Analyses
24
Apr
stablecoin

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Stablecoins explained

Stablecoin is a cryptocurrency whose price is pegged to fiat currency. The use of stablecoins has exploded in recent years.

The biggest stablecoins in the market are Tether (USDT), USD Coin (USDC), Binance USD (BUSD), Dai (DAI), and True USD (TUSD). Tether is the best-known stablecoin. USD Coin is the second largest stablecoin on the market. Dai is the largest stablecoin that is backed only by cryptocurrencies.

Algorithmic stablecoins have been primarily disappointing so far. The regulation of stablecoins is undergoing significant changes in the United States and the EU. Stablecoins can be bought on all major crypto exchanges. There are also risks associated with stablecoins. The use of stablecoins will increase – despite the risks and regulatory changes.

What is a stablecoin?

A stablecoin is a cryptocurrency pegged to the US dollar, euro, or other fiat currencies. The largest stablecoins are Tether (USDT), USD Coin (USDC), and Dai (DAI). Stablecoins are essentially tokenized fiat currencies.

The US dollar has dominated the stablecoin market since its inception. Dollar-pegged stablecoins make up more than 99 percent of the market. Euro and other fiat currencies are represented only marginally.

The table below lists the largest stablecoins on the market. They are all pegged to the US dollar.

StablecoinTickerMarket cap
Tether USDT $110 billion
USD Coin USDC $34 billion
Dai DAI $5,5 billion
First Digital USD FDUSD $3.6 billion
Ethena USD USDe $2.3 billion

The stablecoin market is valued at $165 billion, with Tether’s share at two-thirds. At its peak in April 2022, the stablecoin market was valued at $180 billion.

The price of stablecoins remains stable because of their collateral. For example, one US dollar is deposited into Tether’s bank account for each USDT the company has issued. Tether invests the dollars in US government bonds to earn yield, earning billions annually.

The stablecoin business became highly profitable after 2022 due to the increase in interest rates.

What are stablecoins used for?

The most common uses of stablecoins are DeFi, trading, money transfers, and saving. The use of stablecoins exploded in 2020. The reason for this was the popularity of decentralized financial services. Before 2020, the market cap of all stablecoin was only a couple of billion dollars.

After 2020, the derivatives market has accelerated the use of stablecoins. Tether (USDT) is the main source of liquidity in crypto trading. New stablecoins have also entered the market, which has attracted more money to the sector.

Next, let’s go through the uses of stable currencies in more detail.

DeFi

Stablecoins are a substitute for dollars in decentralized finance. Since DeFi apps are smart contracts on the blockchain, they have no connections to the banking system. The only way to deposit dollars into a DeFi app is to use a stablecoin.

Below is a screenshot of Aave, one of the most popular DeFi apps.

aave

The DeFi sector could not function without a liquid stablecoin market. Dollars are needed, especially in lending services, such as Aave. For example, you can take out a stablecoin loan against your Ethereum coins or deposit stablecoins in Aave to earn yield.

Trading

Stablecoins have long been the currency of professional crypto traders. The derivatives market runs almost entirely on stablecoin trading pairs, where USDT is strongly represented.

The reason for using stablecoins is the ease of movement of funds and the attitude of banks. At the end of a trading day, you can transfer funds of up to hundreds of millions of dollars from the crypto exchange to your crypto wallet for a minimal fee.

Banks have a negative attitude toward money transfers to and from crypto exchanges. It would be impossible for traders to move large sums between the crypto exchange and their bank. With stablecoins, this is not a problem.

Stablecoins also make transferring funds between crypto exchanges, wallets, and DeFi apps easy.

Money transfers

Stablecoins have increasingly replaced Bitcoin (and other cryptocurrencies) in digital money transfers. Their advantage is their price stability. Cryptos’ volatile prices are ill-suited for transactions where the payment method must remain stable.

To the surprise of many, Tron is the most popular platform for stablecoin payments traffic. More USDT tokens are circulating on Tron’s blockchain than on Ethereum! Tron is widespread, especially in Asia. Its cheap and fast transactions are well-suited for stablecoin payments.

Saving

Saving in stablecoins is very popular in countries with high inflation. Argentina and Turkey are good examples. Dollar-based stablecoins help millions of people globally to maintain their purchasing power. Below is a picture of Argentina, where inflation is still raging at over one hundred percent annually.

argentina

Bitcoin (and other cryptocurrencies) are excellent ways to grow wealth in the long run. However, the problem is high volatility in the short term. The most important things for people living in poor conditions are predictable income and the protection of their purchasing power.

Stablecoins can also be used for currency hedging in Western countries. For example, the exchange rates between the US dollar and other currencies can change by more than 10 percent annually. If you have a significant cash position in euros, you can consider moving half of that to USD stablecoins.

The advantage of stablecoins is the possibility of keeping funds outside the banking system.

The biggest stablecoins on the market

The biggest stablecoins on the market are Tether (USDT), USD Coin (USDC), and Dai (DAI). The ranking list could be different if Binance and Terra’s stablecoins were still on the market. Here are a few words about these stablecoins, which were very popular a few years ago.

  • Binance USD (BUSD) was the third largest stablecoin and, at its peak, worth more than $23 billion before being driven off the market by the SEC in 2023.
  • Terra USD (UST) became very popular during the 2021 bull market, growing to a market cap of nearly $14 billion before the Terra ecosystem collapsed in May 2022.

Next, let’s go through the biggest stablecoins in more detail.

Tether (USDT)

Tether (USDT) is the biggest and the best-known stablecoin. It was launched already in 2014. Tether operated on the Bitcoin blockchain using the Omni Layer level for the first years. In 2019, USDT tokens started circulating on the Ethereum and Tron blockchains.

More than 98% of USDT tokens are still on the Ethereum and Tron blockchains. Tron has been the leading Tether platform since late 2021. The graphic below shows the development of Tether on different blockchains. The data comes from The Block’s database, which has a lot of good information about stablecoins.

Tether has maintained its position as a leading stablecoin despite receiving more negative publicity than its competitors combined. USD Coin seemed to emerge as a real threat in the early 2020s as a so-called regulated option. However, the US banking crisis 2023 caused a big blow to USD Coin’s reputation and strengthened Tether’s position further.

Tether has been criticized for the lack of audits. Nowadays, the company publishes comprehensive reports on USDT stablecoin collateral. Below is an example of CEO Paolo Ardoino’s X post from January 2024.

Tether invests the USD collateral in US Treasuries. Due to high-yielding bonds, the company has made huge profits from this operation. Tether is also a significant Bitcoin holder and has invested over half a billion dollars in Bitcoin mining in South America.

USD Coin (USDC)

USD Coin (USDC) is the second largest stablecoin on the market. It was launched in 2018 by the US companies Circle and Coinbase. USD Coin aims to challenge the “offshore stablecoin” Tether by offering a US-regulated alternative.

USDC’s popularity started to snowball during the crypto boom of 2021. USDC’s market cap rose to more than 50 billion dollars at its peak. It seemed to be a real threat to Tether’s dominance in the stablecoin market.

However, the regulatory war in the United States in 2023 decreased USD Coin’s popularity. The banking crisis in March 2023 also put USDC in the headlines for all the wrong reasons when three billion dollars worth of collateral threatened to be trapped inside the collapsed Silicon Valley Bank.

Many investors have been startled by the attitude of the American authorities towards the crypto industry. In the past, the USD Coin was considered a safe option precisely because of US regulations. Now, this advantage has become a reputational disadvantage.

The picture below shows Gary Gensler, the head of the US Securities and Exchange Commission. He has profiled himself as a figurehead of the regulatory war in the United States.

gary gensler sec
Image credit: Flickr / Third Way Think Tank

USD Coin can significantly increase its popularity when the new stablecoin regulation of the US and EU is introduced. In the best case, Tether could not operate in these markets. However, the situation is still open, especially in the United States.

Dai (DAI)

Dai (DAI) is the third-largest stablecoin on the market. It is backed by cryptocurrencies, where Dai differs from Tether and USD Coin. Dai is tightly linked to Maker DAO, a decentralized organization that manages the development of Maker protocol and Dai.

dai

DAI is minted through over-collateralized loans. For example, to create $1000 of DAI, you must lock $1500 worth of cryptocurrency to Maker’s smart contract. This ensures a sufficient buffer in the volatile crypto market.

If the value of the collateral threatens to fall below the value of the loan, the collateral is liquidated and sold on the market. The person who minted the DAI tokens can add new collateral to avoid liquidation.

At first, only Ether (ETH) was used as collateral, but other cryptocurrencies are now allowed. Other stablecoins, such as USDC, are also used as collateral for DAI.

Dai’s market cap is currently $5.5 billion, peaking at nearly $10 billion in February 2022.

Other stablecoins

Algorithmic stablecoins have been disappointing so far. The market has seen various attempts to create stablecoins that deviate from the traditional collateral model, but they have had problems keeping up with the dollar peg. Terra’s UST is undoubtedly the most famous example.

At its best, UST became the third-largest stablecoin in the market. It maintained its dollar peg through a separate LUNA token minting and burning mechanism. UST worked for a couple of years without problems until it collapsed almost overnight with the LUNA token.

The collapse of Terra did not end the development of algorithmic stablecoins. Frax is an example of an algorithmic stablecoin that is still running. However, such projects are plagued by a small market cap and too much volatility in their price.

Ethena, which entered the market in 2024, differs from traditional stablecoins. Its popularity is growing surprisingly fast. Ethena is not an algorithmic stablecoin per se or a traditional USD-backed implementation. Ethena’s USDe maintains its dollar peg with a delta-neutral long & short position. It also distributes rewards to its stakers.

Finally, we should also mention the USDD stablecoin, created on the Tron platform and run by the Tron DAO. USDD uses Tron’s native token, TRX, and Bitcoin as collateral. Like Frax, it has lost its dollar peg regularly, although its collateral ratio is over 200 percent.

Stablecoin regulation

Stablecoin regulation is undergoing significant changes in the United States and the EU. The situation in the United States is unclear because the country lacks regulation for the entire crypto market – not just for stablecoins. The situation in the EU is better in this respect.

The EU has approved a regulation on cryptocurrencies and crypto exchanges (MiCa), which will be implemented at the end of 2024. The EU will also introduce an entirely new regulation of stablecoins. Its schedule is even earlier, as the new stablecoin rules will be enforced from July 1, 2024.

The new EU regulations set strict requirements, e.g., for stablecoin reserves. Their issuers must also be companies operating in the EU area. In practice, all current stablecoin issuers must apply for new European licenses. Otherwise, the stablecoin in question is not offered in crypto exchanges to European customers.

At this point, it is good to highlight the EUROe-stablecoin launched by Finnish Membrane Finance.

EUROe entered the market in the spring of 2023 and was the first euro-based stable currency to meet the new EU regulations. We have published an in-depth article about EUROe, which provides more information about the project.

EUROe has not started to grow yet, as only a few million euros worth of EUROe has been minted. However, the popularity of EUROe and other euro-based stable currencies may increase with the new EU regulation.

The situation in the United States remains unclear. Many analysts believe regulators favor USD Coin, and Tether will suffer from the upcoming regulations. The SEC might also launch an attack on the DeFi sector. What kind of impact would this have on Dai and other decentralized stablecoins?

We will update this part of the article once we have more information about the regulation. An investor should be aware of the changes behind the scenes and follow the industry’s development, especially in the EU region.

The risks of stablecoins

There are also risks associated with stablecoins. Although they are theoretically safe and stable currencies, history has proven that even stablecoin investments can be risky. Next, let’s go through things that a stablecoin investor should remember. Let’s look at the risks from the perspective of the largest stablecoins, i.e., USDT and USDC.

Reserves

The most significant risks are related to stablecoin reserves, meaning the collateral. Will the issuer be able to respond to every redemption request when the market panics and convert the stablecoins back to dollars? It is also essential to understand what a redemption request means.

Only the ownership of the tokens changes when a small investor sells USDT for dollars in a crypto exchange. A redemption request means that one of Tether’s partners (e.g., crypto exchange) sends USDT tokens to Tether and wants to redeem them for dollars. The redeemed USD tokens are removed from circulation, and Tether’s market cap decreases.

dollar

The dollars backing the USDT tokens are invested in US government bonds. The market for these bonds is liquid, so Tether should have no problem selling them for dollars and responding to the redemption request.

What if the market is threatened by a 2008-style financial crisis, which will also freeze the bond market? A “black swan” like this could also cause problems for issuers of stable currencies.

Currency exchange rate risk

Currency risk is another consideration if you intend to keep large sums in stablecoins. The US dollar has traditionally been the safest currency, so USDT and USDC have helped investors hedge against currency risk. However, the situation may change in the future.

Do you want to keep the fiat portion of your portfolio in your local currency or dollar-based stablecoins? This is up to each investor to decide. If it is about large sums and a time window of several years, the difference in purchasing power can be tens of percent.

Other risks

The third risk is also related to the stablecoins’ collateral. For example, more than three billion dollars of USD Coin’s collateral remained in the vaults of Silicon Valley Bank, which collapsed in the spring of 2023. In the end, this situation was resolved happily, but a similar event may also occur at other banks.

A regular investor won’t know precisely where the reserves are and the risks associated with the banking partners. The US government can also freeze any dollar-denominated deposits if it sees fit. This could cause panic among stablecoin holders and cause the price collapse.

How to buy stablecoins

It is easy to buy stablecoins from all the major crypto exchanges. Practically every major exchange supports USDT, USDC, and DAI. Below is a table that shows you four popular crypto exchanges and what stablecoins they support.

Crypto exchangeStablecoinRating as a stablecoin exchangeVisit website
Tether (USDT)
USD Coin (USDC)
Dai (DAI)
First Digital USD (FDUSD)
Ethena (USDe)
Visit Binance
Tether (USDT)
USD Coin (USDC)
Dai (DAI)
First Digital USD (FDUSD)
Ethena (USDe)
Visit Bitget
Tether (USDT)
USD Coin (USDC)
Dai (DAI)
First Digital USD (FDUSD)
Ethena (USDe)
Visit KuCoin
Tether (USDT)
USD Coin (USDC)
Dai (DAI)
First Digital USD (FDUSD)
Ethena (USDe)
Visit Coinbase

Storing stablecoins is also easy. All major stablecoins circulate on the Ethereum network as ERC20 tokens, supported by the most popular crypto wallets. For example, Metamask, Exodus, and Trust Wallet are good wallet apps that support USDT, USDC, and DAI.

Summary

Many people underestimate the significance of stablecoins in the cryptocurrency industry. They are integral to crypto trading and transacting in almost every blockchain.

The growth of stablecoins has been strong since 2020. They peaked in popularity in 2022 when Terra’s UST and Binance USD supported the development of Tether, USD Coin, and Dai. The collapse of Terra started a downward trend lasting until October 2023.

Stablecoins returned to solid growth in 2024. It’s only a matter of time before the stablecoin market breaks the trillion-dollar mark. This will probably happen after the US market receives regulatory clarity. Regulation will be in the headlines in the coming years. Stablecoin issuers will be subject to new laws and oversight.

It is important to remember that the EU and the United States, despite their great importance, are only part of the world. Stablecoins are also increasingly used in everyday life in Asian and African countries.

Antti Hyppänen

Antti Hyppänen is the founder and editor-in-chief of AboutBitcoin.io. Antti has written articles about cryptos since 2017. He follows the crypto market every day of the year and is responsible for the daily operations of AboutBitcoin. Antti is not a maximalist regarding any cryptocurrency but looks at the industry objectively. Antti’s investment profile is “buy & hold,” i.e., he does not trade or use leverage. His crypto portfolio consists of mainly Bitcoin and Ethereum. Antti also follows macroeconomic events. In addition to cryptos, his interests include gold, silver, and the US stock market.

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