The World of Stable Crypto Coins: Types and Regulations

Stable crypto coins are a type of digital currency designed to maintain a stable value, often pegged to a traditional asset like the US dollar. They're becoming increasingly popular.

There are two main types of stable coins: fiat-collateralized and cryptocurrency-collateralized. Fiat-collateralized stable coins are backed by traditional assets, such as the US dollar, while cryptocurrency-collateralized stable coins are backed by other cryptocurrencies.

Fiat-collateralized stable coins are regulated by the same financial authorities that oversee traditional currencies, such as the US Securities and Exchange Commission (SEC).

Stablecoins are cryptocurrencies whose value is pegged to another currency, commodity, or financial instrument, aiming to provide an alternative to the high volatility of popular cryptocurrencies.

They are programmable digital currencies, most commonly pegged 1:1 to fiat currencies like the USD. Stablecoins have combined the power of blockchain technology with the financial stability necessary for practical use cases of cryptocurrencies.

Stablecoins first appeared in 2014, combining technological benefits of blockchain with financial stability needed for widespread adoption. By solving the issue of crypto price volatility, stablecoins have unlocked new use cases beyond trading and speculation.

Stablecoins are designed to tackle price fluctuations by tying the value of cryptocurrencies to other more stable assets – usually fiat currencies. Fiat is the government-issued currency we're all used to using on a day-to-day basis.

The entity behind a stablecoin sets up a "reserve" where it securely stores the asset or basket of assets backing the stablecoin. This reserve serves as collateral for the stablecoin, ensuring its value remains stable.

USD Coin is a stablecoin launched jointly by cryptocurrency firms Circle and Coinbase in 2018 through the Centre Consortium. It is pegged to the U.S. dollar and is an open-source protocol, allowing anyone to develop their own products.

Stablecoins come in different types, including fiat-backed, collateralized, and algorithmic. Fiat-backed stablecoins, like USD Coin, are pegged to a specific fiat currency, while collateralized stablecoins are backed by other cryptocurrencies.

Algorithmic stablecoins, on the other hand, aren't collateralized at all; instead, coins are either burned or created to keep the coin's value in line with the target price.

Stablecoins use various types of collateral to maintain their value, including fiat currencies, precious metals, and other cryptocurrencies. The most common type of collateral is fiat currency, with the US dollar being the most popular.

Fiat collateral is often held in reserve with a central issuer and must reflect the number of corresponding stablecoins in circulation. For example, Gemini Dollar (GUSD) is pegged 1:1 to the USD and is backed by funds held by State Street bank.

Some stablecoins use precious metals like gold or silver as collateral, such as Digix (DGX), which is backed by 1 gram of gold. Other stablecoins use other cryptocurrencies, like MakerDAO's Dai (DAI), which is pegged to the US dollar but is backed by Ethereum (ETH) and other cryptocurrencies.

Here are some examples of stablecoins and their types of collateral:

These different types of collateral provide a range of options for stablecoin issuers and users, each with its own advantages and disadvantages.

There are several types of collateral used to back stablecoins, including fiat currencies, precious metals, other cryptocurrencies, and commodities.

Fiat currencies, such as the US dollar, are the most common collateral for stablecoins. In fact, the U.S. dollar is the most popular among fiat currencies used as backing for stablecoins, with companies like Gemini and Circle issuing stablecoins pegged to its value.

Precious metals, like gold and silver, are also used as collateral for some stablecoins. Each Digix token, for example, is backed by 1 gram of gold and is redeemable for the underlying asset or collateral at current market prices.

Other cryptocurrencies, such as ether, are used as collateral for some stablecoins, with MakerDAO's Dai (DAI) stablecoin pegged to the U.S. dollar but backed by Ethereum (ETH) and other cryptocurrencies.

Commodities, such as gold and silver, are used as collateral for some stablecoins, with each PAX Gold (PAXG) token backed by one fine troy ounce of a 400 oz London Good Delivery gold bar.

Here's a breakdown of the different types of collateral used for stablecoins:

These types of collateral are used to ensure the stability and value of stablecoins, which are designed to maintain their value through various mechanisms.

Algorithmic Coins are a type of stablecoin that don't rely on fiat, crypto, or commodities as collateral. They instead use algorithms and smart contracts to manage the supply of tokens in circulation, adjusting the supply based on market demand.

Algorithmic Coins are designed to maintain their value over the long term through programmed mechanisms, but they face challenges in maintaining long-term stability. For example, TerraUSD (UST) collapsed in 2022, highlighting risks associated with purely algorithmic stabilizing mechanisms.

These Coins can be minted without collateral, as seen with DefiDollar (DUSD) and Ampleforth (AMPL). DefiDollar leverages Curve's sUSD pool to mint DUSD using DAI, USDC, USDT, or sUSD, while Ampleforth incentivizes on-chain liquidity by issuing AMPL tokens as a reward for providing liquidity to automated market-making platforms.

Algorithmic Coins adjust their supply on-chain, without the need for collateral. This is a key feature of seigniorage-style Coins, which utilize algorithms to control the stablecoin's money supply, similar to a central bank's approach to printing and destroying currency.

Some notable examples of Algorithmic Coins include Ampleforth (AMPL), Frax (FRAX), and Ethena's USDe. These Coins use a combination of collateralization and algorithmic adjustments to maintain their value, but they still face challenges in maintaining long-term stability.

Here are some key features of Algorithmic Coins:

Stablecoins are a type of cryptocurrency that's pegged to the value of a traditional currency, like the US dollar. They're designed to be less volatile than other cryptocurrencies, making them a more stable option for everyday transactions.

One of the most popular stablecoins is USD Coin, which is mentioned in an article that explains how it works. USD Coin is a digital currency that's pegged to the US dollar, allowing users to make transactions without the need for traditional currency exchange.

The stability of stablecoins is their main appeal, and they're often used in situations where volatility is a concern.

Stablecoins offer a 1:1 ratio with a collateralized asset, making them a reliable store of value on the blockchain. They enable 24/7 transfers of funds, a crucial aspect for those outside of traditional finance business hours.

Stablecoins facilitate payments for goods and services using a stable store of value, making them a viable option for merchants. This is especially important for merchants who don't want to take a loss if the price of a cryptocurrency plunges after they get paid in it.

You can use stablecoins to send money from one crypto exchange to another exchange, providing a convenient and stable way to transfer funds. This is a significant advantage over traditional cryptocurrencies that can be highly volatile.

Stablecoins also allow for participation in DeFi lending, borrowing, and insurance, making them a valuable tool for the crypto native ecosystem. They have become a versatile tool for everyday use cases, powering a broad range of utility for the crypto native ecosystem and TradFi alike.

In regions facing economic instability or high inflation, stablecoins have become a preferred store of value, pegged to assets like the USD. This provides individuals and businesses with a way to preserve purchasing power and shield their assets from local currency volatility.

Stablecoins often trade at a premium in high-inflation regions, reflecting users' willingness to pay for stability and faster money movement.

Regulators are taking a closer look at stablecoins, with the International Organization of Securities Commissions proposing rules that focus on systemically important stablecoins. This is because the $162 billion market has the potential to disrupt payment and settlement transactions.

In the US, politicians are calling for tighter regulation, with Senator Cynthia Lummis pushing for regular audits of stablecoin issuers. The proposed framework would require stablecoin issuers to be registered non-depository trusts or depository institutions.

The Markets in Crypto Assets Regulation in Europe bans algorithmic stablecoins and requires all others to have assets held in custody by a third party, with a 1:1 ratio of assets to coins.

Stablecoins are a game-changer for foreign exchange and trade finance, enabling businesses to transact in a globally accepted digital currency.

This reduces reliance on intermediaries and mitigates risks associated with fluctuating exchange rates. Stablecoins also simplify transactions for importers and exporters.

By providing a stable and transparent medium for international trade, stablecoins are particularly beneficial in regions with limited access to foreign currency.

Regulations are a major concern for stablecoin issuers and users alike. The International Organization of Securities Commissions (IOSCO) proposed rules in October 2021 to regulate stablecoins as financial market infrastructure alongside payment systems and clearinghouses.

Regulators are increasingly calling for tighter oversight of stablecoins, with some politicians pushing for bank-like regulations. In November 2021, Senator Cynthia Lummis called for regular audits of stablecoin issuers.

The US government is also taking steps to regulate stablecoins, with Senators Lummis and Kirsten Gillibrand introducing a bill in 2024 to create a regulatory framework for stablecoins. Their proposed framework would prohibit anyone from issuing a stablecoin unless they were a registered non-depository trust or a depository institution with authorization to issue them.

In Europe, the Markets in Crypto Assets Regulation took effect in 2023, essentially banning algorithmic stablecoins and requiring all others to have assets held in custody by a third party. Reserves must be liquid and have a 1:1 ratio of assets to coins.

Regulatory bodies are grappling with the challenge of creating frameworks that encourage innovation while ensuring consumer protection, financial stability, and compliance with anti-money laundering and counter-terrorism financing (AML/CFT) standards.

The Financial Innovation and Technology for the 21st Century Act, currently in progress, excludes certain stablecoins from regulation by the SEC and CFTC, except for fraud and certain activities by registered firms.

Tether's lack of transparency is a major concern, particularly when it comes to producing audits for reserves used to collateralize the quantity of minted USDT stablecoin.

Tether has been accused of failing to provide these audits, which has led to speculation about the true backing of USDT.

Some research suggests that the creation of unbacked USDT may be linked to the rise in Bitcoin's price in 2017, although this is still a topic of debate.

There is little to no evidence that Tether's USD minting events influenced Bitcoin values unless they were publicized to the public by Whale Alert, which raises questions about the potential for manipulation.

Illicit activity in the stablecoin ecosystem is a growing concern. Less than 1% of on-chain transactions are estimated to be illicit, but stablecoins have been used in activities like money laundering and fraud.

Their stability and global accessibility make them attractive tools for bad actors. Stablecoins can be used to transfer value quickly across borders without relying on traditional financial institutions.

Stablecoins have been used to facilitate international trade and transfer funds to entities in non-sanctioned jurisdictions. This is particularly concerning in regions like Russia, where entities are exploring alternatives to bypass Western financial restrictions.

The pseudonymous nature of blockchain transactions makes it difficult to obscure the origins of funds. However, complex networks of wallets and exchanges can be used to conceal the true source of funds.

Smaller-scale activities, such as fund transfers by sanctioned entities and politically exposed persons, pose significant security and compliance risks. These activities can go undetected due to the relatively high liquidity and acceptance of stablecoins across cryptocurrency exchanges.

Stablecoin issuers are teaming up with law enforcement to fight financial crime. They're using Chainalysis to monitor transactions in real-time and identify suspicious activity.

Issuers like Tether are working closely with global law enforcement agencies, financial crime units, and regulators. This collaboration is helping to stop illegal transactions and recover stolen funds.

Most centralized stablecoin issuers have the power to freeze or permanently delete tokens in wallets linked to confirmed criminal activities. This allows them to take swift action against illicit activities.

By working together, stablecoin issuers and law enforcement are making progress in preventing financial crime.

Stablecoins have some significant drawbacks to consider. Counterparty risk is a major vulnerability, where the entity backing the stablecoin may not actually have the collateral it claims to have.

Tether, for instance, has faced questions over whether it maintains a true 1-1 backing between USDT tokens and U.S. dollars.

In the worst-case scenario, the reserves backing a stablecoin could turn out to be insufficient to redeem every unit, potentially shaking confidence in the coin.

Some stablecoins even have a back door to stop transactions, adding a layer of control that undermines the decentralized nature of cryptocurrencies.

USD Coin openly has a mechanism to freeze payments if coins are used in an illicit manner, and Circle, the firm behind USDC, has confirmed that it has frozen $100,000 of the stablecoin at the behest of law enforcement.

Many stablecoins have historically struggled with stability, and some have even been crashed to zero in the past, like TerraUSD.

De-Pegging is a major concern for stablecoins. Many projects can advance a product and call it a stablecoin, but this doesn't necessarily mean it's stable.

TerraUSD and others have been crashed to zero in the past, despite being called stablecoins. This is a stark reminder of the risks involved.

The value of a stablecoin is only as good as its ability to maintain a stable value. In the case of TerraUSD, its price plunged more than 60% on May 11, 2022, vaporizing its peg to the U.S. dollar.

The Luna token used to peg Terra slumped more than 80% overnight, causing the entire system to fail. This highlights the potential for catastrophic losses when a stablecoin's value is not properly maintained.

Defunct Coins are a harsh reality in the world of cryptocurrency. Basis, a stablecoin project, shut down in December 2018 after receiving over $100 million in venture capital funding, citing concerns about US regulation.

The collapse of Terra's stablecoin UST in May 2022 is another notable example, with the coin plummeting from $1 to 26 cents. This led to the failure of Terraform Labs and the loss of nearly $40 billion invested in the Terra and Luna coins.

Diem, formerly known as Libra, was abandoned by Facebook/Meta and later purchased by Silvergate Capital. This shows that even well-known and well-funded projects can fail.

Stablecoins have some drawbacks to consider.

One of the main concerns is counterparty risk, which occurs when the entity storing the reserves doesn't actually have the collateral it claims to have.

Tether, a well-known stablecoin, has faced questions about whether it maintains a true 1-1 backing between USDT tokens and U.S. dollars.

In the worst-case scenario, the reserves backing a stablecoin could turn out to be insufficient to redeem every unit, potentially shaking confidence in the coin.

Some stablecoins, like USD Coin, have a back door to stop payments if coins are used in an illicit manner.

Circle, the firm behind USDC, froze $100,000 of the stablecoin at the behest of law enforcement in July 2020.