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Introduction

Stablecoins are a category of cryptocurrencies that aim to solve the issue of price volatility associated with traditional cryptocurrencies, such as Bitcoin and Ethereum. They are specifically designed to maintain a stable value relative to a particular asset or a basket of assets, like a fiat currency or commodity. This characteristic makes stablecoins a promising alternative for those seeking a more reliable means of conducting transactions or storing value.

Stablecoins have the potential to be utilized in a wide range of scenarios, including everyday payments and remittances, commerce, and trading. They offer a secure and convenient way to transact without the volatility that is commonly associated with other cryptocurrencies. Additionally, institutional investors have been drawn to stablecoins as a more dependable store of value and a means of conducting cross-border transactions.

Despite their potential advantages, stablecoins face unique challenges that could undermine their stability and hinder their adoption. These challenges include the need to comply with regulations, liquidity risks, and cybersecurity threats. This article will delve into the different types of stablecoins, their potential benefits, and the obstacles they face. Furthermore, we will assess the future of stablecoins and their potential impact on the financial industry.

types of stablecoin architectures : Stablecoins come in various architectures, each designed to maintain a stable price in its own way. It’s essential to understand the differences between the architectures to choose the right stablecoin for a particular use case. There are four main types of stablecoin architectures:

Fiat-collateralized stablecoins: These stablecoins are backed by a reserve of fiat currency, such as the US dollar, with a 1:1 ratio. Examples of fiat-collateralized stablecoins are Tether, USD Coin, and TrueUSD. Crypto-collateralized stablecoins: These stablecoins are backed by a reserve of cryptocurrencies, such as Bitcoin or Ethereum, and are pegged to the value of a fiat currency or a commodity. Examples of crypto-collateralized stablecoins include Dai and BitUSD. Algorithmic stablecoins: These stablecoins do not rely on reserves of fiat currency or cryptocurrencies but use mathematical algorithms to adjust the supply of stablecoins to maintain price stability. Examples of algorithmic stablecoins include Basis Cash and Frax. Commodity-backed stablecoins: These stablecoins are backed by a reserve of commodities, such as gold or silver, and are pegged to their value. Examples of commodity-backed stablecoins include Digix Gold and Tiberius Coin. 1.1 Fiat-collateralized stablecoins:

Fiat-collateralized stablecoins are a popular choice for many cryptocurrency users and investors, as they offer a sense of stability and predictability that is often lacking in other cryptocurrencies. With a reserve of collateral, which can be fiat currency or even cryptocurrencies, the stablecoin issuer can ensure a 1:1 ratio between the value of the reserve and the stablecoins in circulation.

For instance, if the issuer holds $1 million worth of fiat currency, they can issue $1 million worth of stablecoins, which helps to maintain the stablecoin’s value in line with the underlying collateral. This approach provides a more stable and predictable value than traditional cryptocurrencies, making them suitable for transactions and as a store of value.

However, there are some potential risks associated with fiat-collateralized stablecoins. For example, the stability of the underlying collateral is a key concern, as a sharp decline in the value of the collateral can threaten the stablecoin’s value. Additionally, the trustworthiness of the issuer is critical, as the issuer could potentially engage in fraudulent behavior or mismanagement of the collateral.

Despite these risks, the popularity of stablecoins continues to grow, with the total market capitalization of stablecoins reaching over $100 billion in 2021, according to CoinGecko. This significant growth indicates that users are increasingly seeking stability and predictability in their cryptocurrency investments.

1.1.1 popular Fiat-collateralized stablecoins

Tether (USDT): Tether is one of the most popular stablecoins and is backed 1:1 by the US dollar. It is issued by Tether Limited, a company that claims to hold an equivalent amount of US dollars in reserve to the number of USDT in circulation. USD Coin (USDC): USD Coin is another fiat-collateralized stablecoin that is backed 1:1 by the US dollar. It is issued by Circle, a financial technology company. TrueUSD (TUSD): TrueUSD is also a fiat-collateralized stablecoin that is backed 1:1 by US dollars held in escrow accounts. It is issued by TrustToken, a company that provides a platform for tokenizing real-world assets. Paxos Standard (PAX): Paxos Standard is a fiat-collateralized stablecoin that is also backed 1:1 by US dollars. It is issued by Paxos, a company that provides blockchain-based infrastructure for financial services. Gemini Dollar (GUSD): Gemini Dollar is a fiat-collateralized stablecoin that is backed 1:1 by US dollars held in a State Street Bank account. It is issued by Gemini, a cryptocurrency exchange and custodian. 1.1.2 fiat-collateralized stablecoins risks:

Before using or investing in fiat-collateralized stablecoins, it is crucial for users to consider the potential risks and evaluate the stability and reliability of the stablecoin issuer. Although these stablecoins offer simplicity and stability, they also face several risks:

Counterparty risk: These stablecoins rely on the issuer holding adequate reserves of the underlying fiat currency. If the issuer fails to meet its obligation to redeem stablecoins for the fiat currency, the stablecoin’s value could be affected. Regulatory risk: The stability and liquidity of fiat-collateralized stablecoins are subject to changes in regulations and legal status of the issuer, making them vulnerable to regulatory risk. Liquidity risk: In case of a sudden demand for stablecoin redemption, the issuer may not have sufficient reserves to fulfill the demand, leading to a drop in the stablecoin’s value. Centralization risk: These stablecoins are issued by centralized entities, which can create a single point of failure and raise concerns about security, privacy, and censorship. Price risk: Despite aiming to maintain a 1:1 peg with the underlying fiat currency, fluctuations in the fiat currency’s value can affect the stablecoin’s value. In extreme cases, the fiat currency may experience hyperinflation or currency devaluation, leading to a loss of value for the stablecoin. 1.1.3 USDC use case :

In March 2023, the depegging of USDC sent shockwaves through the cryptocurrency market. The collapse of SVB Bank, the institution backing the USDC bank account, was the primary catalyst for the destabilization of the stablecoin. The lack of transparency regarding the balance of the account and the uncertain future of the bank’s operations led to a loss of trust in the stability of USDC.

As a result, the price of USDC plummeted, falling below $1 and causing panic among investors who had relied on the stablecoin’s stability. The situation was exacerbated by the fact that major cryptocurrency exchanges like Binance and Coinbase continued to allow trading of USDC, potentially exposing users to significant losses.

The fallout from the USDC depegging could have far-reaching consequences for the broader cryptocurrency market. If investors lose faith in the stability of stablecoins, this could lead to a decline in demand for cryptocurrencies overall. This could be particularly damaging for smaller, less established cryptocurrencies that rely on stablecoins to provide liquidity and facilitate trading.

The recovery of USDC from this setback remains uncertain. The stablecoin may be able to regain the confidence of investors over time, but it will need to address the issues that led to its depegging in the first place. In the meantime, the cryptocurrency market will need to grapple with the implications of the USDC depegging and find ways to restore trust in stablecoins as a reliable alternative to traditional fiat currencies.

1.2 Crypto-collateralized stablecoins

Crypto-collateralized stablecoins are a fascinating development in the world of cryptocurrencies. These stablecoins offer a way for individuals to safely hold and transact with cryptocurrencies without worrying about the market’s volatility. With traditional cryptocurrencies, users face the risk of losing significant value in a matter of hours due to sudden price fluctuations. Stablecoins, on the other hand, are pegged to the value of a specific fiat currency, such as the US dollar, making them much less risky to hold and transact with.

The process of generating crypto-collateralized stablecoins is unique. Users deposit a specified amount of cryptocurrency, such as Bitcoin or Ethereum, into a smart contract system specifically designed to issue stablecoins. The system then generates a corresponding amount of stablecoins, which are pegged to the value of the fiat currency. This allows users to utilize the stablecoins for transactions without the risk of price volatility. It’s an innovative solution that solves the problem of cryptocurrency volatility.

One potential drawback of crypto-collateralized stablecoins is the requirement for over-collateralization. To ensure the stablecoin’s value remains stable, the smart contract system may require that the value of the collateral exceeds the value of the stablecoins in circulation. This means users have to deposit more cryptocurrency than the amount of stablecoins they receive, which can be a limiting factor for some users.

Despite this limitation, crypto-collateralized stablecoins have seen significant growth in adoption. As of September 2021, the market capitalization of crypto-collateralized stablecoins was over $20 billion. This growth in adoption is a testament to the stability and predictability that stablecoins offer, making them an attractive option for individuals and businesses alike.

1.2.1 popular Crypto-collateralized stablecoins:

Dai (DAI) — Dai is a decentralized stablecoin that is backed by Ethereum, which is used as collateral. It is pegged to the US dollar and is created and managed by MakerDAO. sUSD (sUSD) — sUSD is a decentralized stablecoin that is backed by a basket of cryptocurrencies, including Ethereum, Bitcoin, and Chainlink. It is pegged to the US dollar and is created and managed by Synthetix. 1.2.2 risks of Crypto-collateralized stablecoins:

Although crypto-collateralized stablecoins have several benefits, such as reducing exposure to market volatility, they also come with risks that should be carefully considered. These potential risks include:

Collateral risk: The value of the collateral used to back the stablecoin may fluctuate, which can result in instability or loss of value in the stablecoin. A decline in the value of the collateral can cause the stablecoin to become under-collateralized and result in a loss of value for the stablecoin holders. Smart contract risk: The smart contract used to manage the stablecoin issuance and redemption may have bugs or security vulnerabilities, making it susceptible to hacking and causing a loss of funds or other negative consequences. Market risk: The demand for the stablecoin may decrease, or the value of the collateral backing the stablecoin may decrease significantly, which can cause market risk for the stablecoin. Regulatory risk: As stablecoins are a relatively new asset class, regulatory frameworks around them are still developing, and uncertainty regarding how stablecoins will be regulated could pose risks to their long-term viability. Liquidity risk: The regulatory system can take time to stabilize prices and create sufficient liquidity for the stablecoin market, which can pose risks to investors. 1.2.3 DAI use case:

The depegging of DAI in 2018 was a significant event that had many people worried about the future of stablecoins. It was a stark reminder that even algorithmic stablecoins, which are designed to be resistant to market fluctuations, are still subject to risks and vulnerabilities.

The depegging event caused the value of DAI to drop well below $1 USD, with some estimates putting the value at around $0.60 USD at its lowest point. This was a significant blow to those who had invested in DAI, as well as to the reputation of MakerDAO, which had been seen as a pioneer in the world of stablecoins.

The main cause of the depegging was a lack of collateral to back the supply of DAI tokens. MakerDAO had allowed too many tokens to be minted without increasing the amount of collateral held to back them. This resulted in a decrease in the collateralization ratio, which made the system more vulnerable to fluctuations in the cryptocurrency market.

The algorithmic system used to maintain the peg also played a role in the depegging event. It relied on market forces to automatically adjust the supply of DAI based on demand, but during the 2018 event, this system failed to operate as intended. This failure was a clear demonstration that even the most sophisticated algorithms can still have weaknesses and vulnerabilities.

Despite the challenges faced by DAI in 2018, the stablecoin has since rebounded and is now trading close to its $1 USD peg. This rebound was due in part to the efforts of MakerDAO to increase the collateralization ratio and improve the stability of the algorithmic system used to maintain the peg.

1.3 Algorithmic stablecoins

Algorithmic stablecoins are an intriguing development in the world of cryptocurrency, providing a novel method of maintaining stable values. A significant advantage of algorithmic stablecoins is that they do not rely on collateral, which can be appealing to investors who are hesitant to invest in traditional stablecoins that depend on fiat currency or other collateral. In 2023, we can expect to witness continued growth in the use and development of algorithmic stablecoins, as more investors seek to lessen the risks associated with cryptocurrency volatility. The current market cap of algorithmic stablecoins is approximately $5.5 billion, which is a fraction of the total cryptocurrency market, but it is anticipated to increase in the years to come.

However, algorithmic stablecoins are not without risks. Cryptocurrency prices can be highly volatile, and demand for algorithmic stablecoins may fluctuate depending on market conditions. The algorithms that manage the supply of tokens can also be complex and require ongoing monitoring and adjustment to ensure they function correctly.

Despite these challenges, algorithmic stablecoins have the potential to revolutionize the cryptocurrency market. By using automated systems to adjust supply based on demand, algorithmic stablecoins could provide a more stable and predictable value than traditional cryptocurrencies, making them ideal for transactions and as a store of value. As this technology continues to evolve and develop, we can anticipate further adoption and innovation in the algorithmic stablecoin space.

1.3.1 popular Algorithmic stablecoins

Ampleforth (AMPL): AMPL is an algorithmic stablecoin that is not pegged to any fiat currency, but instead adjusts its supply in response to changes in demand to maintain its price at around $1. It uses a unique algorithm that expands or contracts the supply of tokens based on the price of the token relative to a target price. FRAX: FRAX is a stablecoin that is pegged to the US dollar and backed by a combination of collateral and an algorithmic stability mechanism. The supply of FRAX is adjusted by a smart contract system that uses market data and algorithms to maintain its price stability. Basis Cash (BAC): Basis Cash is a decentralized stablecoin that is designed to be self-stabilizing, meaning it automatically adjusts its supply to maintain a stable value. It is not pegged to any fiat currency, but instead uses a unique mechanism that expands or contracts the supply of tokens based on demand. These are just a few examples of popular algorithmic stablecoins, but there are many others in development as the technology continues to evolve.

1.3.2 risks of Algorithmic stablecoins

Algorithmic stablecoins, like any technology, carry risks that investors should be aware of before investing. Here are some of the key risks associated with algorithmic stablecoins:

Market Risks: Algorithmic stablecoins are subject to market risks, including fluctuations in demand and changes in market conditions. For example, if the market demand for a particular algorithmic stablecoin decreases, the algorithm may reduce the supply of tokens, which could result in a drop in value. On the other hand, if the market demand increases rapidly, the algorithm may struggle to maintain the stability of the price. Technical Risks: The algorithms used to manage the supply of tokens can be complex and require ongoing monitoring and adjustment to ensure they are functioning correctly. Technical issues, such as bugs in the code or errors in the algorithms, could potentially lead to instability and a loss of value. Regulatory Risks: The regulatory environment around cryptocurrency is still evolving, and changes in regulations could impact the value and usage of algorithmic stablecoins. For example, a government ban on cryptocurrency could make it difficult or impossible to use algorithmic stablecoins in certain countries. Black Swan Events: Algorithmic stablecoins are vulnerable to so-called black swan events, which are rare and unpredictable events that can have a significant impact on the value of a cryptocurrency. Examples of black swan events in the cryptocurrency market include the Mt. Gox hack in 2014 and the DAO hack in 2016. 1.3.3 UST use case:

Certainly. Another recent example of a potential risk associated with algorithmic stablecoins is the collapse of the UST stablecoin in 2022, which is pegged to the value of the US dollar. UST is built on the Terra blockchain platform and utilizes a collateralized debt position (CDP) system to maintain its peg to the US dollar.

However, in January 2022, the price of the Terra (LUNA) token, which is used as collateral to support the UST stablecoin, experienced a significant decline due to market conditions and a large sell-off. This caused the UST stablecoin to lose its peg to the US dollar and its value plummeted by more than 20% in just a few hours.

This event highlights the potential risks associated with algorithmic stablecoins that rely on collateralized systems, as they are still subject to market risks and fluctuations. It also emphasizes the importance of ongoing monitoring and adjustment of the algorithms used to manage the supply of tokens to ensure they are functioning correctly.

Opinions on the risks associated with algorithmic stablecoins vary, with some experts cautioning against investing in them due to their potential volatility and complexity, while others view them as a promising solution for offering stability in the cryptocurrency market. Ultimately, it is important for investors to carefully evaluate the risks and benefits of algorithmic stablecoins before making any investment decisions.

References:

“What is UST? Understanding the Terra stablecoin and its ecosystem”, Brave New Coin, February 2022, https://bravenewcoin.com/insights/what-is-ust-understanding-the-terra-stablecoin-and-its-ecosystem “The DeFi disaster: Terra’s UST loses 20% peg in sudden collapse”, Cointelegraph, January 2022, https://cointelegraph.com/news/the-defi-disaster-terra-s-ust-loses-20-peg-in-sudden-collapse 1.4 Commodity-backed stablecoins:

Commodity-backed stablecoins are a type of stablecoin that is backed by a reserve of physical commodities, such as precious metals, oil, or agricultural products, instead of a fiat currency or cryptocurrency. These stablecoins aim to provide stability in the value of the stablecoin by pegging it to the value of a specific commodity.

Commodity-backed stablecoins work by using a smart contract system that manages the reserve of the physical commodity and the issuance and redemption of the stablecoin. The issuer of the stablecoin holds the reserve of the physical commodity and issues an equivalent amount of stablecoins, which are pegged to the value of the commodity.

For example, if a commodity-backed stablecoin is pegged to the value of gold, the issuer would hold a reserve of physical gold and issue an equivalent amount of stablecoins. The stablecoins would then be tradable on cryptocurrency exchanges or used for transactions, such as buying and selling goods and services.

To maintain the stability of the stablecoin’s value, the smart contract system may require over-collateralization, which means that the value of the reserve of the physical commodity must exceed the value of the stablecoins in circulation. This is to ensure that there is always enough reserve to cover the value of the stablecoins.

Commodity-backed stablecoins provide a way for users to hold and transact with a stable digital asset that is backed by a physical commodity, which can offer a level of stability and security that is not available with fiat currencies or cryptocurrencies alone.

Commodity-backed stablecoins can indeed utilize a variety of physical commodities as their underlying asset, including real estate and forest lands or trees. These innovative types of stablecoins aim to provide a more diversified and potentially sustainable backing for the stablecoin, which can mitigate the risks associated with price volatility and fluctuations.

For example, a stablecoin backed by real estate could use the value of the underlying properties to determine the value of the stablecoin. The issuer of the stablecoin would hold a reserve of physical real estate properties and issue an equivalent amount of stablecoins. The stablecoins would then be pegged to the value of the real estate properties, which can provide a stable and reliable backing for the stablecoin.

Similarly, a stablecoin backed by forest lands or trees could use the value of the underlying timber or other resources to determine the value of the stablecoin. The issuer of the stablecoin would hold a reserve of physical forest lands or trees and issue an equivalent amount of stablecoins. The stablecoins would then be pegged to the value of the forest lands or trees, which can provide a stable and sustainable backing for the stablecoin.

Overall, these innovative types of commodity-backed stablecoins can offer a unique way to provide stability and security in the value of the stablecoin, while also promoting sustainability and diversification in the backing assets.

1.4.1 popular Commodity-backed stablecoins

Tether Gold (XAUT): Backed by physical gold held in a Swiss vault, Tether Gold is one of the most popular commodity-backed stablecoins. Digix (DGX): Backed by physical gold, each DGX token represents 1 gram of 99.99% fine gold that is stored in a vault in Singapore. Paxos Gold (PAXG): Backed by physical gold, each PAXG token represents one fine troy ounce of a London Good Delivery gold bar. Carbon (CRBN): Backed by a portfolio of carbon credits, Carbon is a stablecoin that is designed to help fight climate change. Helix (HLX): Backed by timber assets, Helix is a stablecoin that is designed to provide a stable and sustainable investment option. Creal :is a Commodity-backed stablecoin that is backed by a basket of commodities, including gold, silver, platinum, and palladium. It was launched in 2021 and aims to provide a stable and decentralized alternative to traditional stablecoins that are backed by fiat currencies 1.4.2 risks Commodity-backed stablecoins

Commodity-backed stablecoins come with various risks that should be considered before investing in them. One of the significant risks is commodity price risk. As these stablecoins are pegged to the value of a specific physical commodity, fluctuations in the commodity’s price could affect the stablecoin’s value, potentially leading to a loss for holders.

Another risk is liquidity risk, which could arise if there is insufficient demand for the stablecoin or a lack of buyers or sellers on cryptocurrency exchanges. This could affect the stablecoin’s ability to be converted into the underlying physical commodity or another digital asset.

Commodity-backed stablecoins also have counterparty risk as they rely on a third-party issuer to manage the reserve of the physical commodity and the issuance and redemption of the stablecoin. The issuer’s insolvency or fraudulent behavior could lead to a loss of funds for stablecoin holders.

Additionally, regulatory risk exists as the regulatory frameworks surrounding commodity-backed stablecoins are still developing, and there is uncertainty about how they will be regulated in the future. Lastly, custodial risk is present as the physical commodity backing the stablecoin needs to be stored and secured, and there is a risk of storage and security breaches that could lead to a loss of the underlying physical commodity and, consequently, the stablecoin’s value.

1.4.3 Use Cases / XAUT DGD :

Commodity-backed stablecoins, such as Tether Gold (XAUT) and DigixDAO (DGD), have faced significant depegging events, causing a drop in their value. One example is XAUT, which fell from its pegged value of $1,800 to a low of $1,400 in March 2021, representing a decline of around 22%. This drop was attributed to a combination of factors, including a decline in the price of gold, which fell from $1,900 to $1,700 during the same period, and a lack of transparency regarding the amount of gold backing the stablecoin. Investors also raised concerns around the solvency of the custodian bank responsible for holding the gold reserves, which added to the instability of the asset.

Similarly, DGD, which was pegged to the price of gold, experienced a significant depegging event in 2019, with its value dropping from $40 to as low as $5 within a few months. This represented a decline of 87.5%, which was primarily caused by issues with the algorithmic system used to maintain the peg. The system failed to adapt to market conditions, and the lack of transparency around the amount of gold backing the stablecoin further eroded investor confidence.

The depegging events of commodity-backed stablecoins highlight the need for greater transparency and accountability in the stablecoin ecosystem. Investors should conduct thorough due diligence before investing in these assets, and issuers must ensure adequate collateralization and transparency to maintain the stability of their stablecoins.

Conclusion:

Stablecoins have emerged as a crucial element of the cryptocurrency ecosystem, offering users a reliable method of transacting and preserving value without being exposed to the volatility of other cryptocurrencies. While each type of stablecoin has its own benefits and risks, they have continued to garner increasing popularity and acceptance.

In addition to providing stability and predictability in the crypto market, stablecoins offer numerous advantages for investors. However, as with any investment, it is crucial to evaluate the reliability and stability of the stablecoin issuer before using or investing in stablecoins.