What are Stablecoins: A Basic Primer

Tether pioneered the concept of a stablecoin in July 2014. In less than a decade, Tether has grown into a 65 billion dollar supply (as of August 2021) that is being discussed as a genuine disruptive Fintech by governments, institutions, and regulators.

Seven years later, USDt remains the market leader and dominant stablecoin in an industry that has grown to exceed $100 billion in the total supply of stablecoins. As a challenger to the incumbent payment industries, stablecoins have become a key discussion area for regulators and lawmakers. This represents one of the most rapid and wide-reaching payment technology innovations that markets have seen in decades.

It is clear today that Tether tokens are playing a critical role in shaping the future of money around the globe. However, most people may not even understand what a stablecoin is, why they have grown so quickly, or why they have drawn so much attention lately!

What is a Stablecoin?

Stablecoin is an industry term that generally refers to a digital asset issued on a blockchain, whose goal is to maintain the most stable price possible.
This immediately raises the question of what people mean by “stable” and what benchmark we use to measure stability against.

You may be surprised to learn that not all stablecoins are really “stable”. Some experience much higher levels of volatility than most would expect.
For USDt, stable means having a very very low level of volatility, generally experiencing price fluctuations that are a small fraction of one percent.

Image take from Bitfinex USDt/USD market for 2021
However, some stablecoins take a different design approach and mandate. While they focus on returning to a fixed value whenever the price deviates from it, these assets may experience a much higher level of volatility than what users might expect, with fluctuations that have even exceeded twenty percent!

Against what do stablecoins benchmark their stability?

Stability is a relative term. In the case of USDt, one USDt is always redeemable for one US dollar. The stability of USDt is always in comparison to the value of one dollar.

However, stablecoins can be benchmarked against any currency or asset. Tether issues other stablecoins which are pegged to the Euro, offshore Chinese Yuan, and even Gold. The actual price of a stablecoin may vary in absolute terms if the asset is pegged to changes in value, but the goal is to track that asset as closely as possible.

Most other stablecoins choose to peg themselves to the US dollar. However, in the future, we may see this change for reasons which aren’t apparent today.

How do Stablecoins Remain Stable?

There are several ways that current stablecoins have endeavoured to achieve price stability. Stablecoins can be collateralized or non-collateralized. Most collateralized stablecoins are backed by traditional asset reserves which include cash, commercial paper, and treasury bills.

Collateralized Stablecoins

Collateralized stablecoins are stablecoins where each coin is backed by a fixed quantity of collateral. These stablecoins can either be backed by traditional asset reserves held by the issuer or can be collateralized by cryptocurrency. In both cases, collateralized stablecoins are redeemable for their underlying collateral either via the issuer or via the smart contract responsible for issuance.

The vast majority of stablecoins are collateralized via traditional asset reserves. This includes USDt. All issued USDt are always 100% backed by Tether reserves, which include traditional currency and cash equivalents and, from time to time, may include other assets and receivables from loans made by Tether to third parties.

Users can always redeem USDt directly for dollars. Tether has never refused a client redemption request and Tether’s reserves exceed the amount of USDt in circulation.

Additionally, while the market has not traditionally had transparency into the composition of collateralized stablecoin reserves, Tether is proud to embrace its role as a leader in the stablecoin space by being the first collateralized stablecoin to provide an attestation to the breakdown of its reserves.

Following our mission to remain transparent to the community, other stablecoin providers are following Tether’s lead and are starting to provide asset breakdowns.

Crypto collateralized stablecoins operate differently from stablecoins backed by traditional asset reserves. In short, crypto collateralized stablecoins use various crypto assets as backing. However, as these assets are highly volatile, the protocol must always be over-collateralized, which means they need more collateral than the number of coins issued, and usually by a significant margin.

Crypto collateralized stablecoins are generally issued on-chain via a system of contracts, but have historically dealt with greater volatility than USDt.

Non-Collateralized Stablecoins

Non-collateralized Stablecoins can also be referred to as algorithmic stablecoins. These coins are not backed by any collateral and use a complex system of features to try to achieve price stability, which may or may not be successful.

The early example of a stablecoin that featured price swings in excess of twenty percent was an algorithmic stablecoin. The mechanisms by which these protocols try to achieve stability are too variable to discuss in detail.

Algorithmic stablecoins only represent a small fraction of the total amount of issued stablecoins at this time.

Why Stablecoins?

Stablecoins are digital bearer assets that are designed to maintain price stability, and they have become a significant disruptor to the future of money. By the end of the decade, people will be using stablecoins globally as a way to transact and to secure independent property rights in countries where blockchain’s offer stronger guarantees than their local government.

Stablecoins can both transact and settle very quickly. While we have many modern payment systems that can send money quickly, none of these can settle quickly. It can take days for payments to settle on traditional payment rails fully. With stablecoins, this processing time can be reduced to minutes or even seconds, depending on the infrastructure being used.

Stablecoins can also be stored using a private key or digital wallet. While this may seem new or unfamiliar to many people, millions of people now use digital wallets to manage their assets daily. In countries and areas where local property guarantees are weak, the ability to store any amount of value in a digitized form has the potential to transform the lives of many around the globe.

Stablecoins allow users to connect and transact using a common payment standard, breaking free from a system where every country has its own currency and its own payment infrastructure. With stablecoins, users around the world will benefit from the same financial services no matter where they are.

Finally, stablecoins free users from being forced to rely on their local currency. Many users may not want to store their value or to account for their payments in their local currency. Stablecoins empower users to choose whichever monetary medium offers them the most benefits instead of being forced to use their local currency or system of property rights. In turn, stablecoin issuers can continue to evaluate different standards against which to peg stablecoins to address the needs of users around the world.

By the end of the decade, stablecoins will likely represent a significant percentage of the money supply and of payments around the world. As the pioneer and market leader, Tether is proud to be at the forefront.