Stablecoins blog post series – part 1: background

If you deal with the subject of cryptocurrencies, you will inevitably stumble across the topic of stablecoins, and the question of what exactly stablecoins are quickly arises. In this series of blog posts, we want to take you on a brief, condensed journey through this topic.

A stablecoin is a cryptocurrency that is stable to a certain base currency. The most common use case is in the area of crypto trading because the (cross-border) clearing between crypto exchanges can be processed faster with stablecoins than via the classic payment channels. In addition, they are becoming increasingly popular in emerging and developing countries due to their stability of value compared to local currencies.

In short, the benefits of a stablecoin can be summed up in four main points:

• Value reference and medium of exchange for trade
• Protection against exchange rate fluctuations
• Generating interest income in the area of decentralised finance
• Fast and limitless payments

Algorithmic vs. collateralised stablecoins
There are two different types of stablecoins: collateralised stablecoins and algorithmic stablecoins:

In the case of collateralised stablecoins backed by USD, the company behind the stablecoin deposits USD in a bank and issues its stablecoin. The aim is to achieve 1:1 cover. In the case of algorithmic stablecoins, only an algorithm tries to keep the exchange rate between the stablecoin and the underlying asset (e.g. USD) constant.

After the collapse of the algorithmic stablecoin "TerraUSD" in May 2022, there is only one really significant algorithmic stablecoin left: MakerDao's "DAI".

Collateralised stablecoins are usually issued by crypto exchanges. The biggest stablecoins sorted by market capitalisation are Tether, USD Coin and Binance USD. Together, they reach a total market capitalisation of around USD 130 billion (as of Nov. 2022).

Stablecoins digitally represent the value of an underlying asset on a 1:1 basis and are considered digital money. They are often covered by USD bank deposits, US government bonds or other securities. If one remembers the so-called gold standard, it is easy to recognises quite intentional parallels here.

Advantages compared to classic payments
The advantages over classic payment systems are that stablecoins are accessible to everyone worldwide and around the clock. The transaction fees are low, and cross-border payments can be made quickly and easily. A credit transfer is also possible without KYC and without the involvement of a bank. All that is needed is a smartphone with an Internet connection and a digital wallet of the currency.

As mentioned at the beginning of our article, in addition to crypto exchange traders, more and more people from emerging and developing countries have a particular interest in stablecoins.

Many emerging and developing countries are struggling with high double-digit inflation rates. The own national currencies continue to lose value against the US dollar. This also affects the trust of the citizens in the respective countries. In the recent past, many of these countries experienced a so-called "bank run".

A bank run or banking storm occurs when investors want to withdraw their deposits from their banks as soon as possible. If several or all banks within a market economy are affected, this is referred to as a banking storm or banking panic.

Governments were therefore forced to close local banks. For local citizens in such a situation, stablecoins can become an attractive alternative to their domestic currency to protect themselves from financial impasses.

In various situations, stablecoins can therefore be a practical solution to problems that cannot be solved or can only be solved poorly in the FIAT system, or may even be a way out for citizens in times of economic difficulties. However, where there is light, there is also shadow. And we want to look at that with you in part 2 of our series.

Authors: Philipp Uhinck, Benjamin Schreck