Stablecoins: What they are and how they operate

The essence of stablecoins

Stablecoins are a special type of digital asset whose value is pegged to another currency, commonly the US dollar. They maintain this parity through reserves of dollars, other cryptocurrencies, or a combination of both, held in bank accounts under U.S. supervision. Investors often use them as a refuge against the volatility of the crypto market or to generate passive returns through staking or lending. Among the most well-known are Tether (USDT), USD Coin (USDC), Euro Coin (EUROC), and Gate Dollar (GUSD). They can be purchased or exchanged on Gate.

These stable digital coins are becoming increasingly relevant in the crypto ecosystem by providing stability and liquidity. This article analyzes the importance of stablecoins, their advantages, and potential challenges.

Current panorama of stablecoins

Nowadays, there are around 200 stablecoins. Some of the most notable examples are:

🔹 Tether (USDT) is considered the pioneer among stablecoins and leads in market capitalization, with nearly $72.5 billion in June 2022. The temporary loss of its peg in May 2022 marked a milestone in the history of these coins.

🔹 USD Coin (USDC) represents tokenized US dollars on the Ethereum network (ETH). It is managed by a consortium called Center, formed by Circle and Coinbase. Circle is backed by Goldman Sachs, while Coinbase is one of the most recognized cryptocurrency exchanges.

🔹 Gate Dollar (GUSD) is an ERC-20 stablecoin based on Ethereum (ETH). Its value is pegged 1:1 to the US dollar and backed by reserves in bank accounts insured by the FDIC. It was created by Gate, which promotes it as one of the first regulated stablecoins. Along with USDP and BUSD, GUSD is one of the three existing stablecoins with governmental regulation.

🔹 Dai (DAI) is a cryptocurrency on the Ethereum (ETH) network regulated and maintained by MakerDAO, a decentralized autonomous organization. Dai is considered one of the first examples of decentralized finance (DeFi) that achieved widespread adoption.

🔹 Pax Dollar (USDP), formerly known as Paxos Standard (PAX), is a stablecoin on Ethereum (ETH) pegged to the US dollar. It is the native cryptocurrency of Paxos, a financial institution regulated by the NYDFS.

🔹 PayPal USD (PYUSD) is a stablecoin recently launched by PayPal in collaboration with Paxos. It is backed by dollars and other assets, with a 1:1 parity to the US dollar. To ensure transparency, Paxos will publish monthly asset reports and will undergo external audits, with the first proof of reserves statement expected in September 2023.

Their stability allows them to function as a store of value in the crypto markets. Stablecoins also drive the development of decentralized finance (DeFi), serving as collateral in smart contracts or to leverage positions.

Challenges and potential risks

🔹 Regulatory oversight: Stablecoins are facing increasing scrutiny from governments and financial authorities seeking to ensure transparency and prevent misuse.

🔹 Centralization risks: Some stablecoins rely on a single entity to manage the backing assets, which introduces counterparty risk.

🔹 Market confidence: The stability of these coins depends on trust in the issuer's ability to maintain parity.

Operating mechanism

In its most basic form, an exchange that offers a fiat-backed stablecoin deposits one dollar ( or the corresponding moneda ) for each stablecoin issued. This anchors the stablecoin to that moneda and, in theory, allows users to exchange their stablecoins for fiat moneda at a 1:1 ratio.

Although fiat-backed stablecoins represent the majority of market capitalization, there are others linked to different assets:

🔹 Stablecoins backed by gold and other precious metals, such as Digix Gold

🔹 Stablecoins backed by other crypto assets, with Dai being the most well-known example

🔹 Algorithmic stablecoins, also called non-collateralized, such as the Ampleforth token or AMPL

Despite the differences in their mechanisms, all seek to offer the user a high degree of certainty about the value of the asset.

Technological innovations

Advancements in blockchain technology, such as improvements in scalability and interoperability, will enhance the functionality and efficiency of stablecoins. These enhancements will facilitate seamless integration with various blockchain networks and applications.

Regulatory framework

The establishment of clear and consistent regulatory frameworks will provide a predictable environment for issuers and users of stablecoins. Regulatory compliance will reinforce market confidence and promote the growth of stablecoins in the global financial system.

Market Confidence

The stability of stablecoins relies on the trust in the issuer's ability to maintain parity. Any doubts about the issuer's reserves or operational practices could lead to a decoupling, causing fluctuations in the value of the stablecoin.

Future outlook

The future of stablecoins looks promising, with continuous developments aimed at improving their stability, security, and usability.

Practical applications

New use cases for stablecoins continuously emerge as more people discover the potential of this technology. These range from business transactions, loans, and collateral to financial access and payroll. However, here we focus on the main use cases related to payments:

🔹 Payments with stablecoins: Payments are the primary use of stablecoins, as companies that accept them benefit from lower transaction fees. For example, accepting payments in stablecoins allows companies to avoid the typical processing fees of 2% to 3% charged by financial institutions on fiat transactions.

🔹 Settlements with stablecoins: Settlements with stablecoins offer significant advantages for entities operating 24/7 on the blockchain, allowing for nearly instant settlements globally. Settlements in fiat, on the other hand, are limited by banking hours or those of centralized financial institutions.

🔹 Remittances with stablecoins: Given their inherent price stability, stablecoins are especially useful for international payments and remittances, particularly benefiting those who need this stability the most, such as expatriate workers. Traditional off-chain remittance services often charge high fees for international transfers, which poses a barrier for these workers when sending money to their families.

The future of stablecoins

Stablecoins have become an attractive option for consumers who want to invest in cryptocurrencies but also seek the stability and predictability of fiat currencies. As of the time of writing this article, the stablecoin market reaches nearly 140 billion US dollars. The stablecoin with the highest market capitalization is Tether, pegged to the US dollar and backed by fiat, with a total market value of just over 66 billion dollars.

However, some sectors have called for greater regulation of stablecoins due to their rapid growth and popularity. Stablecoins have the potential to transform traditional payment systems and financial infrastructure, while representing the most direct competition in the crypto world for fiat monedas, which are strictly regulated by government agencies and central banks. This could imply increased scrutiny on stablecoin providers, as their cryptocurrencies are displacing traditional fiat monedas while offering new forms of financial products and platforms.