Over the past months and weeks, we learn about two significant stablecoin that fall on blockchain Algorand.
In February 2020 Tether (the largest in terms of stablecoin capitalization) announced integration with the platform Algorand, and a moment later, in June, we learn that USDC, will also expand its roots to the next platform, going beyond Ethereum.
In this post I will look at what types of different stablecoins we have, what challenges and advantages each type has, and why stablecoins are important for platforms such as Algorand that build DeFi ecosystems.
Generally, if at some point kryptowaluty they are to become a useful medium of value exchange and be used as a unit of account, their very variable price will be a big obstacle to achieving this goal.
We know that Bitcoin may have fluctuations of 10-20% during the day, and other cryptocurrencies are subject to even greater fluctuations, so keeping and using them for making payment transactions can be a bit off-putting for some.
Stablecoins are the answer to this phenomenon.
Stablecoins are cryptocurrencies with a stable price, which means that the market price of stablecoins is linked to another stable assetsuch as U.S. Dollaror Canadian.
At the same time, we are increasingly hearing about stablecoins protected by cryptocurrencies, or those whose price is attached to precious metals, or not attached to anything, balanced algorithmically.
Let's look at these phenomena.
I discuss the subject of Algorand, USDC and Stablecoins quite extensively in this video.
Why does Algorand need Stablecoin?
If a platform like Algorand thinks about becoming a platform for decentralized finance (DeFi), must provide some form of value exchange.
Businesses and consumers do not want to be exposed to the unnecessary risk of currency fluctuations during transactions.
There are of course some customers for whom volatility cryptocurrency prices is an advantage and they can use it to their root (trading, leverage etc.), but for the vast majority of communities, a medium of exchange that is predictable and stable seems more useful.
You can not pay someone a salary in Bitcoin or Alogs, if the purchasing power of such value is constantly changing, at least few will accept such a solution. Cryptocurrency volatility also excludes (or hinders) blockchain-based loans and the construction of smart contracts that require price stability.
There is a large number of users who do not want to speculate on the price, and this will be for them an entry barrier that will effectively deter them from the crypto world. I know a lot of such people around me.
The idea of cryptocurrency with a stable price has been discussed for a long time. On this topic studies were written by Vitalik Buterin back in 2014 ..
Over the past years, many different approaches to the stablecoin model have been born. The big challenge is to reconcile the spirit of decentralization, the effective use of stablecoin data security measures, and the techniques that will make a given stablecoin resistant to attacks and sudden price changes in the markets.
Algorand as a platform that will have many applications in regulated markets will first need a stable, regulated and reliable stablecoin. Hence, even the availability of such value as USDC on the Algorand platform is a big step forward.
At the same time, with time, there will be use cases in which a more decentralized stablecoin may be more useful, perhaps protected with other cryptocurrencies, so in the long run Algorand will also certainly look for alternatives in this area when it comes to the approach to StableCoins modeling. Let's see what we have three main dives and their pros and cons.
Stablecoin - types
At a high level of abstraction, stablecoin types include three families:
- stablecoin secured with fiat money (Fiat)
- stablecoin secured by another cryptocurrency
- stablecoin without protection
Stablecoin secured by FIAT
If we want to build a stablecoin, it's best to start with the most obvious approach, i.e. we create a cryptocurrency that is literally IOU (I Owe You, which means "I owe you"), which can be exchanged 1 to 1 for fiat (e.g. in the case of Tether 1 USDT = 1 USD or Circle, 1 USDC = 1 USD)
This is the simplest scheme for a stablecoin coin, quite logical and easy to implement. However, it requires centralizationbecause you have to trust the depositary that it actually holds the USD equivalent. In this case, you also need to implement audits that will periodically control the depositary, which obviously generates additional costs and delays, in addition, it can be costly to maintain.
But centralization comes with the greatest certainty when it comes to price stability. All security is stored in fiat reserves and will remain intact, even in the event of an attack on a given cryptocurrency. At the moment, this can't be said for any other type of stablecoin, so Algorand by choosing USDC (one of the better regulated and audited stablecoins) and USDT (Stablecoin with the highest capitalization - i.e. liquidity) made a good first step on the fuel path for future DeFI systems.
In sum pros and cons for this type of stablecoin:
- Very high price stability (close to 100%).
- Simple to build and understand the principle of operation.
- Hardly susceptible to hacker attacks or attempts to manipulate the price.
- Strictly regulated approach (plus and minus)
- Centralized - you need a trusted "curator" to store fiat security,
- Costly and slow blockchain <> fiat communication (change in reserves to plus or in minus)
- Strictly regulated approach (plus and minus),
- Requires regular audits to ensure transparency.
This is what Tether was supposed to be, although the sentences here are divided or Tether in fact it is not a partial reserve and does it maintain full collateral in USD.
Hence extending the group of stablecoins to Algorand by USDC seems to be a very good ideawhen we think of fully regulated markets.
USDC is the fastest growing stablecoin, already supported by many companies in the fintech area, in various products and services. USDC has still recorded over USD 50 billion in volume of transactions and settlements based on public blockchains. As more and more financial institutions and enterprises want to build decentralized financial applications, they need a well-matched infrastructure and a regulated and widely accepted stablecoin coin, and USDC is considered such.
A very nicely developed area of stablecoins can be found in the resources Messaria.
Stablecoin secured by CRYPTO
And now let's assume that we do not want to integrate with traditional financial rails, and get attached to one or another Fiat. After all, we just reinvented money, why go back to centralized banks and currencies supported by central banks.
If we move away from fiat's attachment to money, we can also remove centralization from such stablecoin.
The idea is: let's do the same as in the example above, but instead of USD, let's use another cryptocurrency instead of fiat. In this way wszystko could remain on the blockchain, from a to z.
Yeah. But here the first hills appear. Cryptocurrencies are unstable, which means your security will also change and the stablecoin coin should of course not fluctuate.
For now, there is one way to solve this problem: securing a stablecoin coin with a higher deposit in cryptocurrencies so that it can absorb price fluctuations.
Let's assume that we have deposited a $ 200 Algos smart contract, and then we spent $ 100 on it based on stablecoins. In this case, stablecoins are 200% secured. This means that the price of Algo may fall by 25%, and our stablecoins will still be hedged by USD 150 in Algo, and will still be able to be valued at USD 1 each.
But why would anyone want to allocate their $ 200 in Algo tokens to create a stablecoin? There are two incentives:
first, you can pay interest to the issuer, which is already being done by some solutions.
Secondly, we can create additional stablecoins as a form of financial leverage and allow the issuer to earn in this way. It is a bit complicated, so I will not develop it in this article, I discussed it on the occasion of the video on the topic platform Money On Chain.
The general scheme is that you excessively secure the stablecoin coin with another cryptocurrency, and if the price falls below the level of collateral, the funds in the form of stablecoin can be liquidated (sold by vending machine = smart contract = to cover collateral). All this can be managed by blockchain in a decentralized and automatic way and we usually use smart contracts here.
Stablecoins built in this way are a nice idea. I am saying that for some time also Algorand will try to build his solutions here. Currently, for more serious applications with this type of approach may be too early, because this type of stablecoins have several serious disadvantages:
- are more exposed to price volatility than fiat-secured coins,
- may be unexpectedly liquidated.
If you secure your crypto coin and the crypto data falls hard enough, your stablecoin will be automatically liquidated (sold). At this point you will be exposed to normal currency risk.
The only way to prevent this is redundant security in crypto (200% or even 400%), i.e. every $ 1 you secure stablecoin by $ 200 or even $ 400 in Algos, Bitocoin or Ether, which ultimately makes crypto-secured coins - capital are much more capital-intensive than their counterparts in fiat. Well ... but that's how it looks at the moment.
To sum up the pros / cons:
- A more decentralized approach
- You can quickly and cheaply switch from stablecoin to crypto security and vice versa (everything is done on blockchain)
- A more transparent model, anyone can easily check the protection factor of a given stablecoin.
- It can be used to create leverage.
- It can be automatically liquidated when the market collapses
- Less stable price than in the case of Fiat security
- Very attached to the security reliability of cryptocurrencies
- Inefficient use of capital (2-4x more)
- Very complex construction, hard to understand for a person not interested in technical details.
Since that time By from MakerDAO is widely considered the most promising stablecoin, secured by Ether, but the market crash in March 2020, exposed the weaknesses of DAI (which eventually also made peg to USDC)
Will we see this kind of stablecoin on an Algorand blockchain at some point, protected in the form of Algo tokens?
Stablecoin WITHOUT security?
As we delve into the subject of stablecoins, we finally come to the topic of non-collateralized stablecoins, because do we really need fiat or crypto as security?
Central Banks have managed to deviate from the gold standard and Fiat money is no longer secured by any underlying assets. Perhaps this means that protection is not necessary and the stablecoin coin could adopt the same model?
QUESTION: How to ensure the stability of such a "unprotected" stablecoin?
This would require designing a smart contract that would act as a central bank. The monetary policy of this contract would have only one goal: to maintain a stable currency price, e.g. always at USD 1.
How to do it? In theory, it seems simple. Since the contract issues the currency, so it can automatically control the money supply, adapting it to demand, so that it will always be a value of 1 USD.
Let's assume, for example, that a given stablecoin for some reason would fire over 1USD and would cost, for example, 2 USD. This would mean that the price is too high - or in other words, the supply is too low. To counter this, a smart contract would have to generate new coins and then auction them on the open market, increasing supply, and do so until the price returns to $ 1.
This is nothing new to central banks (e.g. in Switzerland in 2011) it happened to tie the CHF rate to another currency (e.g. EUR) in order not to lead to excessive strengthening of the CHF against the EUR (this was harmful to the economy), and for this purpose they used very similar mechanisms, only that not based on a smart contract.
Of course, if we ever wanted a smart contract to regulate money supply like the Central Bank, there are a number of questions to address:
- How to make such a smart contract gain the trust that central banks have today
- How to secure such a smart contract against attacks so that, protecting huge funds, it is as effective as central banks
- How to make it possible to restore it in the event of a system failure based on such a mechanism?
.. and many other questions .. so while these types of solutions are very fascinating, I have the impression that some time must pass before we are ready for them, so at this stage these are quite conceptual considerations, but it is possible that some projects will go this way.
There are many questions on how to do it right. How much pressure can such a system withstand? How long will the pressure of increased supply last? Will such a system be trustworthy? At what point and whether to allow manual intervention? These aspects can make such a monetary system susceptible to panic and swings based on sentiments and speculation.
In the context of growing discussions about CBDC (digital currencies of central banks) - perhaps at the beginning we will see the creation of CBDC secured with national currencies, and over time looking at all the inefficiencies and delays of such a "pega" (attachment) - at some point CBDC will give up pega and become the most clear example of stablecoins in this category?
Taking all this into account, unprotected stablecoins are the most ambitious project. Stablecoin without collateral in USD or in crypto is independent of all other assets. Even if the dollar or bitcoin collapse, such a coin could survive as a stable carrier of value.
This is an exciting opportunity, I have the impression that it will be exploited in the context of CBDC over a decade or two. It can radically change the world. But if it fails, then the failure in this case can be even more catastrophic.
- Requires no security, cost effective.
- Most decentralized and independent (unrelated to any other cryptocurrency or fiat)
- Most susceptible to market manipulation
- Safety limits are difficult to predict
- High implementation complexity
The perfect stablecoin?
At the moment, it seems that these 3 main currents are and will be further explored at an even faster pace, but these are not the only directions. There are stablecoins secured in gold or even stablecoin which is a basket of currencies (SDR form).
Algorand and Circle are players who take regulations seriously. USDC is currently the second largest stablecoin in terms of market capitalization. This coin was developed as a joint venture of the large cryptocurrency exchange Coinbase and Circle (including Poloniex), so it heralds that a lot of interesting solutions on this basis can be built in the near future. Stablecoin is on the one hand the topic of boredom (because it is stable) and on the other hand extremely interesting (because it is required for wider adoption) so I will definitely be curiously watching how Algorand and other projects develop their ecosystems and experiment with various stablecoins and their applications in the DeFI area.
Andrzej_0xa0 on Twitter