What is a stablecoin? Why are they important?

Volatility in crypto is a fact, that’s why we have lifesavers such as stablecoins that lessen the shocks. Learn how they can help you.

Key takeaways

  • Stablecoins are tokens that aim to maintain their price around the same levels, in all circumstances and regardless of external volatility.
  • Most stablecoins try to track the US Dollar, by having an enduring value of $1.0.
  • Since their creation, in 2014, they have surpassed $150 billion in combined market capitalization.
  • Maya proposes a suite of stablecoins and an offering of different liquidity pools paired against them.

If you asked us about the most important innovations in the cryptocurrencies’ ecosystem we would give you a pretty long list. It would include Bitcoin itself of course, smart contracts, privacy-focused coins, zero-knowledge proof and more. And we would also save a special place for stablecoins, a family of tokens born in 2014 but popularized during the 2017 bull market. 

Stablecoins are tokens that aim to maintain their price around the same levels, in all circumstances and regardless of external volatility or wild market conditions. By far, the most common type of stablecoins try to maintain price parity to exactly one US Dollar. Examples of these $1 USD “pegged” stablecoins include USDT, TUSD, DAI and many more.

There are other types of stablecoins, looking to maintain parity to different fiat currencies, like Euros or Yen, or even to other types of assets like gold or silver, but in this article we will mainly stick to explaining the nuances of USD tracking tokens.

As of July 2022, the combined stablecoins’ market value is worth more than $154 billion dollars, which represents around 17% of the total cryptocurrencies’ market capitalization.

How do stablecoins work?

There are basically three ways in which stablecoins try to track the price of an external asset, and they all pose some pros and cons:

Fiat Backed Stablecoins

As their name suggests, these are tokens backed by actual fiat money, and they, theoretically, work like so:

Some big, trustworthy, financial institution acts as an escrow, holding a bunch of, say, US dollars, in their custody, and then issues tokens representing this “treasury” into a blockchain. They issue the same amount of tokens as they hold US Dollars in order to have a 1:1 relation and thus the same price. Ideally, clients holding these tokens can also redeem them for their “real” dollars at any time.

In other words, for each unit of the stablecoin that the company mints on-chain, there is one dollar in their bank account to back it.

This type of stablecoin was pioneered in 2014 by Tether Ltd, with their “USD Tether” or USDT. However, there have been many doubts about the cash holdings backing their coin and, in 2021, Tether was even fined $41 million after US regulators found them guilty of misstating their reserves. As of July 2022, USDT remains the most widely used and owned stablecoin. 

Other well-known cryptocurrencies in this category include USD Coin (USDC),  which is issued by Circle, Gemini Dollar (GUSD) issued by Gemini exchange, and the Paxos Standard Token (PAX).

Crypto-Collateral-Backed Stablecoins

These are cryptocurrencies collateralized by other cryptocurrencies and issued programmatically, by use of smart contracts, that receive volatile assets and mint their USD notional value into stable assets.

They are generally more decentralized and transparent but, to some people, financially inefficient, since they require over-collateralization to work, which means that the deposited amount of crypto is always higher than the minted amount of crypto.

For example, a user can deposit 1 ETH into a stablecoin smart contract and get only 66% of its value as tokenized US dollars. If, at the time of mint, 1 ETH is worth $3,000, then this user gets only $2,000 in stablecoins. This is necessary because ETH is volatile and its price can abruptly drop at any moment; in many ways, this mechanism resembles pledged loans.

Finally, if said user wants his ETH back, he can repay the $2,000 “loan” plus a time-sensitive interest fee.

The pioneer cryptocurrency in this category is DAI, created by MakerDAO, on the Ethereum blockchain.

DAI started receiving heavy criticism when they started allowing USDC as collateral for DAI, since many people perceive this coin to be heavily centralized and too comformative with financial regulators. Today, USDC represents around 25% of DAI’s reserves and some legacy users in the crypto ecosystem have turned their back to MakerDAO.

Algorithmic Stablecoins

Algorithmic stablecoins are digital assets that rely on algorithms and smart contracts to try and maintain price stability through mechanisms like automatic inflation controls, automatic buying/selling, and more.

The leading algorithmic stablecoin was TerraUSD (UST), which, at its peak, had a market cap topping USD $18 billion. Because UST’s price control mechanisms were not sustainable or resilient enough, in May 2022 this stablecoin imploded and lost 99% of its value. Many people argue that algorithmic stablecoins simply can’t work in the long run.

Let’s go ahead and explore why anyone would want to own tokens that are trying not to increase in price at all!

Why are stablecoins useful?

Stablecoins can offer many of the best attributes of other cryptocurrencies to their users while saving them the headaches that big price fluctuations can bring.

For example, stablecoins are fast and cheap to transfer while also being borderless and transparent in nature; this makes them an excellent option when considering paying someone in other countries or continents. Both parties can monitor the international payment and definitely decide if and when it was settled.

They can also interact in the DeFi world and are thus a valuable alternative to having fiat currencies inside traditional banking institutions. Someone holding stablecoins can use decentralized investment or saving products, lend them, stake them or otherwise use them inside the crypto world as they see fit.

For many people, including more conservative users, stablecoins offer an interesting “middle ground”, to participate in crypto, without having to bear too much volatility 24/7.

The role of stablecoins in the Maya Ecosystem

At Maya, we believe that decentralized Cross-Chain technologies still require much more liquidity depth and daily trading volumes, and that stablecoins play an important role to achieve this.

That is why we have considered the possibility of launching up to five different stablecoins, based on the three types of models previously mentioned. We have also designed Stable Pools of liquidity, that pair external assets against our stablecoins, to complement our existing CACAO-paired, regular pools. These ideas are all longer term, and would be discussed within our community in due time.

You can read more about these cool Maya features in Chapter 5 and Chapter 6 of our Whitepaper. Don’t forget to stay in touch, via our official Twitter account or our Discord Server!