12-2. Stablecoin

Stablecoin

Stablecoin

Stablecoin

• crytocurrencies designed to minimize the efects of price volatility
• to minimize volatility the value of a stablecoin, it can be pegged to a currency or exchange traded commodities(such as gold)
• stablecoins backed by currencies or commodities directly are said to be centralized
• stablecoins levereaging other cryptocurrencies are referred to as decentralized

Why the Stablecoins are Needed

• Cryptocurrencies prices are volatile -> fuel speculation, hinder real-world adoption
• Users don't want to be exposed to unnecessary currency risk when transacting in cryptocurrencies
• Cryptocurrency volatility precludes long-term smart contracts that require price stability
• Some users just want a store of value on a censorship-resistant ledger, escaping the local banking system, currency controls or a collapsing economy
• Much cryptocurrency innovation and adoption has been bottlenecked around price-stability

 

Price of Stability

All stablecoins imply a peg

• generally peg to the US dollar, but sometimes peg to other major currencies or to the consumer price index(물가지수)
• stablecoin claims to be an asset that prices itself, rather than an asset that is priced by supply and demand BUT this goes against everything we know about how markets work

Stablecoins are just currency peg

• there are many currency pegs still being maintained
• but, pegs tend to be inflexible and difficult to maintain as the history has taught
• no currency peg can be maintained against sufficiently adverse conditions

Peg can be maintained, but only within a certain band of market behavior

• how wide is the band of behavior it can support?
• if you assume currency markets are performing a random walk, every peg will eventually wak outside of its stable band and break
• 👉 we can tell a peg stable if it lasts 20 years

Question for Peg

1. How much volatility can this peg withstand? (Namely, downward selling pressure)
2. How expensive is it to maintain the peg?
3. How easy is it to analyze the band of behavior from which it can recover?
4. How transparently can traders observe the true market conditions?

• 3, 4 are important because currency peg are all about Schelling point
  • if market participants cannot identify when a peg is objectively weak, death spiral happens
  • transparent peg is more robust to manipulation or sentiment swings

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Types of Stablecoins

Fiat-collateralized

Fiat-collateralized stablecoins

• simplest scheme for a stablecoin, centralized
• cryptocurrency that's literally an IOU, redeemable for $1
• deposit dollars into a bank account and issue stablecoins 1:1 against those dollars
  • it is less a peg than just a digital representation of a dollar
• greatest price-robustness -> can withstand any cryptocurrency volatility
• highly regulated and constrained
  • if you want to exit the stablecoin and get your fiat back out, process is slow and expensive

Pros and Cons

• Pros
  • 100% price-stable 🤔
  • Simplest
  • Less vulnerable to hacks, since no collateral is held on the blockchain
• Cons
  • Centralized: need a trusted custodian to store the fiat
  • Expensive and slow liquidation into fiat
  • Highly regulated
  • Need regular audits to ensure transparency

 

Crypto-collateralized

Crypto-collateralized stablecoins

• instead of USD, using reverses of another cryptocurrency
  • everything can be on the blockchain, no fiat required
• cryptocurrencies are unstable, which means your collateral will fluctuatle -> over-collateralize the stablecoin so it can absorb price fluctuations in the collateral
  • if we deposit \$200 worth of Ether and then issue \$1 * 100 stablecoins = 200% collateralized
  • if the price of Ether drop by 25%, stablecoins will still be safely collateralized by $150 Ether
• you over-collateralize the coin and if the price drops enough, the stablecoins get liquidated
• BitUSD: first stablecoin to use this schema(collateralized with BitShares)
• Dai: MakerDAO's stablecoin considered the most promising crypto-collateralized stablecoin, collateralied by Ether

Incentives in Crypto-collateralized stablecoins

• you could pay the issure interest
• can create leverage
  • you locks up \$200 ETH and create \$100 stablecoins
  • use \$100 stablecoins to buy another \$100 of Ether
  • if Ether goes up 2x, you can have \$600, instead of \$400

Pros and Cons

• Pros
  • More decentralized
  • Can liquidate quickly and cheaply into underlying crypto collateral (just a blockchain tx)
  • Very transparent
  • Can be used to create leverage
• Cons
  • Can be auto-liquidated during a price crash into underlying collateral
  • Less price stable than fiat
  • Tied to the health of a particular cryptocurrency
  • Inefficient use of capital
  • Most complexity

Non-collateralized

Non-collateralized stable coin

• colleteral is unnecessary
• independent from all other currencies
• would not have perverse incentives to inflate or deflate the currency -> algorithm only have one goal: stability
• but if it fails, failure could be even more catastrophic, as there would be no collateral to liquidate the coin back into and the coin would almost certainly crash to zero
• ex. Basecoin, TerraUSD

 

Pros and Cons

• Pros
  • No colleteral required
  • Most decentralized and independent (not tied to any other cryptocurrency or to fiat)
• Cons
  • Requires continual growth
  • Most vulnerable to crypto decline or crash, and cannot be liquidated in a crash
  • Difficult to analyze safety bounds or health
  • Some complexity