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Most stable cryptocurrency: How stablecoins help volatile crypto markets?

16:28, 27 April 2022

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Stablecoins form the backbone of cryptocurrency markets by bridging traditional finance and digital asset markets. 

USD-backed stablecoins like Tether (USDT) and USD Coin (USDC) act as proxies to fiat currencies within decentralised finance (DeFi) ecosystems, eliminating third-party interactions with banking institutions and facilitating faster trading, borrowing and lending.

The stablecoin sector has seen healthy growth in market value. Data from The Block showed total stablecoin supply ballooned from below $15m at the start of January 2017 to over $180bn by late-April 2022. 

Algorithmic stablecoins like TerraUSD (UST), which are pegged to USD, have become increasingly popular, and are gaining market share from leaders USDT and USDC. 

The growing importance and market capitalisation of stablecoins has also made regulators concerned about investor protection, market integrity, terror financing and potential risks posed to the global financial system. 

In this article we will discuss what makes stablecoins like USDT and USDC the most stable cryptocurrency in the market. We will also look at the biggest stablecoins available and the outlook for 2022.

Stablecoins: Bridging old and new finance

What are stablecoins? In brief, stablecoins are cryptocurrencies that hold a stable price and are backed by reserve assets, such as a fiat currency, commodities or other cryptocurrencies.

There are different types of stablecoins. Fiat-backed stablecoins are the most common. They are backed at a ratio of 1:1 by the US dollar, euro or any other fiat currency. When a holder of a fiat-backed stablecoin redeems their tokens for cash, they receive an equivalent amount of fiat, before transaction fees and other costs. Fiat-collaterised stablecoins are considered the most stable crypto coins in the market as their values are not expected to fluctuate. USD-backed USDT and USDC are the best examples of this type of stablecoins.

Commodity-backed stablecoins are cryptocurrencies collateralised by commodities like gold, oil or precious metals. Gold-backed stablecoins, like PAX Gold (PAXG) and Tether Gold (XAUT) track the value of one fine troy ounce of physical gold, and can be redeemed for their weight in gold.

Crypto-backed stablecoins, like Dai (DAI), are pegged to the US dollar and backed by cryptocurrencies like bitcoin (BTC) and ether (ETH). 

Meanwhile, algorithmic stablecoin are not backed by any reserve asset but are pegged to a fiat currency. For example, Terra’s UST uses arbitrage incentivising mechanisms to maintain its dollar peg. We will discuss UST in more detail later.

Safe haven in a volatile cryptoverse

“Stablecoins allow traders to lock in the value of their cryptocurrency in what amounts to the US dollars.”
by Chainanalysis

So what are stablecoins used for in the cryptoverse? Stablecoins allow traders to transact across various cryptocurrency markets and blockchain applications without having to deal with financial institutions. Following developments in the decentralised finance sector, using stablecoins for lending and collateralising loans has become increasingly popular. 

The price stability guaranteed by stablecoins makes them a safe haven asset in volatile cryptocurrency markets. Traders and investors use stablecoins to shield themselves from downward market pressures by converting their cryptocurrencies to stable coins in order to preserve value during bear cycles.

“Thanks to their, well, stability, stablecoins allow traders to lock in the value of their cryptocurrency in what amounts to the US dollars, shielding themselves from the volatility of cryptocurrency without having to move funds off exchanges,” said blockchain data platform Chainalysis.

“This role makes stablecoins by far the most frequently traded assets in the cryptocurrency ecosystem.”

With the explosive growth in DeFi in recent years, stablecoins have found an important place in crypto lending and borrowing platforms. Stablecoin deposits are in high demand, with cryptocurrency platforms offering interest rates up to 20% on deposits, as these stable digital currencies provide liquidity needed on decentralised exchanges and DeFi protocols

Moreover, stablecoins are also used as means of payment and cross-border remittances, as they offer faster and cheaper transactions with less exchange rate risks.

What are the best stablecoins?

Here is a list of the top five biggest stablecoins according to the data from CoinMarketCap, as of 27 April. Many of these tokens are considered as some of the most reliable stablecoins in the market today.

Biggest stablecoins by market capitalisation

Tether (USDT)

Tether (USDT) was the first stablecoin to gain prominence in the crypto universe. According to its whitepaper, Tether was initially issued on the bitcoin blockchain, and each USDT token is backed in a one-to-one ratio by one US dollar.

As of 27 April, USDT was the third largest cryptocurrency in terms of market capitalisation, valued at over $83bn. USDT is currently the top stablecoin in terms of market supply, with a dominance of over 45%, as of 27 April, according to data from The Block.

Tether to USD chart, 2015 - 2022

“One of the main reasons that Tether has remained so dominant is its superior liquidity compared to other stablecoins,” a report by Bitstamp and CoinMetrics stated.

Tether has attracted scrutiny from the US Commodity Futures Trading Commission (CFTC) after it was revealed that its dollar reserves had not been “fully-backed” between 2016 and 2018.   

USD Coin (USDC) 

USDC is a US dollar-backed stablecoin created by peer-to-peer payment services company Circle and Nasdaq-listed crypto exchange Coinbase (COIN). USDC differentiates itself from USDT by providing full transparency and publishing attested reports regarding its reserve balances. 

USD Coin to USD chart, 2018 - 2022

Over the years, USDC has grown to become the second largest stablecoin, with a market capitalisation of over $49.9bn, as of 27 April. USDC has eaten into USDT’s market share with its share of total stablecoin supply currently at about 24%. 

TerraUSD (UST) 

Market capitalisation of Terra’s UST surged in the last year making the algorithmic stablecoin the third biggest in the market after USDT and USDC, valued at over $18m, as of 27 April. Terra is a layer-one blockchain protocol built on top of interoperability-focused blockchain platform, Cosmos. 

UST is linked to the US dollar. Its peg is maintained through a network of arbitrageurs, who buy and sell a Terra-based cryptocurrency token called LUNA.     

TerraUSD to USD chart, 2020 - 2022

To understand how this works, let's say you want to mint a UST. You will have to burn an equivalent dollar amount of LUNA, before fees, to mint an equivalent dollar amount of UST. 

UST’s unit price is kept in check and pegged to the US dollar by traders, who profit from price discrepancies known as arbitrageurs. They sell LUNA for UST when the value of the stablecoin falls below $1, and buy LUNA for UST when UST rises above $1 mark. 

According to Delphi Research, UST’s year-to-date growth in 2022 gas only trailed no. 2 stablecoin USDC by less than $80m. The blockchain research company noted that UST demand is mainly driven by Terra-based passive income protocol Anchor, due to its 20% deposit rate for UST. 

Binance USD (BUSD)

BUSD is the fourth biggest stablecoin, with a market capitalisation of over $17bn. 

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The USD-backed stablecoin issued by crypto exchange company Binance saw strong growth in 2021. The stable digital currency grew from a market capitalisation of about $1bn at the start of the year to over $14.6bn by the end of 2021, data from CoinMarketCap showed.

Binance USD to USD chart, 2019 - 2022

According to its website: “BUSD is a 1:1 USD-backed stablecoin approved by the New York State Department of Financial Services (NYDFS), issued in partnership with Paxos.”

Dai (DAI)

Dai stablecoin is a decentralised, unbiased, collateral-backed cryptocurrency soft-pegged to the US dollar, according to its whitepaper. Users generate dai by depositing crypto collateral assets within the Ethereum-based DeFi platform called Maker Protocol.

“Every dai in circulation is directly backed by excess collateral, meaning that the value of the collateral is higher than the value of the dai debt, and all dai transactions are publicly viewable on the Ethereum blockchain,” said Maker Protocol on its website.

Dai to USD chart, 2019 - 2022

As of 27 April, dai held about 5% share of total stablecoin supply. Dai was the 20th largest cryptocurrency and the fifth biggest stablecoin after USDT, USDC, UST and BUSD, with a market capitalisation of $9.1bn..

Forecasts for stablecoins 2022

“It (BTC reserve) can be used to help protect the peg of the UST stablecoin in stressful conditions.”
by Kanav Kariya, president of Jump Crypto

According to Caroline Malcolm, head of international policy at Chainalysis, 2022 will be the year when regulators around the world “take on crypto”.

Malcolm listed stablecoins and central bank digital currencies (CBDC), anti-money laundering (AML) rules, taxes, DeFi regulations and consumer protection as policy areas that are expected to see “meaningful movement” internationally.

US authorities have asked Congress to “act promptly” to ensure that stablecoins are subject to “appropriate federal prudential oversight on a consistent and comprehensive basis”, in a report of November 2021. 

In March 2022, US President Joe Biden published an executive order, saying that the US “must take strong steps to reduce the risks that digital assets could pose to consumers, investors, and business protections.”

The executive order added that the International Financial Stability Board is leading work on issues related to stablecoins, cross-border fund transfers and other international dimensions of digital assets and payments. 

The expected regulatory drive into cryptocurrencies looks increasingly likely. Chainalysis reported that hackers stole $1.3bn from crypto exchanges, platforms and private entities in the first three month of 2022.

“Digital thieves had a big year in 2021, stealing $3.2 billion worth of cryptocurrency. But in 2022, they’re shaping up to steal even more,” said the blockchain data company.

Following explosive growth in recent months, Terra’s UST will remain in focus for the rest of the year. 

Critics of the algorithmic stablecoin have questioned if UST growth is sustainable as UST demand is heavily dependent on Terra-based DeFi protocol Anchor’s attractive near 20% deposit rate. About $13.15bn in UST was locked in the Anchor protocol, representing about 72% of UST’s circulating supply, as of 27 April. 

In late March, Anchor’s community passed a vote to implement a “sustainable” semi-dynamic interest rate that will increase or decrease by 1.5% each month depending on the UST yield reserves. 

A non-profit organisation called the Luna Foundation Guard (LFG) was set up in February to establish a UST reserve denominated in bitcoin, as an answer to UST’s sustainability questions.

“It (BTC reserve) can be used to help protect the peg of the UST stablecoin in stressful conditions. This is similar to how many central banks hold reserves of foreign currencies to back monetary liabilities and protect against dynamic market conditions,” said Kanav Kariya, president of Jump Crypto.

Questions about UST come at a time when DeFi users are fretting over contagion risks in the event of a stablecoin losing its peg. Algorithmic stablecoins losing their peg is not unheard of.

In January, Ethereum-based DeFi protocol Abracadabra’s algorithm stablecoin MIM fell off its dollar peg as investors fled the protocol after it was alleged that the CFO of its sister network, Wonderland, was a former convict and co-founder of the now-defunct and fraudulent Canada-based crypto exchange QuadrigaCX.

Neutrino USD (USDN), an algorithmic stablecoin of the Waves blockchain network with a similar arbitrage mechanism to UST, fell as low as $0.647 on 4 April after Waves was accused of running a Ponzi scheme. Elsewhere, Solana-based stablecoin CASH fell to $0.0005 after a glitch allowed hackers to mint tokens without collateral. 

On the positive side, Huobi Ventures said decentralised stablecoins such as UST & DAI will steal more market share from centralised stablecoins in 2022, adding that a “collapse” of institutional trust has driven up user demand for decentralised stablecoins. 

The note also said that a “more compliant” USDC is expected to succeed current leader USDT as the largest stablecoin protocol by market capitalisation.

Note that price predictions can be wrong. Forecasts and analyst opinions shouldn’t be used as a substitute for your own research. Always conduct your own due diligence. And never invest or trade money you cannot afford to lose. 

Are stablecoins a good investment ?

As we now know what stablecoins are, a question remains: are stablecoins a good investment ? 

Stablecoins are one of the safest cryptocurrencies out there, but people investing in them should not expect returns on their holdings because they are designed to be stable and track the unit price of fiat currencies, be it USD, EUR or GBP. Stablecoins are mainly used for trading and as a means to hold value in volatile markets. 

How to buy stablecoins? You can buy stablecoins on centralised exchanges such as Binance or Coinbase. One can also buy stablecoins for investment on decentralised exchanges, like Uniswap and SushiSwap.

Note that all trading and investing of cryptocurrencies contains high risk. Always conduct your due diligence in advance. Only you  can decide whether to invest. And never trade money you cannot afford to lose. 

FAQs

What are the safest stablecoins?

USDT, USDC and BUSD are USD-backed stablecoins, and are among biggest stablecoins by market capitalization. UST is an algorithmic stablecoin pegged to the US dollar. Dai is pegged to the US dollar and backed by other crypto assets. It should be noted that stablecoins losing their peg is not unheard of.

What are the risks of stablecoins?

Stablecoins losing their peg is not unheard of. Neutrino USD (USDN), an algorithmic stablecoin of the Waves blockchain network with a similar arbitrage mechanism to UST, fell as low as $0.647 after Waves was accused of running a Ponzi scheme. Elsewhere, Solana-based stablecoin CASH fell to $0.0005 after a glitch allowed hackers to mint tokens without collateral.

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