The ability to store funds in a price-stable real-world currency while keeping them on the blockchain is critical for DeFi users. Stablecoins have become a $150 billion sub-sector of the DeFi economy thanks to this combination of safety and convenience.
However, the overnight collapse of the Terra ecosystem has raised serious concerns about different stablecoins’ ability to maintain their $1 peg. On 9 May 2022, TerraUSD (UST) plummeted in value from $1 to a third of that just two days later. Within a fortnight it was trading at just $0.05, with no realistic hope of recovery.
UST was a so-called algorithmic stablecoin. Its price on the open market was maintained by economic incentives, but also by users’ confidence in the effectiveness of these incentives. When UST began to lose its peg, users also lost their confidence and rushed to sell their UST to salvage their funds. The more UST was sold, the further from its $1 peg the currency traded, further eroding confidence and creating a ‘death spiral’ that could not be halted.
The near total destruction of $18 billion of value in UST ‘stablecoins’ has led users to question how safe other stablecoins truly are.
There are many stablecoins on the market, but just a handful that are widely used. TimeX lists only the most trustworthy and well-established stablecoins. None of these are algorithmic coins, like UST, but they all are fully backed by assets of value, albeit in different ways.
Altogether, TimeX supports five stablecoins. Here’s how they work.
Tether (USDT) is a fiat-backed stablecoin, meaning that every USDT in existence is theoretically backed by $1 of cash or equivalent assets held by the issuing company.
Tether has had a controversial history, partly due to the fact the company has not always been transparent about its reserves. It has been unclear whether USDT really is fully backed – and therefore whether the tokens really are worth $1 each. However, Tether remains the largest stablecoin by capitalisation, and the most widely used by crypto traders and investors. One positive outcome of a recent legal case against Tether is that it does appear that the company now holds sufficient reserves to honour their obligations, if required.
TimeX has listed USDT due to its exceptional popularity in the crypto world. When UST crashed, USDT also briefly depegged on the open market as traders sold the token for assets deemed even safer. However, Tether continued to redeem USDT for $1 via their website, allowing users to withdraw their funds in full.
USD Coin is another fiat-backed stablecoin. While it’s superficially similar to USDT, the issuing company (Circle, in partnership with Coinbase) has been far more transparent than Tether. The assets that back USDC are held in regulated US-based financial institutions, and regularly audited, giving users greater confidence that USDC is 100% backed and that tokens can be redeemed for cash at any time.
However, like USDT, USDC’s reserves consist of both cash and a mixture of other assets. While the composition of that portfolio changes, USDC has tended to have a higher proportion of cash and cash equivalents, like short-term US Treasuries, while USDT has had a higher proportion of alternative and more illiquid assets, like corporate debt. In extreme circumstances, this may mean USDC tokens are more easily convertible to cash.
USDT and USDC are both fiat-backed stablecoins issued by centralised companies. Dai is something different: a decentralised, crypto-collateralised stablecoin. This avoids the single points of failure inherent in a fiat-backed stablecoin, while still maintaining a store of value that tracks the US dollar.
Dai can be generated by any user by locking collateral assets (like ETH, WBTC, and more) in a Maker Vault. Because crypto is volatile, Dai has to be over-collateralised. For example, a user typically needs to lock $150 worth of ETH in a Vault to generate 100 Dai. When the Dai are repaid to the Vault, the collateral assets are unlocked. If the collateral ratio falls below the specified level (e.g. 150%), the assets in the Vault are auctioned to pay for the Dai generated, to prevent the system from incurring bad debt.
The system of smart contracts and oracles that underpins Dai is called the Maker Protocol, which is managed and maintained by a global community of Maker (MKR) token holders. Together, the Maker Protocol and community are known as MakerDAO.
AUDT are 1:1 backed by Australian dollars, held in the company’s regulated bank account. AUDT is fully audited. Because Chrono.Tech and AUDT are Australian crypto companies, they are regulated by AUSTRAC, the country’s financial intelligence agency. This means they adhere to the highest standards of security and best practices for blockchain businesses, giving users confidence that AUDT can be redeemed for AUD quickly and at any time.
AUDT is mainly used by traders with Australian bank accounts, since this is how funds are moved into and out of the blockchain, but anyone can use AUDT as a store of value and an alternative to USD-backed tokens.
Binance USD (BUSD) is another fiat-backed stablecoin that is pegged to the US dollar. It is used specifically by Binance as an on-chain store of value and dollar equivalent token.
BUSD is similar in principle to USDT and USDC, but has important differences. It is issued by the Paxos Trust and is regulated by the New York State Department of Financial Services (NYDFS), making it one of the only fully-regulated stablecoins in existence. (Paxos Dollars, or USDP, is another – BUSD is simply the white-labelled version of USDP, and the two stablecoins are essentially the same beneath the surface. The only other fully-regulated stablecoin is Gemini Dollars, GUSD.)
Because BUSD itself is US-regulated, not just the institutions with which it holds collateral assets, Paxos has to maintain a higher standard than other stablecoins. In practice, this means the tokens are 1:1 backed only by the safest possible assets. As the Trust explain, ‘Paxos, as the issuer of both USDP and BUSD, holds only cash, US Treasury Bills, and reverse repo secured by US Treasuries behind USDP and BUSD in order to have non-credit exposed assets to meet even the catastrophic scenario of a full redemption of these coins.’ Reserves are held in a bankruptcy remote trust, regulated by NYDFS, ensuring that BUSD (and USDP) can be redeemed for cash quickly and reliably. This regulation-focused approach makes BUSD arguably the safest of the fiat-backed stablecoins, ahead of USDT and USDC, though it does not yet have quite the same degree of adoption.