Stability of Stablecoins

in LeoFinance2 months ago (edited)

So called stablecoins are sometimes considered as a "stepdaughter by-product" of crypto. Well, it's kinda wrong.

Of course, in theory BTC, ETH, and others can exist just fine without stablecoins. But in practice, they will be pretty much useless then, because to some great extend stablecoins are the backbone of all today's cryptocurrency trading. Stablecoins are pretty much the only thing that somehow connects all this crypto jazz to the real world.

pexelsbilelnaili4335696.jpg

However, not all stablecoins are equal. I would divide them into three groups: backed, collateralized, and algorithmic (well, not the best taxonomy, but good enough for my article).

Backed stablecoins are backed by real money. E.g. somewhere there's a bank account, and every time US$1 is deposited there, 1 coin gets minted. That's how USDT, USDC, and some others work (in theory, at least). In theory, every such coin is like an "IOU", i.e. you can give your coin back and receive your US$1 from the account. The good news is that to do it you don't need any cryptomarket to exist, an IOU is an IOU and 1 coin is $1 no matter what. The bad news is that the bank account (even if it is opened in the name of a smart-contract or a DAO, in theory) can be blocked or confiscated, or the stablecoin company can go bust, and so on. Shortly, even though backed stablecoins don't need any market, they are actually far from being "riskless".

Collateralized stablecoins are backed by some "collateral" and maintain stability with rebalancing around collateral's price. For example, DAI is backed by ETH collateral and balances itself at ~US$1 with some tricky math around ETH/USD price. Collateralized stablecoins can live without a bank account, neither they need a centralized governing company, and so on. Actually, pretty much the only things they need are "collateral" and its fiat trading going somewhere. E.g. DAI needs a pile of collateralized ETH and ETH/USD trading. In other words, if all ETH collateral is taken out of CDPs or ETH/USD trading ceases to exist, you will hardly get $1 for 1 DAI...

Algorighmic stablecoins have neither fiat backing nor crypto collateral. They are supposed to maintain "stability" with fancy math around something. I'd mention ESD as an example. This funny creature tries "to maintain price stability and to avoid centralization pitfalls" by pegging itself to USDC and allowing itself to be not so stable during "periods of volatility". Shortly, algorithmic experiments should be treated as experiments as of now, some shit with good math and poor stability. I don't even want to mention the risks, such shit can go to zero at any second. The only hope that in the future, after numerous failed experiments, some smart guys will finally build a decent algorithmic stablecoin.

I'd only want to reiterate some point I find the most important. Backed stablecoins can exist on their own, without any other cryptothings, as long as there's a bank account with some money on it. Collateralized and algorithmic stablecoins rely on some other cryptothings to exist (being it ETH/USD market or USDC peg). In other words, the latter two are tied to fiat too, although some indirect way. Well, actually, it's hard to have a fiat-pegged stablecoin without any connection to fiat...

Shortly, all today's stablecoins have their pros and cons. And honestly, backed stablecoins (especially accountable ones) seem to have more pros and overall stability.

Maybe a good thing would be a bank account opened in the name of a smart-contract at some off-shore bank (it's not that impossible, most companies today have accounts opened "in the name of a legal entity"). Technically, a bank<->contract API is only a matter of coding, after all.

Posted Using LeoFinance Beta

Sort:  

Is pretty interesting how stablecoins work. I couldn't do something like that. Thanks there are bright people out there.

Indeed,stablecoins are fundamental and the key in a lot of DeFi platforms.

Posted Using LeoFinance Beta

Congratulations @alnash! You have completed the following achievement on the Hive blockchain and have been rewarded with new badge(s) :

You published more than 80 posts. Your next target is to reach 90 posts.

You can view your badges on your board and compare yourself to others in the Ranking
If you no longer want to receive notifications, reply to this comment with the word STOP