# Stablecoins: The New Backbone of Cryptocurrency Markets

Stablecoins, following Bitcoin and Ethereum, now occupy a crucial position in the cryptocurrency market. They process over $200 billion in transactions worldwide, transforming payment and asset transfer methods. According to CoinMarketCap, approximately 200 stablecoins are currently registered, but the definition and technical structure of stablecoins remain complex. This article examines the types and evolution of stablecoins, comparing them to the history of the US banking system through an analysis presented by a16z partner Sam Bronner.

# What Are Stablecoins?

Stablecoins are cryptocurrencies designed to maintain stability by pegging their value to external assets, such as fiat currencies or commodities. They retain the transparency and efficiency of blockchain technology while mitigating extreme price volatility, much like Bitcoin. This attempt to combine the advantages of traditional finance and cryptocurrencies by offering digital asset stability is highly valued in the market.

# The Success and Failure of Stablecoins

Stablecoins are categorized into three types: fiat-collateralized, asset-collateralized, and strategy-based synthetic dollars (SBSDs). The most commonly used fiat-collateralized stablecoins, like Tether (USDT) and USD Coin (USDC), account for 94% of all stablecoins. Their simple structure and reliability have swiftly expanded their market share.

In contrast, decentralized over-collateralized stablecoins offer stability but face limited demand. Under-collateralized stablecoins, highlighted by the Terra-Luna debacle, appeared capital efficient but ended in significant failures. Recently introduced SBSDs, combining collateral with investment strategies, lack stability and reliability, making them challenging to classify as standard stablecoins.

# Fiat-Collateralized Stablecoins Through the Lens of Bank Deposits

Fiat-collateralized stablecoins share similarities with banknotes issued during the US National Banking Era (1865-1913). At that time, the value of banknotes depended on the credibility, accessibility, and payment capabilities of the issuing bank. Despite these variables, federal regulation ensured trust by guaranteeing redemption with government bonds or other fiat currencies. Similarly, fiat-collateralized stablecoins are redeemable in fiat currency, making them easily understandable and trustworthy for users.

However, just like historical banknotes posed liquidity challenges for users far from the issuing bank, stablecoins may face similar issues. Platforms like Uniswap and Coinbase are gradually mitigating these liquidity problems.

# Asset-Collateralized Stablecoins and the Fractional Reserve System

Asset-collateralized stablecoins are generated through on-chain lending protocols, resembling the traditional banking credit creation process. For instance, Sky Protocol issues stablecoins backed by low-volatility and highly liquid assets. This mirrors the fractional reserve system initiated by the Federal Reserve Act of 1913.

The fractional reserve system allowed banks to create credit based on a portion of their asset reserves. Despite changes like the establishment of the FDIC and the abolition of the gold standard, this system remains fundamental to the US financial system. Asset-collateralized stablecoins, a digital interpretation of this tradition, differentiate themselves by enhancing transparency and auditability.

# Challenges and Risks of Strategy-Based Synthetic Dollars (SBSDs)

SBSDs are a new type of token combining collateral and investment strategies. However, their centralized management, under-collateralization, and financial derivatives nature make them difficult to classify as traditional stablecoins. They are closer to equity in an open-ended hedge fund. While SBSDs can offer high returns, they are vulnerable to market volatility and risks from centralized operations. Notably, de-pegging incidents can lead to rapid instability. SBSDs may attract users willing to take on high risks, but actual trading involvement remains limited. Furthermore, the SEC has issued sanctions against “stablecoin” issuers operating like investment fund shares.

# Major Stablecoins in the Market

Stablecoins provide stability in the cryptocurrency market, occupying a central role in trading and financial services. Here’s a look at some major stablecoins, their design, and their current market status.

– **Tether (USDT)**
– **Launched:** 2014 by Tether Limited
– **Type:** Fiat-collateralized pioneer, pegged 1:1 to USD, backed by cash and cash-equivalent reserves.
– **Market Status:** Over $140 billion market cap as of 2024, held in over 109 million on-chain wallets, widely accepted across multiple blockchains.
– **Use Cases:** Cross-border payments, asset protection on exchanges.

– **USD Coin (USDC)**
– **Launched:** 2018 by Circle in cooperation with Coinbase
– **Type:** Pegged 1:1 to USD, emphasizes regulatory compliance and transparency, reserves held in regulated financial institutions with regular audits.
– **Market Status:** 42 billion tokens in circulation as of December 2024, second-largest market cap, used as major collateral in DeFi and exchanges.
– **Use Cases:** Exchange trading, DeFi collateral, secure payment method.

– **Ripple USD (RLUSD)**
– **Launched:** December 17, 2024, by Ripple
– **Type:** Fully backed by USD, Treasury bills, and cash equivalents, operates on XRP Ledger and Ethereum blockchain.
– **Market Status:** $53 million market cap in its first week, tradable on global exchanges like Uphold, Bitso, and MoonPay.
– **Use Cases:** Liquidity for cross-border payments and DeFi integration, collateral for on-chain real asset transactions.

– **Ethena USDe (USDe)**
– **Launched:** February 2024 by Ethena Labs
– **Type:** Synthetic yield-generating stablecoin, maintains peg through delta-neutral strategy, offers APY.
– **Market Status:** $6 billion market cap within ten months, uses tokenized money market funds from BlackRock and Securitize for enhanced profitability.
– **Use Cases:** DeFi investment vehicle, collateral for stable income generation.

– **Dai (DAI)**
– **Launched:** December 18, 2017, by MakerDAO
– **Type:** Decentralized crypto-collateralized stablecoin, over-collateralized and pegged 1:1 to USD, generated by depositing Ethereum-based assets.
– **Market Status:** $5.3 billion supply as of December 2024, widely used in DeFi for lending, borrowing, and payments.
– **Use Cases:** Provides stable digital currency for underbanked individuals, key collateral in DeFi.

– **First Digital USD (FDUSD)**
– **Launched:** June 2023 by First Digital Limited
– **Type:** Fully backed by cash and cash equivalents, initially on Ethereum and Binance Smart Chain, expanding to other blockchains.
– **Market Status:** Exceeded $1 billion market cap within six months, fifth largest stablecoin by end of 2024 with $1.3 billion market cap, rapid growth through Binance partnership.
– **Use Cases:** Cross-border payments, DeFi services, digital payment platforms.

– **PayPal USD (PYUSD)**
– **Launched:** August 2023 by PayPal
– **Type:** Backed by USD deposits, short-term Treasuries, issued as ERC-20 token on Ethereum blockchain.
– **Market Status:** $494 million market cap as of December 2024, expanding functionality with Solana blockchain integration and merchant crypto payments support.
– **Use Cases:** Remittances and payments within PayPal ecosystem, cryptocurrency exchange.

# Risk and Outlook of Stablecoins

Stablecoins face several risks, including regulatory uncertainty, technical vulnerabilities, and threats like de-pegging and market manipulation. The Financial Stability Oversight Council (FSOC) has warned that these risks could pose systemic threats to the financial system. Nevertheless, stablecoins continue to provide stability within the crypto ecosystem, establishing themselves as essential components of digital finance. As technology advances and the market grows, the role of stablecoins is expected to expand. Understanding the evolution of stablecoins and leveraging them appropriately will be critical for digital asset investments.