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What is a Stablecoin? Most Comprehensive Video Guide - YouTube
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- [Intructor] Stablecoins are
price stable cryptocurrencies,
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meaning the market price of a stablecoin
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is pegged to another stable
asset like the US dollar.
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Bitcoin and Ether are the two
dominant cryptocurrencies,
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but their prices are volatile.
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Speculation on a cryptocurrency
can fuel its volatility,
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which can fuel further speculation,
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which in the long run
hinders real world adoption.
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Businesses and consumers
don't want to be exposed
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to unnecessary currency risk
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when transacting in cryptocurrencies.
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You can't pay someone a salary in Bitcoin
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if the purchasing power of
their wages keeps fluctuating.
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Cryptocurrency volatility also hinders
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blockchain-based loans,
derivatives, prediction markets,
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and other longer-term smart contracts
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that require price stability.
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And of course, there's
the long tail of users
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who don't want to speculate.
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They just want to store and use money
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on a censorship-resistant ledger.
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Escaping the local banking system,
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currency controls are
a collapsing economy.
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The idea of a price-stable cryptocurrency
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has been in the air for a long time.
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Much cryptocurrency
innovation and adoption
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has been bottle-necked
around price stability.
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For this reason, building a stablecoin
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has long been considered the Holy Grail
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of the cryptocurrency ecosystem.
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At a high level, there are
three types of stablecoins.
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Fiat-collateralized coins,
crypto-collateralized coins,
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and non-collateralized coins.
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A fiat-collateralized
stablecoin is a cryptocurrency
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that is backed by a real-world
currency like the USD.
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It works by depositing
dollars into a bank account
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and issuing stablecoins
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in a one-to-one ratio
against those dollars.
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When a user wants to
liquidate their stablecoins
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back into USD, you
destroy their stablecoins
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and wire them the USD.
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This asset should definitely
trade at one dollar.
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It is less a peg than just
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a digital representation of a dollar.
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Some examples of this type of stablecoin
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are Tether and True USD.
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This is the simplest type of stablecoin,
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which is a great advantage
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both in helping people to
understand how it works,
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and in implementing those solutions.
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It is also 100% price stable,
because for each coin,
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there is one dollar in reserve
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that can be redeemed at any time.
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And perhaps most importantly,
it is less vulnerable to hacks
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because no collateral is
actually held on the blockchain.
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However, this safety and
stability comes at a price.
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Fiat-collateralized stablecoins
are inherently centralized
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because they need a trusted custodian
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to store the real money, otherwise,
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they will be vulnerable to theft.
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You will also need to have
auditors who will periodically
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check in on the custodians and make sure
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that there's enough
money stored in reserve,
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which can be expensive.
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Lastly, a fiat-backed
stablecoin is highly regulated
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and constrained by legacy payment rails.
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If you want to exit the stablecoin
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and get your fiat back out,
you'll need to wire money
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or mail checks, a slow
and expensive process.
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If we move away from
fiat, we can also remove
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the centralization from the stablecoin.
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This is where the idea
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of crypto-collateralized
stablecoins comes in.
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They operate in the same way
as fiat-backed stablecoins,
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but are backed with reserves
of another cryptocurrency
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as opposed to a fiat currency like USD.
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This way, the entire system
can live on the blockchain
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and remain decentralized.
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MakerDao's Die is the
most prominent example
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of a crypto-collateralized stablecoin.
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One major difference to note
between fiat-backed stablecoins
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and crypto-backed stablecoins
is the ratio between
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the collateral and the stablecoin,
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also known as the collateralization ratio.
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Because fiat currency is generally stable,
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we can use a one-to-one
collateralization ratio
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where for each coin, we have
one dollar stored in reserve.
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Using a one-to-one collateralization ratio
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for a crypto-backed stablecoin however,
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would make the stablecoin just as volatile
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as the collateral backing it
which would defeat its purpose.
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For this reason, crypto-backed stablecoins
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are over-collateralized, which means that
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for every dollar of the stablecoin,
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there is more than one dollar
of cryptocurrency in reserve.
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The more volatile a cryptocurrency is,
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the higher this ratio would have to be
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to ensure that even if the price drops
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there will still be one dollar in reserve
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for every stablecoin in circulation.
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There are a lot of advantages
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to using a crypto-collateralized
stablecoin.
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First and foremost, it
is fully decentralized
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and can benefit from the inherent
virtues of the blockchain.
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Stablecoins can be liquidated
quickly and cheaply
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into the underlying crypto collateral
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with a simple blockchain transaction.
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The entire system is
also very transparent.
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Everyone can easily inspect
the history of transactions,
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the collateralization ratios
of a particular crypto asset,
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and how much reserves actually exist
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in the system at a given time.
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Compare this with the opaque
and cumbersome process
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of ensuring that there is
enough reserve in a bank
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for fiat-collateralized cryptocurrencies.
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For all that they promise however,
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crypto-collateralized stablecoins
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still face some challenges.
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Having to deal with the volatility
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of the cryptocurrency market
means that these stablecoins
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are not as price stable
as fiat-backed coins,
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and can be auto-liquidated
during a price crash
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of the underlying collateral,
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which would essentially
mean that the holders
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of the stablecoin would
lose their collateral.
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Accounting for this
volatility means having
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to over-collateralize each coin,
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which ultimately makes for an
inefficient use of capital,
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because for every dollar you put in,
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you can only take out some
percentage less than that dollar.
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Crypto-collateralized coins
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are also rather complex in design,
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and have to resort to very intricate,
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and sometimes non-intuitive methods
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to ensure their stability,
which makes their adoption
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and implementation more difficult.
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The last type of stablecoin
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is a non-collateralized stablecoin.
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And as you can tell from the name,
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it aims to maintain stability
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without relying on a
collateral in reserve.
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This might sound a bit odd,
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but it's not that crazy of an idea.
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In fact, fiat currencies
have been able to do this
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for decades by using central
banks to control money supply.
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You can learn more about the
details of how this is done
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and why it works by
watching our weekly webinar
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from April 3rd, 2018 called
How Money Stays Stable.
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As we discuss in the webinar,
the value of a currency
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is determined through supply and demand.
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If there's more people who want a currency
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than there is units of
that currency available,
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the price of that currency
will go up, and vice versa.
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Central banks use this information
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to ensure a currency's price stays stable
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by printing new money when the
price of a currency goes up
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and buying back and destroying money
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when the price of a currency goes down.
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Non-collateralized stablecoins
want to do the same thing.
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By coding logic into smart contracts,
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they can perform the
functions of a central bank.
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These smart contracts will use oracles
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to monitor the price of
the stablecoin on exchanges
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and will create new coins
when the price goes up,
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and buy back and destroy coins
when the price goes down.
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Currently, the most promising project
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in this category is Basis Coin.
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A non-collateralized coin is independent
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from all other currencies.
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Even if the US dollar and Ether collapse,
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a non-collateralized
coin could survive them
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as a stable store of value.
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Unlike the central banks of nation-states,
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a non-collateralized stablecoin
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would not have perverse incentives
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to inflate or deflate the currency.
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Its algorithm would only have
one global mandate, stability.
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This is an exciting possibility.
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And if it succeeds, a
non-collateralized stablecoin
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could radically change the world.
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But if it fails, that failure
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could be even more catastrophic,
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as there would be no collateral
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to liquidate the coin back into,
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and the coin would almost
certainly crash to zero.
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The system also has some
inherent complexity,
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and can be rather opaque
and difficult to analyze.
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Most importantly though,
it relies on faith
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in its stability and continual growth,
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just like national fiat currency does,
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which makes it very difficult to adopt
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at this early stage when faith
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in cryptocurrencies themselves
hasn't been solidified.
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Thanks for watching this video.
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We hope you enjoyed it.
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If you wanna learn more about MakerDao,
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the different kinds of
stablecoins there are,
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decentralized lending, and much more,
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consider checking out
the course on our website
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for an in-depth guide to MakerDao.
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