Most beginners, in the crypto world, start with exchanging their fiat currencies for stablecoins. Those stablecoins, can later be exchanged for other digital assets.
Actually, stablecoins are more than just a channel for crypto investment. They are the foundation of the DeFi industry, acting as a medium of exchange and being used for liquidity pools and yield farming.
Half of the market is being occupied by USDT, which is a centralized stablecoin. DAI is the leading decentralized stablecoin, which takes the fourth place, followed by UST — an algorithmic stablecoin.
Centralized, decentralized and algorithmic stablecoins are all different. Let us have a look at how stable and safe they are.
Centralized stablecoins
As we already mentioned, USDT is the leading decentralized stablecoin. The issued model here is that the user sends a chosen amount of USD to Tether’s account and the same amount of USDT will be sent to the user, after confirmation.
USDT’s price movements are mainly based on the degree of credit recognition, the depository bank and the USD by the holders of the stablecoin.
One of the main issues that the centralized institutions face is the transparency and compliance of Tether. Anyway, the huge number of users and use cases of the USDT, make people use it.
USDT’s market capitalization has been growing. Actually, it rose as much as three times, from the beginning of 2021 to the early November. USDC, which takes the second place, has less than half the market cap.
Centralized stablecoins rely on fiat currency to keep their value, and unlike decentralized coins, they are vulnerable to regulations.
Overcollateralized Stablecoins
DAI is the leader for this category of stablecoins. In 2021, Liquity went live in 2021, but the lack of use cases for the LUSD stablecoin has limited its adoption.
Overcollateralized stablecoins, mint $1 worth of stablecoins by depositing collateral worth more than $1. Those collateral tokens can be unstable in their own way, for example Ethereum, protocol tokens, LP tokens and others. Since those stablecoins are on the same chain, the risk comes from the instability of the value of the collateral and that is why the liquidation mechanism of such protocols is extremely important.
The daily trading volume of DAI surpasses that of other stablecoins, and the main reason for that is that DAI could be supported on various protocols.
LUSD, on the other hand, has more than 60% of stablecoins circulating within the system and supports fewer external use cases.
The supply and demand of DAI is being regulated through a stability fee and Dai Savings Rate, which also affects the price of DAI. These adjustments are based on a vote by holders of MakerDAO token - MKR, and most of them are being held by early or large investors.
Algorithmic Stablecoins
This type of stablecoins keep their value by stimulating the market to speculate on tokens by using their own protocols. So, the uncollateralized mechanism allows for higher capital utilization, but at the same time can move the price out of anchor if the arbitrage is made differently than the protocol is expecting.
The leader for algorithmic stablecoins is Terra’s coin - UST. It uses a dual token model, with Luna, which is mainly used for governance, staking and verification and UST, which is anchored to USD.
For each UST minted, a dollar worth of Luna should be burned. The connection between UST and USD is being maintained through an arbitrage mechanism.
UST is the top algorithmic stablecoin, mainly because the Terra protocol is set up around its original stablecoin. And since its stabilization mechanism is based on paying out with Luna, it is backed by the promise of Luna. Trust is what ensures arbitrageurs of UST stability.
Conclusion
So, to conclude, we might say that the three types of stablecoins, have their advantages and disadvantages.
Centralized stablecoins have the largest market cap, but their security and lack of transparency brings high risk to the system.
Overcollateralization stablecoins offer price stability, but low capital utilization.
Algorithmic stablecoins manage to maintain stability, but have a potential for volatility.
Stablecoins are a medium of exchange between assets. They don’t have the backing of fiat currencies, and you should always be aware of the risk, before you choose to make and cryptocurrency investment.
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