What exactly is a stablecoin? A deep dive into the "long wick candle" of encryption assets.

Quick Overview

Stablecoins are a type of cryptocurrency that is pegged to assets such as the US dollar, euro, or precious metals, aiming to maintain a relatively stable price. There are three main types currently existing in the market: fiat-collateralized, crypto-collateralized, and algorithmic. Due to their practical application value and large market capitalization, stablecoins are increasingly becoming a focal point for global regulatory agencies.

The Real Use of Stablecoins

In the cryptocurrency space, most assets face the fate of extreme volatility. Bitcoin (BTC) and Ethereum (ETH) have been known for their high volatility since their inception—this has created both speculative opportunities and usage barriers.

Imagine you are a café owner, and one day you settle your bill with BTC, only for that amount to lose 50% of its value the next day. This uncertainty makes cryptocurrencies difficult to become a tool for everyday payments. Businesses cannot formulate reasonable pricing strategies, and consumers are unwilling to bear the risk.

Stablecoins have emerged to fill this gap. They enable users to:

• Lock in profits or losses: Traders can quickly convert to stablecoins during market pullbacks to protect existing profits.
• Cross-chain transfers: Transfer funds across blockchain networks at a constant value
• Conduct daily business: Provide merchants and consumers with a predictable measure of value.

TrueUSD (TUSD) and other mainstream stablecoins ensure this commitment through mechanism design.

How Do Stablecoins Achieve Price Pegging?

To create a cryptocurrency that tracks the price of another asset, the system requires a reliable anchoring mechanism. While methods vary, the most common approach is to use another asset as collateral. It is important to note that there is no guarantee of perfect price anchoring.

The working principle of fiat-collateralized stablecoins

This type of stablecoin holds fiat currencies such as the US dollar and British pound in its reserves. For example, each TUSD is backed by 1 US dollar. Users can convert fiat currency to stablecoins and vice versa at a fixed exchange rate. This model is the most straightforward but also the most centralized.

Crypto-collateralized Stablecoin: Complex yet Transparent

Crypto-collateralized stablecoins use crypto assets as collateral. Due to the inherent volatility of the crypto market, this type of stablecoin requires over-collateralization to maintain stability.

Taking DAI as an example, this is the most well-known crypto-collateralized stablecoin on Ethereum, managed by the MakerDAO community. Its operational mechanism:

• Users lock up $150 worth of cryptocurrency assets as collateral
• The system generates 100 DAI tokens (1.5 times over-collateralized)
• These DAI can be freely transferred, invested, or held.
• To retrieve the collateral, the user needs to repay 100 DAI.

The system maintains stability through game theory and incentive mechanisms:

When DAI falls below 1 dollar, holders are incentivized to exchange DAI for collateral, reducing the circulating supply and driving up the price. When DAI rises above 1 dollar, users are incentivized to mint new DAI, increasing the supply and driving down the price.

Crypto-collateralized stablecoins use smart contracts to automatically enforce these rules, enhancing transparency and auditability. However, this also means that community governance becomes crucial—MakerDAO token holders vote to determine key parameters.

Algorithmic Stablecoins: Ideal but High Risk

Algorithmic stablecoins do not hold any reserves. Instead, they rely on algorithms and smart contracts to control the token supply. This is the rarest and most difficult to maintain of the three types.

The principle is: when the price falls below the pegged target, the system automatically reduces the circulating tokens (through destruction, locking, or repurchase); when the price exceeds the target, the system increases supply to lower the price.

Despite being theoretically elegant, algorithmic stablecoins face significant challenges in practice. Market disruptions often destroy these delicate balances.

The Actual Advantages of Stablecoins

Stablecoins bring real value to investors, traders, and everyday users:

1. Suitable for everyday payments and commerce

Businesses need stability to operate. Mainstream stablecoins become a reliable means of payment—whether for B2B settlements or cross-border remittances—by being pegged to assets.

2. The Convenience of Native Blockchain

Stablecoins can be sent to any compatible crypto wallet around the world (which can be created for free in seconds). Transactions are processed on the blockchain, nearly eliminating the risks of double spending and counterfeiting. This makes stablecoins suitable for a variety of applications.

3. Portfolio Hedging Tools

Smart traders convert some of their assets into stablecoins when the market is bearish. This protects their profits and allows them to quickly buy the dip when opportunities arise. Stablecoins enable you to enter and exit positions without the need to withdraw to a bank account.

4. Liquidity Buffer

Holding stablecoins on the trading platform allows traders to quickly seize market opportunities, avoiding delays in bank transfers.

Potential Risks of Stablecoins

Despite the seemingly perfect nature of stablecoins, they still have obvious limitations:

1. Anchor Failure Risk

Although large projects can usually maintain their peg, many projects have suffered catastrophic failures. Once stablecoins frequently fall below their target price, trust breaks down, which can trigger a price crash.

2. Lack of Transparency

Most stablecoins only provide periodic third-party audit attestations, rather than complete public audits. These audits are conducted by private accounting firms on behalf of the issuers and may not fully alleviate user concerns.

3. Centralized Risks of Fiat-Collateralized

The collateral for this type of stablecoin is held by centralized institutions and is subject to local financial regulations. This gives issuers significant power. Users must trust that the issuer actually holds the claimed reserves - this is a source of systemic risk.

4. Uncertainty in Community Governance

Crypto collateral and algorithmic stablecoins rely on community governance. While democratic voting sounds ideal, users either have to actively participate in voting decisions or be forced to trust the judgment of others. This decentralization of power can sometimes become a weakness.

5. The possibility of being regulated and suppressed

The hybrid nature of stablecoins (both resembling fiat currency and cryptocurrency) is attracting the attention of global regulators. They may face stricter regulations in the future.

Practical Cases in the Stablecoin Ecosystem

The Model of Crypto Collateral: DAI and MakerDAO

DAI is a stablecoin pegged to the US dollar on the Ethereum blockchain, managed by the decentralized organization MakerDAO. MKR token holders can propose and vote on system parameters.

DAI employs an over-collateralization mechanism where users manage their Collateralized Debt Positions (CDP) through smart contracts. The entire process is fully driven by smart contracts, and anyone can audit the code. This design combines both security and transparency.

Fiat-backed benchmark: TrueUSD (TUSD)

TUSD is an independently verified USD-pegged stablecoin and the first stablecoin to adopt on-chain real-time proof of reserves (PoR). Through Chainlink's verification mechanism, users can independently confirm that each TUSD is backed 100% by USD in bank accounts.

How do stablecoins respond to regulation?

The unique dual characteristics of stablecoins—being both a cryptocurrency and having features of fiat currency—have attracted the attention of regulators worldwide.

Since the purpose of stablecoin design is to maintain price stability (rather than price speculation), they have the potential to facilitate low-cost cross-border transfers. Some countries are even experimenting with official versions of stablecoins.

In most jurisdictions, stablecoins may fall under existing cryptocurrency regulatory frameworks. Additionally, if stablecoin reserves are backed by fiat currency, the issuer may be required to obtain permission from financial regulatory authorities.

This regulatory gray area is gradually becoming clearer, and in the long run, it presents both challenges and opportunities for industry development.

Summary

Today, it is hard to find a cryptocurrency investor who has not come into contact with stablecoins. Traders typically hold stablecoins on exchanges to quickly seize market opportunities, investors use them to hedge risks, and business users utilize them for cross-border transfers.

Stablecoins have become an indispensable part of the crypto ecosystem, but their risks cannot be ignored. Several stablecoin projects have collapsed due to failures in maintaining their peg, reserve misappropriations, or legal disputes.

Suggestion:

• Diversify your investments and do not concentrate all your funds in a single stablecoin.
• Conduct in-depth research before trading to understand the project's collateral mechanisms and management structure.
• Recognize that stablecoins are essentially still crypto assets and face similar risks.
• Regularly review your holdings and pay attention to project developments.

Although stablecoins are powerful innovative tools, rationality and caution should be the foundation of their use.