ETA Expert Insights: Understanding Stablecoins
Isaac Smith, Underwriter, US Alliance Group
ETA Technology Committee, Blockchain / Crypto Working Group
The following is a summary of a recent roundtable and presentation by Isaac Smith to the ETA Technology Committee, Blockchain / Crypto Working Group, to help payments professionals understand this payment alternative.
Stablecoins offer the speed and security of a blockchain, but not the volatility of cryptocurrencies and are being used to make regular transactions and store value.
What is a Stablecoin?
- Most stablecoinsare used for trade. Cryptocurrencies have volatile price swings, and stablecoins offer stability for traders.
- Stablecoins are cryptocurrencies that maintain a value of 1:1 to the US Dollar or any other government-issued currency.
- Stablecoinsexist on many types of blockchains.
- Stablecoinscan be used to lend for rates better than those offered by traditional finance but do not offer government-backed insurance.
Trading Pairs and Liquidity Pools
- Stablecoins are usually paired with another cryptocurrency in a trading pair.
- Liquidity pools are made of trading pairs and consist of volatile cryptocurrency. It is a marketplace where only two types of coins are offered for exchange.
- For example, USDT / DOGE. When a DOGE coin increases in value, a trader may exchange his DOGE coin for a stablecoin to prevent further loss if the value drops.
Top Three Stablecoins
- Tether issued USDT
- Launched in 2014, it is currently the largest stablecoinby market cap. (73 Billion)
- Tether has audited itself and claims to have assets that back every USDT coin. Critics doubt the validity of Tether’s claims.
- Fined in October $42 Million by CFTC for allegedly violating CFTC regulations.
- Fears are that the entire cryptocurrency marketplace could crash if Tether does not have adequate backing for all their stablecoins.
- USDC / USD coin
- Launched in 2018 by Circle and Coinbase.
- Circle claims that each USDC is ”backed by fully reserved assets.”
- To assure holders of USDC, Circle announced the publication of weekly USDC reserve reports.
- In March 2021, Visa announced the settlement of transactions with USDC on the Ethereum blockchain.
- BUSD / BINANCE USD
- Launched in 2019 by a partnership between Binance, a popular cryptocurrency exchange, and Paxos, a crypto brokerage.
- BUSD is audited and approved by the NY State Department of Financial Services.
- Considered reliable due to their close cooperation with financial agencies.
Algorithmic Stablecoins
- Uses an algorithm to achieve price stability. Complex calculations constantly occur to stabilize the price. The creation of more coins (minting), the movement of assets, and the burning (destroying) of coins all happen according to code.
- Each algorithmic stablecoin has its unique code and governance system. Code decisions are usually made and voted on by token holders.
- Being backed by other volatile assets requires the algorithm to work perfectly in times of severe market crashes.
- Popular amongst decentralized exchanges where KYC is not required.
- DAI is one example of an algorithmic stablecoin. This stablecoin exists on the Ethereum blockchain. It was created by Maker Protocol, a decentralized finance platform.