Explain in detail the operation modes of different stablecoins: how to choose when the market is going down?
Original author:The DeFi Edge
Original author:
Original compilation: Techflow Intern
Stablecoins are not all the same. Below I will make a detailed interpretation of the operating modes of different stablecoins, and attach my ranking and suggestions for them. What we will introduce in this article:
What is a stablecoin
Why Use Stablecoins
Types of Stablecoins
My advice
1. What is a stable currency?
1. What is a stable currency?
A stablecoin is a token whose value is tied to another asset. Most stablecoins are pegged to the U.S. dollar. Normally, 1 stablecoin = 1 USD. They are a bridge between the real world and the encrypted world.
2. Why use stablecoins?
The advantages of stablecoins are many:
One is that stablecoins reduce the volatility of our investment portfolio. The price of cryptocurrencies can fluctuate wildly, but stablecoins can help us protect our portfolios from losing too much money.
The second is that they can be used as bargaining chips for you to easily buy at low prices. You don't need to wait for 5 days to transfer money from the bank to CEX to purchase assets.
The third is to offset inflation by earning income through stable currency, otherwise the legal currency will depreciate by 8.3% every year. Fourth, we can exchange profits into stable coins.
a scenario
When falling, we can allocate a certain percentage of assets to stablecoins to protect our own assets. During the recent decline, I made a table to compare the difference in returns with and without stablecoins. You can use some of these stablecoins to “buy the dip” once the market drops.
3. Types of stablecoins
Not all stablecoins are created equal. There is no perfect stablecoin right now, we all have trade-offs. Now, let's see what are the different types of stablecoins.
1) Legal currency endorsement
a. Tether (USDT)
These stablecoins are backed by actual U.S. dollars or cash equivalents. If there is $1 billion in fiat-backed stablecoins, we believe there is $1 billion in cash or cash equivalents locked up.
It is the largest stablecoin by market capitalization and the most widely used. But it's also the most controversial - $20 billion of its cash holdings are commercial paper/CoD, and their exact holdings are opaque.
b. USD Coin ($USDC)
No storm, no waves, U.S. regulators fined Tether $41 million last year, and Tether has been lying for years that their stablecoin is fully backed by fiat currency. The New York Supreme Court rejected Tether's petition detailing the shielding of its recent reserves from the public.
c. Binance USD (BUSD)
It is the second largest stablecoin. It was set up as a partnership between Coinbase and Circle (backed by Goldman Sachs), is audited monthly by Grant Thornton, LLP, and is held in cash plus US Treasuries.
BUSD was jointly established by Binance and Paxos, approved by the New York State Department of the Treasury, audited monthly by the top accounting firm Withum, and all dollars are deposited in the reserve account of the Bank of America.
Stablecoin Risks Backed by Fiat Currency
One is centralization, the government has the right to freeze the assets of these companies;
The second is centralized, entities can freeze funds;
The third is that the endorsement of legal currency is not on the chain.
We do believe that companies and auditors have money, but what if they are not?
2) Stablecoins collateralized by tokens
a. MakerDao DAI
We can stake crypto assets and mint new stablecoins, all handled through smart contracts. Stablecoins need to be overcollateralized to avoid possible losses when cryptocurrencies depreciate.
b. Abracadabra ($MIM)
It's at the heart of Daniele Sesta's Frog Nation. It holds the peg well and is one of the most decentralized stablecoins and supports deposits of various coins. But it lost popularity due to the collapse of Frog Nation.
image description
Stablecoin risks backed by encrypted tokens
It is not the most effective capital, because it requires over-collateralization; it has the risk of smart contracts; and it faces the possibility of asset collateral depreciation.
3) Algorithmic (seigniorage) stablecoins
They are either undercollateralized or not backed by anything. The main way they maintain the $1 peg is through arbitrage opportunities, an experiment in human behavior and game theory. Let's look at Luna/UST. Here's how it works simplistically: if 1 UST is less than $1, people can swap it for $1 worth of Luna and make an instant profit. (UST drops to $0.95. People buy and exchange $1 of Luna for an instant profit of $0.05).
"As long as Luna's market value does not return to zero", UST is not explicitly supported by LUNA, and the system allows swaps between the two assets to achieve stability. As long as the market value of $LUNA is non-zero, the system can provide arbitrage incentives to bring the price to the peg. But Luna/UST crashed last week. Whether it was an attack or a bank run, the scary thing is that people lost faith in Luna, the value plummeted, and it failed.
4) Partial mortgage algorithm stable currency
These stablecoins are an attempt to have the best of both worlds — they’re backed by collateral, and they have an algorithmic part. The most popular is FraxFinance. 1 Frax = 1 USD, governed by FXS (Frax Shares) as the governance token.
Its simplified working principle is: since there is an arbitrage opportunity similar to Luna, if Frax < $1, people can mint new Frax and make a profit. Frax is backed by collateral + FXS, which is now 89%. Currently, collateral is earning yield.
Utility of FXS (Frax’s governance token)
Seigniorage, minting new FRAX requires FXS, and the amount of FXS depends on the mortgage rate;
Using FXS as collateral and generating profits will be used for repurchase and destruction;
Agreement fees incurred by FXS;
governing power.
Therefore, a large amount of value will accumulate in FXS.
The future of stablecoins
The new stablecoin is taking Frax’s approach — partly backed by collateral, partly backed by an algorithm. People will continue to experiment with purely algorithmic tokens, which is a bit of a search for the Holy Grail because the reward is too great to ignore.
Emerging stablecoins
USDD - Tron's new stablecoin, offering high yield. Don't Trust Justin Sun (Justin Sun)
USN - Near's stablecoin. Algorithm + double mortgage Near and USDT
CMST - Cosmos' Collateralized Stablecoin. (just announced)
4. Risks involved
Degree of centralization: there are risks in centralization
Collateral endorsement: what collateral do they use and what percentage?
Transparency: If backed by off-chain assets, how transparent is the entity?
Pegged History: How well has the token maintained its peg throughout its history?
Liquidity: where slippage arises
Income Opportunities: Be Careful When Chasing High Profits
Always remember that stablecoins are designed to protect capital - not to make you rich.
5. My suggestion
Hold a variety of different types of stablecoins
Stick to Stablecoins >$1B Market Cap
Beware of Algorithmic Stablecoins Now - UST and DEI Recently Decoupled
Stablecoin Ranking
Here is my personal ranking of the top 5 stablecoins:
Security class: none
Type A: USDC, BUSD
Type B: USDT, DAI, MIM
Class C: Frax
USDT is dubious, but they do have the most liquidity and usage opportunities. For Frax, despite the C rank, I'm positive about it - it's going to go up over time. I created a sample portfolio of two stablecoins. Assuming 40% of your portfolio is in stablecoins, we can split them according to risk tolerance:
One option you'll want to consider is to keep a portion of your fiat currency, which will avoid the risk of stablecoins entirely. The risk here is the reported inflation rate of 8.3% in the US (which is likely to be much higher). So keeping cash in the bank means we lose 8.3% of our assets every year.
