Why are the stable coins being so different? (USDx, USDQ, xUSD, PAX, DAI etc)
The crypto market was getting mushroomed by stablecoins during this year. The total number of promising tokens is around 200. Do we need all of them that much? We predict even more risings and here’s why.
What are the Stablecoins?
Stablecoins are an attempt to create a cryptocurrency that isn’t volatile. A stablecoin’s value is pegged to a real-world currency, also known as fiat currency. The demand for stablecoins is formed by three major groups of investors:
1. Cautious investors, who want to invest only part of the portfolio into the risky coins.
2. Speculators and miners, who need to hedge their crypto positions in case of major volatilities and expected corrections.
3. Margin and futures traders.
4. Algo traders.
Most of the stablecoins are pegged to USD and many exchanges often reference these coins as USDx just for their names: USDT, USDC, USDK, USDS, USDQ, USC, TUSD, GUSD, SCUSD, BitUSD, sUSD etc.
The first and the most popular stable coin is Tether (USDT). Tether dominance is about 80% out of the total stablecoin sector market cap of $4.6B.
The main feature of any stablecoin is a peg to some of the convenient fiat currency. Thus claiming that 1 stablecoin will always be worth 1 USD.
This is not an easy promise, however, the simplest way to fulfill it is to keep the 1 to 1 amount of reserves in fiat bank accounts. The authorities may impose some restrictions, seizure, and limitations on the use of fiat accounts. This brings part of the fiat system risks into the crypto markets.
On July 1, 2019, Bitfinex repaid $100,000,000 of the outstanding loan facility to Tether. This is a very good sign. The whole community expects the full repayment of the loan amount since this action should bring back the trust into Tether. Now, this seems totally possible after the great IEO raising $1B to cover up the funding gap of $850 million and an associated legal indictment.
This case shows a strong exposure to systemic fiat risks. Even when the exchange is doing everything right, there is a high risk from the regulators themselves. At any moment they can find a reason to seize the whole balances if they find something suspicious.
The whole market cap of the Tether is around $3.8B. This amount is mostly in fiat balances. This is a tasty little bite for any investigator.
The case with Bitfinex shows a new systemic risk for a crypto project of holding substantial amounts of reserves in fiat balances. This risk stimulates the development of stable coins backed by cryptocurrencies.
Crypto backed stablecoins from one side have the same advantages as all stablecoins. Any trader can easily use such tokens for hedging in the periods of crypto corrections. In addition to this, the stablecoins are fully in the blockchain and do not have the seizure risks. Usually, the Ethereum blockchain is used. One of the difficulties for this type of stablecoins is to manage the collateral in case of the crypto corrections. The project should create some excessive collateral and also have an algorithm to add more collateral in case of a major market decline.
In this way, the best example of such a correction is a Q DAO ecosystem which consists of USDQ, JPNYQ, and KRWQ stablecoins pegged to national fiat currency (US dollar, Korean Won, and Japanese Yen ). The price of the stablecoin is controlled by a special Target Rate Feedback Mechanism, which maintains the price at $1(or another fiat nominal). If the market price of USDQ falls below the target price, the feedback mechanism increases the target rate, and the generation of new tokens becomes more expensive, so the demand for existing tokens increases too. The reverse mechanism is implemented when the price climbs above the allowed threshold – the target rate gets decreased, and the demand for USDQ tokens decreases with it.
Types of the collateral
1. Fiat collateral
Pro: Easy to buy and sell, always ready for withdrawals.
Contra: Risks of fiat money seizures.
2. Crypto collateral
Pro: Highly stable when crypto is rising. High level of protection. Smart contract-based.
Contra: Requires some management and additional collateral in case of crypto price decline. Fewer exchanges to trade.
3. Algorithmic no collateral
Pro: Advanced management algorithms. Secure and trusted.
Contra: Not yet well developed, complex, rare.
Any stablecoin adds more services, liquidity, and flexibility to the whole crypto market.
The type one stablecoins (fiat-based) are the majority and very popular at the moment.
The type two stablecoins (crypto-based) are gaining popularity for their higher protection and decentralization. The type three stable coins will be very popular at some point in the future when the technology proves to be reliable and secure.