There are many different types of stablecoins. As we know, stablecoins can be backed by other assets, commodities, fiat currencies, and other cryptocurrencies.
It's important to consider what is backing the stablecoin. For now, we'll consider currency-backed stablecoins to limit our market timing risk which lowers the odds of losing money if we bought it when the price was at a peak. We wouldn't want to buy a stablecoin pegged to the value of gold with the risk that gold prices drop suddenly.
Below is a list of the four most popular stablecoins pegged to $1 ranked by market capitalization.
When looking at these stablecoins, let's review their history and consider their popularity, stability, and trustworthiness.
Tether, launched in 2014, is the first blockchain-enabled platform to facilitate the digital use of traditional currencies.
All Tether tokens are pegged at 1-to-1 with a matching fiat currency (e.g., 1 USD₮ = 1 USD) and are backed 100% by Tether's reserves. That means, for every USD₮ (Tether coin tracking the US dollar) available on exchanges, Tether has a matching $1 sitting in a bank or reserve to support the coin's value. Tether publishes these reserve values daily on its website, as shown below.
It's important to note that Tether doesn't actually hold $62.9 billion in cash. Instead, Tether invests that amount and recently shared a breakdown of how it's invested. We'll see that they invested almost a quarter of the value in bonds.
The total liabilities include the total amount of USD₮ coins available. As long as there is an excess of liquid assets in US dollars to cover the liabilities, the value of Tether is stable.
One crucial distinction to note is that while Tether is the largest US dollar-based stablecoin, banks and financial authorities do not regulate it. While the assets most certainly cover the liabilities, there is a degree of risk since Tether is bound by fewer rules.
USD coin (USDC)
USDC is a US dollar-based stablecoin launched in 2018 and issued by regulated financial institutions.
Like Tether, USDC is backed by fully reserved assets, redeemable on a 1:1 basis for US dollars. Circle, a payment infrastructure company, and Coinbase, a centralized crypto exchange, partnered to create the USD Coin, pegged directly to the US dollar.
The daily reserves aren't available; however, Grant Thorton, a tax accounting firm, conducts regular reviews to ensure enough assets are backing the number of coins in circulation.
More importantly, financial institutions regulate USDC. USDC's parent company is a registered Money Service Business in the United States, which means it's regulated by the government's Financial Crimes Enforcement Network (FinCEN). This is an excerpt from Centre's website:
Existing approaches have lacked financial and operational transparency, have operated in unregulated offshore jurisdictions with unknown banking and audit partners, and have been built as closed-loop ecosystems and closed source technologies.
USDC solves these problems by offering a solution with detailed financial and operational transparency, operating within the regulated framework of US money transmission laws, with established banking partners and auditors, and is built on an open source framework with an open membership scheme that eligible financial institutions can participate in.
It is a considerable advantage for USDC to be regulated and backed by Coinbase, one of the most trusted centralized exchanges in the US. We see this with the increased adoption of USDC. Even though USDC launched much later compared to Tether, USDC is already at 40% of the total supply of Tether circulated.
Binance USD (BUSD)
Binance USD launched in 2019 in partnership with a startup Paxos.
BUSD is similar to USDC since it is backed by a major centralized exchange. However, Binance USD is different because a different company provides the whole issuance and custody. Paxos Trust Company is the USD custodian and issuer of BUSD. Each BUSD you hold corresponds to 1 US dollar in the bank account to ensure that you can always buy and redeem your assets anytime with 1:1 pegged US dollars.
This means that Paxos is in charge of maintaining the reserves required to stabilize BUSD, and as of right now, Paxos does not publicly disclose the assets that back BUSD. Instead, there's a statement on the marketing website that lets us know reserves back all coins. BUSD is regulated; however, Paxos and BUSD are approved and regulated by the New York State Department of Financial Services.
DAI is a stablecoin launched in 2017 by MakerDAO to hold the value at $1.
DAI is quite different compared to the other three stablecoins as fiat-assets do not back it. DAI is an ERC-20 token built on the Ethereum blockchain and is the currency users can use to borrow and pay back borrowed money on MakerDAO.
The value of DAI is set to be $1 and stabilized through a series of smart contracts and reserves held in other cryptos—some are stablecoins mentioned above. When the value of the token drops below $1, the smart contracts adjust for this price change and bring the price of the token back to $1 so that borrows and loaners aren't all of a sudden facing steep expenses.
Smart contract execution requires the input of ETH, and so DAI is somewhat dependent on the value of ETH to run the smart contracts. This stablecoin is the most technical of all three and requires a deeper understanding of collateralized debt positions to understand the risks fully.
Picking a Stablecoin
When there isn't a big difference between two stablecoins in popularity, stability, and trustworthiness, the cost of the transactions may matter more at the end of the day.
For example, since Coinbase helped create USDC, Coinbase does not charge a transaction fee when converting fiat to USDC.
In this case, it would be better to save on transaction fees and purchase USDC instead of Tether.
If transaction prices are comparable and it's hard for us to decide on a stablecoin, we could consider USDT or USDC. We can then convert our stablecoin into another crypto since stablecoins aren't intended to earn a return and are used less often in transactions. Instead, buying a stablecoin gives us an idea of how fiat-crypto transactions happen.