the volatility problem. Therefore, stablecoins have the potential to be used as a daily medium of exchange, finally realizing Nakamoto’s original use case for Bitcoin.
Another use case for stablecoins involves smart contracts. During the past few years, several industries have explored the idea of using smart contracts in an effort to lower their costs by removing third party intermediaries. However, companies have been reluctant to use smart contracts because the payment method usually involved a volatile cryptocurrency like Bitcoin or Ethereum. Thanks to stablecoins, several industries are reexamining the use of smart contracts because the problem of volatility has been solved.
Crypto experts believe that we are just beginning to scratch the surface in terms of how stablecoins will be used as a bridge to connect the old legacy financial services industry with a new system based on decentralized finance. Stablecoins could easily become the fastest growing sector within the cryptocurrency universe.
Digitex writers and/or guest authors may or may not have a vested interest in the Digitex project and/or other businesses mentioned throughout the site. None of the content on Digitex is investment advice nor is it a replacement for advice from a certified financial planner.