Price volatility prevents cryptocurrencies from being used as a mainstream currency. Stablecoins aim to maintain a stable value while still benefiting from the mobility and utility of cryptocurrencies.
Stablecoins come in different flavors, listed here from the most proven to least proven structures:
- Fiat-backed (80% of mkt): You wire a dollar to a bank account and get a stablecoin in return. You can redeem your stablecoin for the physical dollar. Example: USDC, USDT.
- Crypto-backed: You lock another crypto asset as collateral to create a stablecoin. As the collateral can be volatile, the stablecoin has to be over-collateralized. Example: DAI.
- Asset-backed: You use resources like gold or oil to back their value. Example: PAX Gold, Tether Gold.
- Algorithmic: You use supply to maintain price. If the stablecoin goes above $1, the system adds more supply to bring down the price. If the stablecoin goes below $1, the system reduces the supply to bring up the price. Example: UST.
The meltdown we are seeing in TerraUSD Coin or UST is more about structural flaws in algorithmic stablecoins and how Luna Foundation Guard managed their reserves than it is about the overall concept of stablecoins.
I have always been skeptical of algorithmic stablecoins. The entire system relies on its ability to absorb enough supply until all withdrawals are satisfied. This is only possible if the reserves, which can be unproven and volatile crypto assets themselves, maintain enough value and liquidity.
UST is a great learning opportunity for builders and investors. As market forces freely play out, we get critical learning about how to innovate in stablecoin structures to make them sustainable long term.
Stablecoins can achieve utility and adoption beyond the first generation of crypto assets. Stablecoins represent a critical piece of infrastructure to take blockchain technology into mainstream use cases such as credit markets, international payments, and government welfare systems.