Stablecoin: The Cornerstone of the Crypto Assets Market

Stablecoins play a crucial role in the Crypto Assets industry. As of the end of July 2024, the market capitalization of stablecoins is approximately $165 billion, accounting for nearly 7% of the total market capitalization of the entire Crypto Assets market, which is $2.417 trillion. Among them, Tether (USDT), as the leading stablecoin, is currently the third largest Crypto Asset by market capitalization, only behind Bitcoin and Ethereum.

This article will delve into the definition, classification, and significant role of stablecoins in the digital currency field. We will also analyze the operating mechanism and potential risks of USDe as an example.

Definition and Function of Stablecoins

According to the definitions provided by the Financial Stability Board and the Bank for International Settlements, a stablecoin is "a type of Crypto Asset designed to maintain a stable value relative to a specific asset or a group of assets." Typically, stablecoins are pegged to fiat currencies such as the US dollar.

So, why do we need stablecoins?

First, in the context of large-scale applications of Web3, stablecoins, as a medium of exchange with stable value, can facilitate daily transactions, achieve fast and low-cost cross-border payments, and avoid the processing delays and high fees of traditional banking systems.

Secondly, stablecoins help to reduce the impact of value fluctuations. Since mainstream Crypto Assets like Bitcoin or Ethereum have significant price volatility, they are not suitable as stable mediums of exchange. During periods of market volatility, stablecoins provide unique value stability, becoming a safe haven for investors.

Classification of Stablecoins

Stablecoins are mainly divided into two categories: collateralized stablecoins and algorithmic stablecoins.

mortgage stablecoin

Stablecoins are fully backed by other assets, ensuring their value is supported by other forms of collateral. Mainly includes:

1. Fiat-collateralized stablecoins: backed by reserves of fiat currency, such as the US dollar. Typical examples include USDT and USDC, which are the top two stablecoins by market capitalization.

2. Commodity-backed stablecoin: Supported by commodity reserves, such as gold. A typical example is Tether Gold (XAUt).

3. Crypto Assets collateralized stablecoins: supported by reserves of other Crypto Assets, such as BTC or ETH. A typical example is DAI.

algorithm stablecoin

Algorithmic stablecoins ensure the security of collateral through algorithms or adjust market circulation to maintain stability. The main methods include:

1. Liquidation: The risk collateral is liquidated through auctions to ensure that the value of all outstanding stablecoin debts is always fully collateralized. A typical example is DAI.

2. Burn and Mint: Reduce the total supply by destroying existing tokens or increase the total supply by minting new tokens. A typical example includes TerraUSD (UST).

3. Adjust the lending rate: Control the supply of stablecoin within the "lending yield framework" by increasing or decreasing the central lending rate. A typical example includes Beanstalk (BEAN).

It is worth noting that these classification methods are not mutually exclusive. Stablecoins can implement multiple mechanisms simultaneously to maintain stability.

Security Risks and Solutions of Stablecoins

1. Collateral Transparency: Many stablecoins enhance transparency by having their collateral held by third-party custodians, undergoing regular audits, and publishing reserve proof reports.

2. Fluctuation of Collateral Value: Many stablecoins implement over-collateralization and liquidation mechanisms to mitigate the potential negative impacts caused by fluctuations in collateral value.

3. Smart contract vulnerabilities: Strict security audits and ongoing security monitoring are crucial for ensuring the security and reliability of these protocols.

4. Market Volatility: In a rapidly changing market environment, the originally designed stablecoin mechanisms may not be able to respond and adjust quickly, resulting in significant price deviations.

Overview of Mainstream Stablecoins

According to the latest data, the top 20 stablecoins account for over 99% of the total market value of stablecoins. Among them, the top 5 stablecoins (USDT, USDC, DAI, USDe, and FDUSD) account for 96% of the total market value. This indicates that the market is dominated by a few key players.

Among the top 20 stablecoins, all stablecoins are backed by certain assets. In addition, 9 of these stablecoins also incorporate algorithmic stabilization mechanisms. This phenomenon indicates that, despite algorithmic stablecoins claiming their stabilization mechanism is well-designed, users show a clear preference for fully collateralized stablecoins, especially those backed by fiat currency.

Case Study: USDe

USDe is a stablecoin issued by Ethena Labs and has currently become the fourth largest stablecoin by market capitalization. USDe uses mainstream Crypto Assets as collateral and employs a "delta hedging" strategy to maintain the stability of the collateral assets.

The returns of USDe mainly come from two parts: staking returns and the returns from delta hedging derivative positions. According to historical data analysis, this combination of returns remains positive even during market downturns.

However, USDe also faces some potential risks:

1. Centralization Risk: Mainly arises from the dependence on centralized exchanges.

2. Market Risk: The yield mechanism of USDe may encounter a continuously negative funding rate, which could result in certain parts of the yield design becoming negative.

Conclusion

Stablecoins play a key role in the Crypto Assets ecosystem, providing stability to the market and facilitating transactions. From fiat-collateralized to algorithmic mechanisms and asset-backed stablecoins, they meet the diverse needs of the crypto community.

With the emergence of new stablecoins like USDe, we need to closely monitor whether they can maintain stability amid market fluctuations and secure a leading position in the highly competitive stablecoin space. At the same time, ongoing security audits and monitoring are crucial for maintaining market stability and trust.