AAX Academy takes you to understand what is the stable currency war?

Stablecoins have long been seen by cryptocurrency traders as a very popular method of buying and selling volatile positions, and now even the traditional financial system is starting to embrace stablecoins as a more efficient means of transferring funds. The market is dominated by USDT issued by Tether, which is still far ahead in terms of market capitalization. Currently, USDT has a market cap of $68.3 billion, followed by USDC, BUSD, DAI, and UST at $29.2 billion, $12.7 billion, $6.5 billion, and $2.6 billion, respectively.

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The utility and fundamentals of stablecoins

Stablecoins have become an important part of the crypto ecosystem. Most cryptocurrencies are highly volatile, which can be a good thing for investors doing quick day trades, but for some use cases, price stability is also important. Stablecoins are designed to absorb reasonable volatility while maintaining a fixed value. When it comes to real-world applicability, they behave more like robust fiat currencies, such as the U.S. dollar, etc., with the benefits of cryptocurrencies.

Without stablecoins, DeFi would not have taken off like it did in early 2020, which indirectly means that the current NFT craze will look very different. The total value locked across blockchains is currently $117.6 billion, but it’s hard to imagine if we would have reached this level without Tether’s USDT and MakerDAO’s DAI paving the way.

There are currently two main types of stablecoins, and a third emerging stablecoin:

• Fiat-based stablecoins

• Cryptocurrency-based stablecoins

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Fiat-based stablecoins

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Cryptocurrency-based stablecoins

These stablecoins are backed by other cryptocurrencies, which, unlike fiat-based stablecoins, can exclude third parties (i.e. central regulators). Crypto-collateralized stablecoins are often over-collateralized. This means that as the prices of cryptocurrencies fluctuate, the prices of stablecoins will not be affected. The stablecoin DAI created by the MakerDao project is a good example. Based on Ethereum, it is one of the most prominent stablecoins in the DeFi ecosystem, embedded in many lending protocols such as Aave and Compound.

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Algorithmic Stablecoin

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Stablecoin competition is heating up

The history of stablecoins begins with USDT in 2014, initially launched as Realcoin. In its first few years, USDT's market capitalization steadily climbed to $1 billion during the 2017 ICO boom, and exploded in 2020 when the cryptocurrency winter thawed. It went from $5 billion to $50 billion in just 12 months, making it the fifth largest cryptocurrency.

The growing competition from other fiat-collateralized and crypto-collateralized stablecoins is closely related to the rise of DeFi. Every new contender in the layer 1 blockchain space is competing with Ethereum-based slow and expensive DeFi, which represents another ecosystem waiting for stablecoins to dominate. USD stablecoins are in great demand on lending, yield farming, and liquidity-providing platforms. The earlier you join, the more coins you get.

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The Arrival of the Killer Stablecoin

Just like the arrival of the long-awaited “killer app” that would push cryptocurrencies into the mainstream, the cryptocurrency industry has long waited for the perfect algorithmic stablecoin to immediately replace the rest. An algorithmic stablecoin is a stablecoin that can be pegged using only software and rules. If we create a truly efficient algorithmic stablecoin, it can scale infinitely to whatever size the economy requires.

In addition to maintaining a reliable peg, scalability is an important part of stablecoins. For example, DAI is the most widely used decentralized stablecoin on Ethereum, but it has serious problems with scaling due to the supply-demand mismatch of its monetary policy. The scalability problem with DAI extends to all stablecoins on Ethereum where the minting cost is greater than the face value of the minted asset. Thus, the money supply is constrained by the market's willingness to bear the cost. This in turn limits the growth and adoption of DeFi.

Algorithmic stablecoins solve the problem of scaling, which is why it is considered the holy grail of stablecoins. It's like Bitcoin, settled on-chain, but actually stable and has purchasing power. Both of the strongest players in this category are fairly new, but have huge potential.

Terra's UST is an algorithmic stablecoin where the minting cost is equal to the face value of the minted stablecoin. In order to mint 1 TerraUSD, only $1 worth of reserve asset LUNA needs to be burned. The TerraUSD monetary policy is theoretically infinitely scalable, which can drive DeFi applications and protocols to reach their full potential without limitations. While UST was only launched in September 2020, since 2019 Terra's won stablecoin has been integrated into payment app CHAI, which has a significant user base in South Korea.

Multicoin's UXD protocol creates a fungible, USD-pegged stablecoin called UXD that shorts an equivalent amount of BTC-USD perpetual swap contracts by accepting BTC (or other crypto) deposits and using them as collateral or deprecating BTC futures. A long BTC spot is perfectly hedged by a 1x BTC-USD short, so the value of the combined position is always $1. Although this is one of the newest players in the space, its planned integration with prominent dApps on the Solana blockchain, like Saber, does make it a serious competitor in an already saturated market.