A Simple Guide to Stablecoins

A Simple Guide to Stablecoins

July 03, 2024

Overview

Stablecoins are crypto assets pegged to fiat currencies (e.g., USDC, USDT) or backed by overcollateralization (e.g., DAI). Algorithmic stablecoins (e.g., UST) use smart contracts for supply management, but can face volatility risks, like UST's peg loss in 2022.

3 min. read

3 min. read

3 min. read

Stablecoins are a type of cryptocurrency designed to maintain a stable value by being pegged to a reserve asset, such as a fiat currency or a commodity. They work like cryptocurrencies in the blockchain space, without the volatility. 

We will discuss the different types of stablecoins in this article and provide examples:

USD-Backed Stablecoins

These stablecoins are directly pegged to the value of the US dollar. They are backed by USD reserves, meaning for every stablecoin issued, there is an equivalent amount of USD held in reserve.

USDC (USD Coin): Issued by Circle, USDC is fully backed by USD reserves held in regulated financial institutions. It's known for its transparency and regular audits.

USDT (Tether): Tether is one of the oldest and most widely used stablecoins. It is also backed by USD reserves. Even if there are numerous allegations regarding the true backing of USDT, the stablecoin remains the top asset in terms of market cap.

Overcollateralized Stablecoins

These stablecoins are backed by streamlined collateral. As the collateral exceeds the value of the stablecoins issued, they provide a cushion against price volatility.

DAI: Issued by the MakerDAO protocol, DAI is an overcollateralized stablecoin backed by various cryptocurrencies, primarily Ethereum. Users lock their crypto assets in smart contracts to mint DAI, ensuring the system's stability through over-collateralization.

Algorithmic Stablecoins

They rely on smart contracts, self-executing code on the blockchain, to manage supply and demand. The smart contract automatically adjusts the total number of stablecoins in circulation to maintain the desired price peg.  

UST (TerraUSD): UST was an algorithmic stablecoin designed to maintain its peg to the USD through a dual-token system with Luna, its companion token. However, In May 2022, a wave of selling threw its system off balance, causing UST to lose its peg and crash in value. This highlights the risks associated with algorithmic stablecoins.

Disclaimer: The information provided in this research paper is for educational and informational purposes only. It does not constitute financial advice, investment guidance, or any solicitation to buy or sell financial instruments. The views expressed herein are those of the authors and do not necessarily reflect the opinions of Kollectiv.

2024