Stablecoins: A Introduction


Why Stablecoins Exist

The crypto world has two long-term trends that continue to maintain huge volatility.

  • One trend is that cryptocurrencies similar to Bitcoin and ETH are designed for deflation. As they continue to gain recognition, they will continue to fluctuate in price.
  • Another trend is that cryptocurrencies have huge freedom and regulatory difficulties, which will continue to lead to large price fluctuations due to speculation.

In this situation, if cryptocurrencies are to be used in a truly planned and auditable manner, a relatively stable currency unit is needed.

For pure cryptocurrency believers, they can choose BTC, ETH, or other currencies to bear such high volatility. However, for more people, a currency unit pegged to the US dollar (currently the most trusted fiat currency in the world) is a better choice - because the price is stable, it can be directly used in our traditional transactions, budgets, audits, and other economic behaviors.

Therefore, people have designed stablecoins, a special form of cryptocurrency. It has two core characteristics:

  • The value is pegged to the US dollar or corresponding fiat currency.
  • It runs on the blockchain and has all the characteristics and advantages of the blockchain.

Therefore, stablecoins are used as a "medium" and a medium between cryptocurrencies and fiat currencies. Because of this feature, it can also play the role of "medium" in many economic behaviors. Next, let's look at how it operates through its issuance mechanism and characteristics.

The Implementation Mechanism of Stablecoins

People have extensively explored the mechanisms of stablecoins. Some have been successful for a long time, while others have collapsed. Past explorations were mainly based on two types: 1. Valuable asset collateral; 2. Algorithms. With the collapse of Terra, the latter has not yet fully proven itself in the overall type. At present, the "asset-backed stablecoin issuance" model is widely recognized in the market.

This is relatively easy to understand and relatively easy to provide transparency and gain recognition. Based on the type of "valuable collateral assets", there are several types of stablecoins, the main ones in the market are: 1. Equivalent collateral of US dollars or other fiat currencies; 2. Cryptocurrency collateral; 3. Gold or other valuable asset collateral; 4. Physical asset collateral. Similarly, the most active and widely recognized in the market are the first two:

  • Equivalent collateral of US dollars or other fiat currencies. With USDT and USDC as typical representatives, this is currently the mainstream method of stablecoins. The core mechanism is that for every $1 deposited in a bank or capital management institution, 1 stablecoin dollar is issued on the blockchain. Users can exchange stablecoins for fiat currency through the issuing institution at any time.
  • Cryptocurrency collateral. Crypto believers prefer this approach: It is usually based on a collateral rate of 200% to allow users to pledge cryptocurrency assets to issue stablecoins based on the protocol. Users need to pay attention to increasing collateral to ensure the collateral rate, or forced sales and auctions will be conducted when prices drop sharply to ensure the price of stablecoins. Dai and pUSD are representative stablecoins of this type. They believe more in open and transparent algorithms to drive stablecoins.

In the long run, there is an interesting competitive relationship between the two. The former is the traditional world trying to find a way to invest in and apply blockchains; the latter is the crypto world striving to be compatible with the traditional world and find ways to exchange and evaluate value with fiat currencies.

Characteristics of Stablecoins

Stablecoins are still cryptocurrencies. Although the cryptocurrencies mentioned above are issued and circulated on various blockchains, Ethereum still has an absolute advantage. This means that stablecoins also have the advantages of blockchains and the characteristics of Ethereum.

  • Convenient transactions: This is the most typical advantage obtained by stablecoins through the blockchain, including easy global transactions, low fees, high efficiency, and other transaction features.
  • Privacy and security: Decentralized transaction records and encryption algorithm protection make stablecoin transactions difficult to tamper with. The transaction process does not require complete bank personal information authentication, providing relatively high privacy levels.
  • Transparency and verifiability: The issuance and transaction process of stablecoins have the characteristics of openness and transparency of the blockchain; it is easy to audit based on ledger data and can be verified based on smart contracts.
  • Programmability: Due to the existence of smart contracts, stablecoins can easily participate in various financial behaviors such as lending, and liquidity mining, and can be widely used as a contractual settlement tool.

The above characteristics are obtained based on blockchain technology. As one of the greatest inventions of mankind, BTC not only provides the BTC value storage currency but also provides the complete technical model of the blockchain. Stablecoins appeared along this technical model and can play a solid and stable value for a long time. The following are the specific functions it undertakes in actual applications.

The Intermediary Function of Stablecoins

As an intermediary between cryptocurrencies and fiat currencies, the core function is to transfer value between the crypto world and the traditional world. If we further subdivide, it has played an actual intermediary role in the following levels and may take on more functions.

As an investment "intermediary"

When traditional investment institutions invest in crypto assets, based on the value logic of stablecoins, they can better utilize the high volatility of cryptocurrencies to make profits, while combining existing financial goals for analysis. Stablecoins have become the "intermediate currency" for traditional investment institutions in the crypto world, used for temporary value storage and financial analysis.

As a participating intermediary in DeFiopen in new window finance

Many people invest in Bitcoin or other cryptocurrencies for the long term. However, as an established asset, the asset itself does not have savings income or other ways to make profits in financial markets. DeFi provides a variety of financial behaviors, and people may also choose stablecoins as an intermediary to participate in such investment behaviors. It retains the potential long-term price increase of Bitcoin or other crypto assets while being able to evaluate temporary profits at the fiat currency price.

As an intermediary for asset transfer

Traditional financial payments, especially cross-border financial payments, may have high payment costs, time costs, and complex processes. Stablecoins are pegged to fiat currencies but fully have the characteristics of blockchain for fast global transfer. Therefore, it can be used well for transferring assets from A to B, settling, and paying efficiently. Many traditional financial institutions have also begun to use stablecoins for settlement, and this trend is continuing.

As an intermediary for transactions with the real world

People can shop with US dollars or with stablecoins pegged to the US dollar. Stablecoins provide an intermediary for the exchange between the crypto world and the physical world. In this respect, it undertakes the intelligence of ordinary fiat currencies. Similarly, convenient transactions and the easy reusability of assets in the crypto field make stablecoins increasingly represent the core function of currency in the crypto world.

As an intermediary for value storage

Currency devaluation is common internationally. For some countries with significant currency devaluation, people can purchase stablecoins to convert existing fiat currencies into a kind of US dollar in a sense to ensure value preservation.

In summary, stablecoins are the value intermediary between the entire crypto world and the traditional world. It is worth mentioning that as the application of stablecoins becomes more and more extensive and the market value of stablecoins becomes larger and larger, its dual value as "currency" and "intermediary" is constantly realized, and it will create more and more value, which can be realized through financial behaviors such as savings, lending, and reinvestment.

The Case of pUSD

pUSDopen in new window is a stablecoin issued by Pandoopen in new window Protocols, supported by a basket of cryptocurrencies, mainly including BTC and ETH. It is "crypto-native" and uses crypto assets as collateral to issue and run on and realize value through various protocols.

As mentioned above, pUSD develops the functions of stablecoins at multiple levels:

  • pUSD can be obtained through the Pando Leaf protocol for collateral or the Pando Swap protocol for purchase.
  • pUSD can be used to purchase other targets for investment transactions on Swap.
  • pUSD can obtain interest income through Pando rings lending.
  • pUSD can participate in liquidity mining on Pando Swap to make a profit.
  • pUSD can be converted between different wallets with zero fees on the Mixin platform.
  • pUSD can be used for shopping on Bazaar.

Similarly, in the current devaluation of currencies such as the yen and the renminbi against the US dollar, pUSD can also serve well as a value-preserving currency.

Blockchains and cryptocurrencies still face long-term development. During this process, stablecoins will play an increasingly important role and become a core intermediary between the crypto world and the traditional world. There are more innovative possibilities. We will update this article as stablecoins continue to develop and witness their growth.

Links: What is DeFi? Exploring the Operating of Decentralized Financeopen in new window

The information contained in this article is for informational purposes only and does not constitute financial, investment, or other professional advice. The views expressed in this article are those of the author and do not necessarily represent the views of the company or organization they work for or Pando. Any investment decisions made by the reader should be made after consulting with their own financial advisor and conducting their own research. The author and the company or organization they work for and Pando will not be liable for any financial losses incurred as a result of reliance on the information contained in this article.