Not all ‘stablecoins’ are like UST and we explain why

Stablecoins have become quite a hot topic of debate in recent weeks, especially after the debacle of UST, whose value plummeted alongside that of Luna, the native token of the Terra blockchain The fall of both assets, which were part of the world’s Top 10 cryptocurrencies by market capitalization, has caused great questions about the other tokens that boast a value anchored to the US dollar as their main characteristic.

Much has been made these days about whether other stablecoins could suffer the same fate as UST , and it has become clear that there is a lot of confusion (and misinformation) about it. For this reason, in this article we will not only mention what the main stablecoins are today, but also how they differ from each other and what mechanisms they use to achieve parity with the US currency.

An important point to keep in mind is that stablecoins differ not only on the technical side, but also on the organizational side. Several of the most widely used alternatives available are centralized, backed by private companies, although completely decentralized options also exist. This brings with it different implications that we will detail below.

But before moving on, it is important to mention the following: that a cryptocurrency is stable does not mean that it is completely risk-free . After all, we are talking about tokens that try to maintain parity with the dollar through different methods. Some stablecoins can be considered “better” or “more reliable” than others —according to the perspective of each person, of course—, but that does not mean that their success is assured, no matter how sustainable, scalable or healthy their mechanisms appear. anchor with US currency.

USDT and USDC, the Most Used Centralized Stablecoins

By far the two most widely used stablecoins today are USDT and USDC . Both are owned by private companies and use a backup system to maintain parity with the US dollar. In both cases, it is made up of fiduciary money and different documents (commercial papers, US Treasury bills, etc.).

USDT, also known as Tether , is the most important stablecoin in the world and its development is in charge of Tether Limited , a company belonging to Bitfinex. Today it has a market capitalization that exceeds 74,000 million dollars , a category in which it is only behind Bitcoin and Ethereum.

When the UST crash occurred, USDT came under heavy pressure and also briefly lost parity with the dollar. However, it later recovered to its usual value.

USDC —or USD Coin— , meanwhile, has been developed by the Circle and Coinbase companies . As we have already indicated, its parity with the US dollar is achieved through a backing of cash and short US treasury bonds pwe. It is currently the second largest stablecoin in the world, with a market capitalization of over $52 billion .

An important point to keep in mind is that USDC is regularly audited to verify that it has sufficient reserves to face the issuance of new tokens. In the case of USDT, meanwhile, this was not always the case. In fact, over the years this stablecoin has been the subject of controversy regarding its support; In February 2021, for example, Tether Limited was forced to pay a fine of more than 18 million dollars after a ruling by the New York Attorney’s Office, which accused the company of not having real support for its crypto asset.

The cases of USDP and BUSD

As we mentioned earlier, USDT and USDC are the largest and most used stablecoins in the world, but they are not the only ones of their kind. Another centralized stablecoin that uses a similar system is Pax Dollar , popularly known as USDP .

It is a token created by Paxos, an American financial institution. Its value is also kept tied to the dollar through a reserve of cash and equivalents. Its developers promote it as “the world’s leading regulated stablecoin ” and they have their reasons, since its operation is supervised through the New York State Department of Financial Services.

A peculiar fact about Paxos is that it has not only entered the world of stablecoins with USDP. The company is responsible for the development of BUSD , the stablecoin of Binance, one of the world’s largest crypto asset exchanges.

Like Pax Dollar, BUSD is regulated by New York authorities and undergoes monthly audits, the results of which are publicly disclosed. Despite being a relatively new proposal, born in 2019, the Binance alternative ranks third among the stablecoins with the largest market capitalization —only behind USDT and USDC—, exceeding 18,000 million dollars .

Low resistance to censorship

Centralized stablecoins have multiple virtues, but they also share a feature that makes them unattractive to many users: low resistance to censorship . This is because the smart contracts that stipulate their operation include an option that allows them to block wallet addresses ( blacklisting ), freeze the funds they possess or directly destroy those tokens.

This can happen for a number of reasons, but it usually occurs when certain movements of funds are suspected by the authorities; either because of an alleged link to money laundering or other illegal activities. Earlier this year, for example, Tether Limited froze $160 million worth of USDT that was stored at three different addresses. The company did not speak publicly about it, but it is estimated that it has blocked more than 500 addresses since the end of 2017.

Dai, the example of decentralized stablecoins

The case of Dai is a very resounding one, as it is a fully decentralized stablecoin . This means that its development is not carried out by a company or financial institution, but by a decentralized autonomous organization —or DAO— called MakerDAO ; but in addition, its parity with the US dollar is not achieved with a reserve in fiduciary money and documents, but through other cryptocurrencies deposited as collateral.

At the time the criticism of Dai was based on the use of USDC as part of its collateral, although it is no longer predominant. It is also important to mention that, unlike other stablecoins , it uses a lending system that is governed by the code and is over-collateralized . Thus, if you want to issue 1 Dai, you need to deposit the equivalent of a higher amount in ETH — around 150% of what is requested — in the smart contract.

This collateral is locked in the smart contract and is only recovered when the user returns the Dai generated, plus interest. This ensures that all issued Dai is over-backed. According to DaiStats , the total of blocked collateral exceeds 11,000 billion dollars, against just over 6,500 million Dai issued.

It is worth noting that all returned Dai are automatically destroyed to avoid inflation that would cause the tokens to continue circulating without backing.

MakerDAO’s proposal has become one of the most prominent in the crypto world in general, not just among stablecoins . Its operation is very interesting but at the same time complex, so I share the following thread where it is explained with simple terminology and practical examples.

Dai being a decentralized stablecoin also helps maintain its transparency of use and management , as everything is recorded on the blockchain. A very peculiar case, but one that perfectly serves to demonstrate it, occurred in December 2021, when a user “burned” 10 million Dai —that is, 10 million dollars— by mistake. This person made a mistake and sent the stablecoins to an address from which they could not be recovered, at least not on his account.

However, MakerDAO did have the technical means to prevent the disappearance of those cryptocurrencies. When the affected user requested the possible restitution of his Dai, the organization started a procedure as established in his smart contract. The first step was the verification that the lost stablecoins really belonged to the subject that claimed them; Once that step was drawn, a voting proposal was carried out in which the holders of MKR, the DAO’s governance token, participated, who said yes to the recovery.

In this way, the 10 million Dai were rescued and returned to their owner , thanks to a democratic and decentralized process. You can read the full (and more detailed) story in the following thread: