Stablecoin: The Cornerstone of the Digital Asset Field

In the current cryptocurrency market, stablecoins play a crucial role. As of the end of July 2024, the total market capitalization of stablecoins reached approximately $165 billion, accounting for nearly 7% of the entire cryptocurrency market's market cap of $2.417 trillion. Among them, the stablecoin giant Tether (USDT) is currently the third largest cryptocurrency by market cap, following Bitcoin and Ethereum.

This article will delve into the definition, classification, and important role of stablecoins in the digital currency ecosystem. We will also explore its operating mechanism and potential risks through a case study of USDe.

Definition and Function of Stablecoin

According to the definitions of the Financial Stability Board and the Bank for International Settlements, a stablecoin is "a cryptocurrency that aims to maintain a stable value relative to a specific asset or a group of assets." Typically, stablecoins are pegged to fiat currencies such as the US dollar.

So, why do we need stablecoins?

First of all, in the context of the booming Web3 applications, digital assets offer higher tradability compared to traditional assets. Stablecoins, as a medium of exchange with stable value, not only facilitate everyday transactions but also enable fast and low-cost cross-border payments, avoiding the processing delays and high fees of traditional banking systems.

Secondly, stablecoins help to mitigate the impact of value fluctuations. Due to the significant price volatility of mainstream cryptocurrencies such as Bitcoin or Ethereum, they are not suitable as a stable means of storing value. During periods of market turmoil, stablecoins provide investors with a safe haven for preserving value.

Classification of Stablecoins

Stablecoins are mainly divided into two categories: collateralized stablecoins and algorithmic stablecoins.

mortgage stablecoin

The collateralized stablecoins are fully backed by other assets, ensuring their value is supported by actual collateral. Mainly includes:

1. Fiat-backed stablecoin: supported by reserves of fiat currency, such as USDT and USDC.
2. Commodity-backed stablecoin: backed by physical assets such as gold, like Tether Gold (XAUt).
3. Cryptocurrency collateral stablecoin: backed by reserves of other cryptocurrencies, such as DAI.

algorithm stablecoin

Algorithmic stablecoins maintain price stability through algorithmic mechanisms, with the main methods including:

1. Liquidation: Liquidate risk collateral through auctions to ensure full collateralization of stablecoin debt.
2. Burn and Mint: Influence price by adjusting the token supply.
3. Adjusting the lending interest rate: Controlling the supply of stablecoins by changing the lending interest rate.

It is worth noting that many stablecoins use a combination of various mechanisms to enhance their stability and reliability.

Security Risks of Stablecoins and Solutions

Collateral Transparency

For stablecoins backed by fiat currencies or commodities, users may question whether the collateral is securely held and can be redeemed at any time. Many projects enhance transparency through third-party custody, regular audits, and the publication of reserve proof reports.

collateral value fluctuations

For cryptocurrency-backed stablecoins, price fluctuations of the underlying assets may lead to under-collateralization. To address this issue, many projects adopt over-collateralization and liquidation mechanisms to mitigate potential risks.

smart contract vulnerability

Stablecoins, especially algorithmic stablecoins, rely on complex smart contracts to achieve their stability mechanism. Strict security audits and continuous monitoring are crucial to ensuring the protocol's security.

market volatility

Under extreme market conditions, stabilization mechanisms may not respond in time, leading to significant deviations in prices from the target. In addition, markets with insufficient liquidity are more susceptible to manipulation, and erroneous oracle data may also trigger pricing issues.

Overview of Mainstream Stablecoins

According to the latest data, the top 20 stablecoins account for over 99% of the total market value of stablecoins. Among them, the top 5 stablecoins (USDT, USDC, DAI, USDe, and FDUSD) account for 96% of the total market value, demonstrating a highly concentrated market structure.

Among these mainstream stablecoins, all stablecoins have adopted some form of asset collateralization, while nearly half also combine algorithmic stabilization mechanisms. This phenomenon indicates that, despite algorithmic stablecoins claiming to have excellent designs, users still tend to prefer stablecoins backed by real assets, especially those supported by fiat currency.

USDe Case Study

USDe is a new type of stablecoin issued by Ethena Labs, and it has currently become the fourth largest stablecoin by market capitalization. Its design principle is mainly based on the operation of centralized exchange (CEX), and it adopts a "delta hedging" strategy to maintain the stability of the collateral assets.

The sources of income for USDe include ETH staking rewards and profits from delta-hedged derivative positions. The latter can be further divided into funding rate income and basis spread income. Historical data shows that even during market downturns, this income combination can still maintain a positive value.

However, USDe also faces some potential risks:

1. Centralized risk: Reliance on CEX may become a vulnerability in the system.
2. Market Risk: A sustained negative funding rate may lead to issues in yield design.

Conclusion

Stablecoins play a critical role in the cryptocurrency ecosystem, providing stability to the market and facilitating transactions. From traditional fiat-backed collateral to emerging algorithmic mechanisms, different types of stablecoins meet the diverse needs of the crypto community.

With the emergence of innovative projects like USDe, the industry has raised higher demands for the security and reliability of stablecoins. Continuous security audits and monitoring are crucial for maintaining market stability and user trust. In the future, whether stablecoins can remain stable and avoid systemic risks in the face of fierce market competition will be a focal point of concern for the entire industry.