In the ever-changing world of cryptocurrencies, stablecoins stand out as pillars of stability in a sea of volatility. But their use is not without risk and you must remain cautious when selecting assets to integrate into a crypto portfolio. What is a stablecoin? What are the different categories of stablecoins, and how can you identify which one best suits your investment needs?
This article was written by Guillaume Chanut, CEO and co-founder of Redacted Labs.
What is a good stablecoin?
The answer obviously depends on the use cases and the needs of each person. We will evaluate what generally makes a good stablecoin according to different criteria:
- Stability and Security : The main function of a stablecoin is to provide stability. It is crucial to check whether the stablecoin has maintained its peg over time;
- Transparency and mechanisms: In the context of stablecoins collateralized by fiat currencies, the transparency of reserves and regular audits strengthens user confidence;
- Liquidity and integrations : A stablecoin must be easily tradable. Liquidity on exchanges is a key indicator of its ease of use.
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The different types of stablecoins
Fiat currency-backed stablecoins were the first to emerge and are today the most widespread and used form of stablecoins. Each unit of these stablecoins is backed by a 1:1 parity with a fiat currency, such as the dollar. This stability, widely sought after, is nevertheless accompanied by compromises in terms of decentralization.
Stablecoins backed by cryptocurrencies came later. These were designed as a response to the shortcomings and disadvantages of fiat-backed stablecoins. Trustless systems and decentralization are the main pillars of the crypto ecosystem, which is why the creation of decentralized protocols was inevitable.
Finally, algorithmic stablecoins have long promised a solution to solving the stablecoin trilemma.
Instead of relying on fiat-backing or over-collateralized crypto-backing, algorithmic stablecoins implemented an algorithm balancing the supply and demand of the stablecoin to maintain the stability of its price.
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What to remember about the categories of stablecoins?
Each of the categories of stablecoins brings different advantages and disadvantages, and the latter will be used by different types of investors, from regulated funds to cypherpunks.
This understanding is essential, as the specific nature of each stablecoin directs the study in distinct ways; for example, the analysis of DAI differs significantly from that of USDT.
About fiat-backed stablecoins
It is important to emphasize that the main weakness of any stablecoin backed by a fiat currency lies in its centralized nature, which gives great power to the issuing entity and makes it vulnerable to censorship. We therefore seek to assess the extent to which these aspects are controlled, transparent, and guarantee user protection.
Let's analyze the main stablecoins in the crypto market backed by fiat currencies:
Nature and amount of collateralization for the main dollar-backed stablecoins (June 2024)
Maintaining the price (peg) of a centralized stablecoin relies on the ability of users and arbitrageurs to access effective redemption. This capacity depends on several key factors: sufficient collateralization, availability of liquid assets, favorable redemption conditions for users and solid banking partnerships.
Notably, Tether's USDT partially relies on less liquid assets whose details are not disclosed, raising questions about its stability. Assets such as T-Bills and Overnight Repos are considered highly liquid and can be sold quickly, boosting investor confidence.
Data relating to fiat-backed stablecoins according to their market capitalization
Regulation is crucial for institutional investors and users seeking increased security. Stablecoin issuers must choose their jurisdiction wisely, taking into account regulatory requirements, including segregated accounts and bankruptcy remote structures to protect user funds.
Despite criticism over its transparency and financial practices, Tether's USDT continues to dominate the stablecoin market thanks to its high liquidity and mass adoption, even though it operates under a less strict regulatory framework than other regulated issuers .
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Our opinion: what is the best stablecoin backed by fiat currency?
Redacted Labs considers USDC to be the most complete and efficient stablecoin on these criteriathanks to Circle's commitment to regulation (EME approval under MiCA), its transparency with regular audits by Deloitte, the protection of user funds and recognition by rating agencies such as Standard & Poor's.
It is also the most integrated stablecoin in the decentralized finance (DeFi) ecosystem.
What about stablecoins backed by cryptocurrencies?
So-called “decentralized” stablecoins may suffer from limitations in terms of scaling and must have effective mechanisms for liquidation, redemption and maintaining their peg against the dollar. These criteria are essential to ensure the stability of the asset.
Here is an overview of the new generation of crypto-collateralized stablecoins, with USDO, USDA, GHO and USDe here:
And for FRAX, crvUSD, DAI and fxUSD:
The new generation of crypto-collateralized stablecoins includes USD0, USDA, GHO, USDe, fxUSD and crvUSD, all with strong potential in DeFi.
Usual's USD0 is backed by T-Bills and redistributes returns to holders with an innovative bond system. Angle Money's USDA is backed by USDC, adding an anti-depeg mechanism and offering an attractive native yield. Aave's GHO benefits from good integrations, but with a simplistic peg mechanism.
Data relating to crypto-backed stablecoins according to their market capitalization
Ethena's USDe is a synthetic asset generating returns via carry trades, dependent on funding fees. The fxUSD of F(x) Protocol which aims to provide strong scalability thanks to the mechanisms of other leveraged tokens without liquidation of the protocol.
Curve Lend's crvUSD, on the other hand, uses innovative liquidation mechanisms to ensure its stability, although it is limited to the Curve ecosystem.
Finally, the leader of decentralized stablecoins, DAI (currently transitioning to Sky dollars, USDS) allows ETH or BTC holders to over-collateralize their assets to generate new stablecoins.
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Our opinion: what is the best stablecoin backed by cryptocurrencies?
It is still early to designate the big winners of this new wave of stablecoins, which offer very different solutions and which will correspond to different typologies of users depending on the search for a strategy for generating returns, specific implementation within others protocols or censorship resistance.
Usual's USDO and AAVE's GHO seem to be favorites today, however, both in terms of their growth and their ability to distribute their stablecoin within the ecosystem.
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Guillaume Chanut, CEO and co-founder of Redacted Labs.
Redacted labs is a DeFi desk offering tailor-made services to professionals wishing to benefit from decentralized finance with institutional risk management.
Our goal at Redacted Labs is to offer our clients the experience of decentralized finance while controlling risks, by offering a fund management service tailored to their services. We firmly believe that decentralized finance is the future and our expertise and experience allows us to meet the growing needs of businesses looking to invest in this area.
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