Unpacking Stablecoins

You probably know the 2 largest cryptocurrencies by market value. Do you know what’s the 3rd largest? 🤔

#Bitcoin and #Etherium reserve the title for being #1 and #2, while Tether (USDT) has jumped up the ranks to pick up the #3 spot. Tether is a stablecoin developed by Bitfinex and has a current market cap of $82.5bn. 👀

Given their growing importance, let’s unravel stablecoins.

What are Stablecoins?

Stablecoins are cryptocurrencies that have a stable value, as opposed to the volatile nature of Bitcoin, Etherium, Solana etc. For instance, a USDT (which is a dollar-denominated stablecoin) has a fixed market value of $1.

How do Stablecoins maintain a fixed value?

Not every stablecoin is created equal. There are 4 types of stablecoins, based on how they maintain their value vs fiat currencies:

  1. Fiat backed: equal reserves of the currency

Fiat backed stablecoins are the most popular, however, other types of stablecoins are quickly gaining traction. 📈

Why do we need stablecoins?

We have fiat currencies and other coins, so why the hell is this digital coin (which is similar to fiat) needed?

Stablecoins are valuable because:

  • they allow crypto holders to stay invested in the crypto-economy, instead of cashing in/out of the ecosystem

they allow stable value exchange and can be used for payments, remittances, loans

  • they are trustless and hence don’t need KYC

Now let’s briefly understand how cryptocurrency backed stablecoins like DAI work. 💡

What’s DAI?

DAI is the stablecoin issued by Maker. Maker is a DAO that enables lending through Collateralised Debt Positions (CDP) smart contracts, leveraging the supply-demand dynamics of Maker and DAI.

The way it works is the following (oversimplified):

  • Say I want to take on debt by collateralising my ETH

Effectively, MakerDAO manages the supply of DAI in a way that 1 DAI = $1. If the DAI price drops <$1, then CDPs become expensive and investors are incentivised to buy DAI. While if the DAI price >$1, then CDPs become cheaper and the investors are incentivised to sell their holdings.

Once Maker/DAI grow in adoption, we could potentially get rid of loan intermediaries (underwriters, credit bureaus, brokers) to make lending great again. Intriguing isn’t it! 👏

#blockchain #crypto #defi

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Priyanshu Taparia

MBA student at London Business School. Worked at GoJek and Uber previously. Know a thing or two about Mobility, Marketplaces, and Payments.