Stablecoins. A Zerocap summary.
What is a Stablecoin?
A stablecoin is a cryptocurrency that aims to hold a consistent value in order to provide a stable store of wealth on the blockchain which can then be used for an array of on-chain activities — primarily as a medium of exchange.
Although most widely used stablecoins are pegged to the US dollar, the majority of top global currencies now have on-chain representations albeit most are illiquid. Highly liquid stablecoins in the market are primarily backed by large stores of fiat currency and treasury bonds, although there has also been a drastic rise in the adoption of algorithmic and crypto-backed stablecoins.
Origin of Stablecoins
The first stablecoin was created in 2014 by BitShares to operate as a stable quote currency for trading pairs on their blockchain. Just four months later, Tether (then RealCoin) launched what is now USDT.
Since then we have seen a host of tokens launched with the purpose of providing the market with a reliable quote asset and a medium of exchange and the market has grown to US$140 billion in market capitalisation amongst the top 5 stable tokens.
Types of Stablecoins
The most commonly used type of stablecoin is reserve backed, most often by fiat currencies and sovereign debt bonds such as US treasuries. Of the top 5 stablecoin listed above, three have fiat reserves — USDT, USDC and BUSD. These are the most used options primarily due to the level of similarity to reserve currencies in traditional equity and money markets. While all have varying tokenomics and clarity surrounding the value of their reserves, they cumulatively host US$45 billion in daily volume signalling high levels of demand.
Another popular alternative is crypto-backed stablecoins, the most popular of which is DAI, created and maintained by MakerDAO. While DAI is technically an algorithmic stablecoin, the model relies on the value of a large list of reserve assets based on the Ethereum blockchain unlike the standard algorithmic stablecoin.
DAI is minted by depositing an ERC-20 token and using this as collateral to borrow DAI against, typically with a collateralisation ratio between 150–170%. Although to traditional participants this seems like a higher risk alternative to the aforementioned assets, a large portion of cryptocurrency market participants prefers this alternative due to its non-reliance on the fiat system, its transparency, over-collateralisation and overall embracement of a permissionless, trustless ecosystem.
In 2020/2021 we saw the rise and fall of a multitude of algorithmic stablecoins, the majority of which lost their pegs and became failed experiments. An algorithmic stablecoin typically operates on a twin-token model that relies on its code and a number of market participants to maintain its peg value. UST is an example of a successfully maintained algorithmic stablecoin that utilises a twin token mode. Users can mint 1 UST by burning US$1 worth of LUNA (the Terra network’s gas token) and vice versa. Due to market inefficiency, if UST moves away from its peg value of $1, arbitrageurs will buy UST (if value <$1) or sell UST (if value >$1), hedging their position through the burn/mint function offered by Terra to capture the difference (minus fees) between the offered 1 UST : US$1 LUNA and the depegged price.
There has also been increased interest in stable asset development over the course of 2021 with the likes of RAI proposing an unpegged stable asset with no link to fiat currencies or stablecoins. Like UST, RAI relies on a twin token model that utilises a managed float of ETH to constantly revalue RAI’s redemption price. Arbitrageurs can then take advantage of price discrepancies between the redemption price and market price to maintain fair value.
Source: CoinGecko’s Q1, 2021 Report
As there are varying types of stablecoins, the risks associated with individual assets do not necessarily apply to the broader market. One of the most discussed concerns of this market is the clarity and authenticity of stablecoin issuers. On one end of the spectrum, USDT claims to be fully collateralised by fiat currency, US treasuries and corporate bonds. Although, on multiple occasions, the issuer has failed to produce any proof of their reserve holdings.
On the other hand, algorithmic stablecoins have exposure to crypto market fluctuations leading to volatile swings in treasury reserves of these assets but are completely transparent. This balance of transparency and volatility is one that much of the market is addressing, producing new projects and stable tokens daily.
Irrespective of a stablecoin’s backing or value model, the leading concern from market participants is the risk of a depegging event whereby the systems in place fail to maintain the token’s value. This would likely be caused by a bank run on the asset leading to a drastic sell-off as owners lose faith in the asset’s stability and value. While most issuers attempt to prevent this risk by holding varying levels of reserves, we have still seen a multitude of these events over the last few years. Algorithmic stablecoins are particularly sensitive to such events due to their reliance on market dynamics and automated systems.
Due to the speed and low -cost of stablecoin transactions, international settlements and remittances have been the primary benefactor of increased access to stablecoins. Remittances cost an average of 6.3% of their transfer value in Q3 2021 costing individuals billions of dollars annually. By cutting this figure by just 5 percentage points, up to US$16 billion would be saved annually, providing a sharp value proposition for further adoption of stablecoins by remitters.
For those more involved with the crypto space, stablecoins provide a stable and liquid quote asset for the buying and selling of other assets on-chain. By facilitating this exchange entirely on the blockchain with a familiar price reference, investors become more comfortable with transacting on-chain. With the addition of these newly onboarded users who were previously opposed to bridging assets on-chain, there is now an order of magnitude more participants that can explore the offering of networks such as Ethereum or Terra and interact with decentralised finance protocols, NFT platforms and play-to-earn games.
The regulatory uncertainty of the crypto space has caused unease for investors and prevented a number of potential participants from entering the space. Amongst the multitude of arguments both for and against the regulation of the crypto space, the stablecoin market has attracted the most attention. This lies partly in the fact that there are no legally binding guarantees or protections in place for consumers as there is within traditional markets.
Due to this and continued adoption, we have seen a crackdown from governments globally. Some have even gone as far as to ban the use of stablecoins in their country. While the regulatory teething period has and will continue to create division, it will ultimately allow the space to continue to grow.
Within Australia, we have not yet seen the launch of a widely adopted AUD stablecoin leading many participants to rely on their USD counterparts when interacting with crypto markets and protocols. This has created a barrier to entry for many that wish to explore what the space has to offer for them. A liquid and transparently backed on-chain AUD would allow a new demographic of crypto users in the nation to become active users.
The case for a retail CBDC remains weak according to the Reserve Bank of Australia (RBA)’s chairman Philip Lowe, and it was expected that any stable asset pegged to AUD would need to come from the private sector until consumer demand gets to a level the RBA is happy with. As it turns out, Lowe was right.
The ANZ A$DC stablecoin
On March 24th, ANZ announced that it had minted its own Australian dollar-based stablecoin, the A$DC. As a means to encourage crypto for clients and reduce transactional risks for the family office Victor Smorgon Group (VSG), it is the first time any bank in the world has minted a stablecoin. Zerocap played a key role in this novel asset, piloting the A$DC stablecoin along with custody provider Fireblocks and the Victor Smorgon Group, which is also Zerocap’s equity partner. The first transaction conducted by ANZ and its A$DC was of $30 million worth of the stablecoin, sent by VSG to Zerocap. The funds arrived in less than 10 minutes.
On the creation of the A$DC stablecoin, here is what our CEO Ryan McCall had to say:
“Truly understanding the needs of institutions like ANZ was critical to Zerocap playing a role in this ground-breaking initiative. From the outset, we’ve focused on establishing the product, technology, compliance and team to properly service private and institutional clients, like the Victor Smorgon Group and ANZ. Digital assets are going mainstream; we’re thrilled to be at the forefront of driving adoption and bringing that vision to life.
BitShares — The first decentralised crypto exchange, founded in 2014.
BUSD — US dollar-based stablecoin issued and fiat-backed by crypto exchange Binance.
CBDC — (Central Bank Digital Currencies) Digital assets issued and backed by a Central Bank, such as China’s Digital Yuan.
DAI — Algorithmic US dollar stablecoin created and issued by MakerDAO.
Gas token — The crypto asset used for transactions in a particular blockchain network e.g. Ether is the gas token of the Ethereum network.
MakerDAO — Decentralised organisation that provides lending and borrowing services for crypto investors.
Tokenomics — The mathematics and structural incentives governing a particular cryptocurrency e.g. total supply, governance functions, inflationary or deflationary measures.
UST — Algorithmic US dollar stablecoin created and issued by the Terra network.
USDC — US dollar-based stablecoin issued and fiat-backed by Circle, one of the main crypto products providers in the world, in partnership with crypto exchange Coinbase.
USDT — US dollar-based stablecoin issued and fiat-backed by Tether.
Zerocap provides digital asset investment and custodial services to forward-thinking investors and institutions globally. Our investment team and Wealth Platform offer frictionless access to digital assets with industry-leading security. To learn more, contact the team at [email protected]
Originally published at https://zerocap.com on March 22, 2022.