Stablecoins: USDT, USDC & DAI - WFM #203
Stablecoins' early origins, collateralization, and overall importance to crypto.
We’re close to the end of our first phase exploration of Blockchain Fundamentals. Over the next couple weeks we’ll wrap it up and move on to Crypto & Finance. While we’ve expanded our topics vs what we had planned, we’re close to on track.
Stablecoins: USDT, USDC & DAI
By Harrison Smith, Head of Research @ Future Mints
Technical Level: 🛠️ 🛠️
Coinbase defines a Stablecoin as “a digital currency that is pegged to a ‘stable’ reserve asset like the U.S. dollar or gold. Stablecoins are designed to reduce volatility relative to unpegged cryptocurrencies like Bitcoin.”
Stablecoins are simply meant to sit at one stable price, often $1 USD.
A few sources argue that the very first stablecoin was issued back in 2014: BitUSD, the brainchild of Dan Larimer (EOS) and Charles Hoskinson (Cardano). BitUSD was collateralized through high-risk tokens, not fiat currency or stable assets.
Shortly after, an ‘algostable’ called NuBits gained popularity. Algorithmic stablecoins (aka ‘algostable’) use a series of logic to keep the price of some underlying token pegged to a stable currency (like USD). It’s a bit like trying to balance a plate on a stick while you’re also balancing on a ball. In theory, it’s doable and the plate won’t drop / break. In theory.
However, neither BitUSD nor NuBits actually fit the criteria of a stablecoin, and both tokens are currently sitting far under their intended $1 price.
Just as Coinbase defined it, for a token to really be a stablecoin, it needs to be pegged to a “stable” asset. Not highly volatile assets, overly speculative tokens, or algorithms.
The first real stablecoin, released later in 2014, was Tether (USDT). Tether has since grown to become the third largest market cap token in the world, only superseded by Bitcoin and Ethereum.
Tether would qualify as a “backed stablecoin” - a backed stablecoin is stabilized by assets outside of the crypto space. Backed stablecoins are able to be redeemed in exchange for the real assets that they are backed by at any point on-demand. The backing for a stablecoin can vary anywhere from fiat to real world commodities.
Tether is backed primarily by U.S. Treasury Bills, Money Market Funds, Secured Loans and Cash & Bank Deposits. This portfolio of stable assets is designed specifically to help Tether maintain its $1 peg. You can see Tether’s reserves breakdown on their website (and below)
USDC is a backed stablecoin created by a U.S. company, Circle, in 2018. USDC is a “digital dollar,” and can be exchanged 1:1 for USD at any point. USDC has now nearly exceeded 10T transactions, and has around $37B in their reserves. These reserves are divided between cash at reserve banks (~$8B) and a short-dated US treasury portfolio (~$29B).
We would be remiss not to mention the recent events surrounding USDC in the past two weeks. $3.3 Billion of the cash Circle held was parked at SVB, so when the bank collapsed, there was fear that those funds were lost. This panic led to USDC briefly dipping from its $1 peg due to the FDIC insurance limits at $250K and the uncertainty of SVB’s stability.
If SVB had been allowed to fail, it’s possible that Circle’s funds would have been largely inaccessible for a while as court battles ensued and regulators spent time unwinding the bank. Thankfully, (for this and other reasons) that didn’t happen.
The impact of this USDC scare extended further - DAI, an ultra-popular stablecoin by the team at MakerDAO, was also impacted by the SVB crisis.
DAI, unlike USDC, is decentralized. It is created directly through the Maker Protocol, which accepts collateral from approved Ethereum-based assets in exchange for DAI. MKR holders must approve specific, corresponding Risk Parameters for each accepted collateral (e.g., more stable assets might get more lenient Risk Parameters, while more risky assets could get stricter Risk Parameters).
While USDC is a backed stablecoin, DAI is a crypto-backed stablecoin - it is backed by generally considered “safe” crypto assets.
One of the primary units of collateral to generate DAI is none other than USDC. The interconnection between the two stablecoins normally causes no issues, but when USDC’s reserves were thought to be damaged, it consequentially damaged the collateral backing DAI.
Of course, when it was announced that the federal government was bailing out SVB, these worries would prove unnecessary, and DAI and USDC would quickly retake their intended $1 peg.
Stablecoins are an important piece of the crypto environment. They can be integrated into digital applications, can be used on nearly every chain, and exist free from the speculation of the crypto landscape. They are in theory, incredibly reliable, and generally help contribute to the widespread adoption and credibility of crypto.
This credibility is jeopardized by the abundance of tokens claiming to be stables that do not actually fit the criteria. Retail markets often aren’t well enough informed about the risks of each token, and it can be hard to differentiate what a token is backed by.
The reality of many stablecoins is that they work great until they don’t. While earning (insert ridiculous percent) APY on stablecoins seems awesome, the economics of these models do not create sound digital money.
After all, “stablecoin” that requires an influx of new buyers to maintain its price is not a stablecoin at all, but we don’t want to spoil the fun that we have in store next week when we discuss algostables in more detail along with recent failures in the stablecoin space.
News of the Week
Do Kwon, the founder of Terraform Labs and the Terra/Luna ecosystem, appears to have been arrested at an airport in Montenegro with falsified documents. Hours later, federal prosecutors in New York hit Kwon with a number of charges, and are reportedly seeking his extradition.
The SEC issued Coinbase a Wells Notice, warning the exchange that it identified potential violations of U.S. securities law. Coinbase CEO Brian Armstrong responded in a thread on his Twitter, and the company released a long-form post.
The Arbitrum airdrop went live yesterday, and nearly 500,000 wallets claimed nearly 1B ARB tokens. At time of writing, 75% of eligible wallets have already claimed their governance tokens for the L2 chain. As always, be wary of scams and phishing attempts.
The Matter Labs team made an appearance on Bankless, discussing the latest developments around zkSync and the release of Era Mainnet Alpha. Notably, all users can now bridge funds and experience dapps built on zkSync Era.