Have you ever heard of a Tether, USD Coin, DAI, AMPL, or other asset that claims to have a target price? Most likely yes, but if not, this article will help you understand how tokens that offer the ability to accept cryptocurrency work without worrying about market volatility.
Stablecoin as an attempt to curb volatility
Crypto as a whole has very high volatility. For example, Bitcoin has continued to grow since the beginning of this year to its historical high, and recently it fell to almost half, taking the entire cryptocurrency market with it.
With long-term use of Bitcoin, if you are an owner or a hodler, you know that its price will be much higher, so this is not a problem for you. But for people who are looking for an asset for everyday use with a relatively stable value, this won’t work. Therefore, stablecoins are intended for this purpose. Stable coins make it possible to accept cryptocurrency without worrying about market volatility.
Types of Stablecoins
There are different types of stablecoins, but in the end they all have the same goal: achieving a relatively stable value, near a predetermined target price, with the minimum possible fluctuations.
- Centralized Stablecoins are linked to FIAT
FIAT is a currency issued by governments that people mostly use every day, such as the ruble, US dollar, euro, pound sterling. These FIAT currencies are centralized, managed by central organizations, and generally remain relatively stable.
For centralized stable coins, a relatively stable price is achieved by linking assets to these fiat currencies. For this purpose, the central organization that manages the binding collects or creates reserve stocks that serve as collateral and a guarantee of return, and supports stablecoins. The ultimate goal is to ensure that the value of stablecoins is equal to the value of the fiat assets that support them.
One of the leaders of the stablecoin market is Tether (USDT). This asset, which is managed by Tether Limited, was created in 2014 with the aim of converting fiats into digital currency. This swap is aimed at a 1-to-1 ratio to the US dollar.
This stablecoin claims that its coin is 100% backed by reserve reserves.
“Every Tether coin is always 100% backed by our reserves, which include traditional currency and cash equivalents. Each Tether is also pegged to the dollar 1 to 1, so the 1 USDT token is always valued at 1 US dollar”, — Tether’s official website
USDT is mainly used on exchanges as a bridge between fiat currency and cryptocurrency, but is also issued on several networks, such as Ethereum as an ERC-20 token, Tron as TRC-20, EOS, and others.
USD Coin (USDC)
Another leader in the stablecoin market is USD Coin (USDC). This asset, created by Coinbase in 2018, is also designed to convert fiats into a digital cryptocurrency with a target ratio of 1: 1 to the US dollar.
The developers of this asset claim that each of the USDC is backed by 1 dollar (USD), and the reserve reserves are in bank accounts.
“The USDC is issued by regulated financial institutions, supported by fully reserved assets, redeemed at a 1: 1 ratio for US dollars, and managed centrally by a membership — based consortium that sets the technical, policy, and financial standards for stablecoins.” — the official website of USD Coin
This crypto asset is also issued on the Ethereum blockchain as an ERC-20 token.
- Decentralized stablecoins linked to cryptocurrency
These stablecoins do not have central organizations managing the assets, but are managed by users participating in the networks, who have weight in voting according to the percentage of the management tokens they hold.
In most cases, when buying / borrowing decentralized stablecoins, a certain amount of other crypto assets, which are reserve reserves, is required as collateral.
Stablecoin Maker Protocol-DAI, requires users to loan crypto assets to purchase. This collateral is provided in the form of Ethereum ETH, the Ethereum network’s own token, or, more recently, with other assets through the multiple collateral capability. After returning the borrowed DAI, the user pays a small commission, characterized as a stability fee. After all, DAI is aiming for a 1: 1 ratio to the US dollar.
Moreover, DAI is regulated by MKR token holders. These holders form a decentralized community in which management is carried out according to the percentage of tokens owned by the participants. This management is a gateway that allows changes to be made to the network, with voting rights according to the number of MKR tokens, to manage the risks and market logic of the Maker system, for example, as a stability fee or what type of assets to allow as collateral.
- Decentralized coins based on the algorithm
This type of crypto asset tries to look as much like a stablecoin as possible, but cannot be considered such a term due to the volatility. These assets rely on an algorithm to remain as stable as possible near their target price, and are not dependent on centralized collateral or lenders due to the use of an elastic supply mechanism.
For example, one way is to change the percentage of token supply by burning or creating coins according to the volume of the market, so that the value of the assets approaches the final target price. Indeed, when the value of assets falls below the target price, the algorithm burns a percentage of the coin supply, which leads to a shortage of them, so that the asset price rises again to the target price. On the other hand, when the asset value exceeds the target price, the algorithm creates a percentage of the coin supply to lower the price to reach the target price again. All this in order to get closer to the final target price. For example, Ampleforth AMPL uses this method.
The target price of the AMPL asset is $1,033. Every day at 02:00 coordinated universal time, there is a rebase so that the value of the token approaches its target price. When the value of an asset exceeds the target price, the rebase is positive, creating a certain number of tokens returned to holders according to the rebase percentage and the amount they hold. And when the asset value is below the target price, the rebase is negative, burning / removing the holders ‘ tokens according to the rebase percentage and the amount they hold.
However, you should be careful with the volatility of the AMPL token market. Indeed, AMPL provides the same function as stablecoins, as it is close to the target price of $ 1.033, but does not eliminate the volatility.
The Ampleforth team highlighted on their website the reasons why:
“We are often asked “If the number of tokens in my wallet can change, then isn’t AMPL still speculative and unstable? Why not use stablecoins like Tether or DAI to denote contracts?” Our response: “Because the goal of the movement for decentralized finance is to create an alternative financial ecosystem that is inaccessible to politics”.
Today, stablecoins rely on either traditional banks or lenders of last resort. AMPL is an independent financial primitive that does not rely on centralized collateral or lenders of last resort. This is similar to Bitcoin, except that it can be used in contracts.” — AMPL official website
Changing the token supply based on market conditions is a good way to reach the final target price without being dependent on centralized collateral or lenders, but it still brings volatility.
Although stablecoins tend to have no volatility, and try to be as stable as possible to achieve the goal, we could say that they are just as stable / volatile as the asset they are linked to / linked to. In fact, any fluctuations in the value of fiat will affect the value of stablecoins.