Let’s delve into the world of decentralised stablecoins to get more clarity on a concept that marries cryptocurrency flexibility with traditional financial stability.
What is a stablecoin?
A stablecoin is a type of cryptocurrency designed to have a stable value, unlike other cryptocurrencies like Bitcoin or Ethereum, which can see their prices fluctuate wildly.
The idea behind stablecoins is to combine the best of both worlds: the stability of traditional money, like dollars or euros, and the flexibility and security of digital currencies.
Stablecoins achieve their stability by being pegged to something with a stable value, such as a widely used currency (like the US dollar) or a commodity (like gold). This means one unit of a stablecoin is meant to always be worth the same as the asset it’s tied to. For example, one stablecoin pegged to the US dollar aims always to be worth exactly one dollar.
This stability makes stablecoins particularly useful for people who want to use digital currency for everyday transactions, like buying coffee or sending money to friends, without worrying about the value of their currency going up or down dramatically in a short period.
It also makes them a popular choice for traders and investors in the cryptocurrency world who are looking for a safe place to store their assets during turbulent market conditions.
According to DeFiLlama, as of April 2024, the total stablecoins market cap has risen to $154.66 billion. However, this value includes both decentralised and centralised stables. The dominant stable is USDT, a centralised stablecoin.
Source: DeFiLlama
The most popular stablecoin: USDT
USDT, or Tether, stands out in the cryptocurrency world due to its centralised nature, meaning it is issued and managed by a single entity, Tether Limited.
This central authority holds reserves in traditional fiat currencies, like the US dollar, to back and stabilise the value of USDT, ensuring that it remains pegged 1:1 with the dollar.
This centralisation contrasts with decentralised cryptocurrencies, where control is spread across a network of users. The centralised approach of USDT provides users with the perceived stability of traditional financial systems while enabling the flexibility of digital transactions.
However, it also introduces reliance on the trustworthiness and solvency of Tether Limited, making its transparency and regulatory compliance crucial to users’ confidence.
What is a decentralised stablecoin?
A decentralised stablecoin is a special kind of digital money that aims to keep its value steady, just like regular stablecoins.
What sets it apart is how it operates without being controlled by any single company or government. Instead, it uses a network of computers and sophisticated software to manage itself.
Imagine a community garden where everyone contributes and decides together how to take care of it, rather than one person owning it and making all the decisions.
In a similar way, decentralised stablecoins are managed by a community of users following rules written in computer code. These rules help keep the stablecoin’s value consistent, often by linking it to something stable like the dollar or gold.
This approach offers a couple of big benefits.
First, it can reduce the risk of a single point of failure, like if a company managing a stablecoin goes out of business.
Second, it promotes transparency and fairness, as everyone can see and understand how the stablecoin is managed.
Decentralised vs centralized stablecoins
| Comparison criteria | Decentralised Stablecoins | Centralised Stablecoins |
| Control and Governance | Operate based on smart contracts and are often governed by community decisions or a DAO. | Managed by a single entity, such as a company, which is responsible for maintaining the stablecoin’s value and reserves. |
| Transparency and Trust | Transparency is provided by the blockchain and smart contracts, allowing public verification. Trust is placed in the code and the governance model. | Trust is placed in the issuing company to hold sufficient reserves, with varying degrees of transparency and external audits. |
| Reserve Management | Use other cryptocurrencies, algorithmic methods, or combinations thereof to maintain their peg, minimising reliance on traditional systems. | Typically backed by traditional assets (fiat currencies, gold, etc.), managed by the issuer. |
| Regulatory Oversight | Faces a complex regulatory landscape due to its distributed nature, which can both pose challenges and offer resistance to regulatory pressure. | They are more likely to be regulated and comply with financial laws, given their ties to traditional financial entities and assets. |
| Accessibility and Integration | It may offer innovative features within the DeFi ecosystem but might be less accessible to newcomers due to its complexity. | Often offer easier integration with traditional financial systems and are generally more accessible to the general public. |
Top decentralised stablecoins
It’s important to note that most stablecoins used by crypto traders are mostly centralised stablecoins.
USDT (Tether), USDC (USD Coin), TUSD (TrueUSD), BUSD (Binance USD), and PAXG (Pax Gold) are generally considered centralised due to their backing by specific companies or organisations that maintain control over their issuance and backing reserves.
FRAX, DAI, and others like FDUSD, USDE, and XAUT offer more decentralised aspects. Here’s a closer look:
- DAI – DAI is pegged to the US dollar and maintains stability through over-collateralization with cryptocurrencies on the Ethereum blockchain. It is governed by the MakerDAO protocol, allowing DAI holders to participate in decision-making.
- FRAX – FRAX is a partially collateralised stablecoin that aims to provide a highly scalable and decentralised stablecoin solution. It operates on the Ethereum blockchain and maintains its peg through a combination of collateral and algorithmic mechanisms, adjusting its collateral ratio based on market conditions.
- FDUSD (Fiat DAO) – FDUSD is part of the Fiat DAO ecosystem, aiming to provide a stable and decentralised currency solution. It is designed to work within the DeFi ecosystem, offering stability through mechanisms that allow it to respond to market dynamics, although detailed specifics about its pegging strategy and blockchain basis are less commonly known compared to more established stablecoins.
- USDE – USDE (Ethena USDe) is an example of a decentralised stablecoin with unique mechanisms for maintaining its peg, often involving algorithmic approaches or community governance for stability. The specifics of its operation, including the assets it is pegged to and the native blockchain, can vary based on the project’s development and governance model.
- XAUT (Tether Gold) – While Tether’s USDT is centralized, XAUT offers a different approach by being a digital token backed by physical gold. It represents one troy ounce of gold on a London Good Delivery bar. However, the management and issuance by Tether might still place it in a more centralized category compared to purely decentralized finance (DeFi) projects.
It’s important to distinguish between the operational models of these stablecoins, especially in terms of decentralisation and the mechanisms they use to maintain their peg.
If you intend to invest in crypto or store funds in decentralised stablecoins, consider using eToro, Binance or Wirex, three highly reliable centralised crypto platforms.