A brief history of Stablecoins

Cryptocurrencies, widely known for their underlying technology and volatile nature, were first introduced to the world in 2008 when Satoshi Nakamoto published the Bitcoin Whitepaper. Since then, blockchain technology which powers the Bitcoin Network was further developed by various enthusiasts, computer scientists and entrepreneurs for a wide range of purposes in the form of other digital assets, blockchain networks and protocols. Accompanying these blockchain protocols are tokens (widely known as cryptocurrencies) which make up part of the incentive mechanism of blockchain networks to bootstrap network effects. Over time, markets were created for these cryptocurrencies allowing market participants to express their views through buying and selling of these cryptocurrencies. As the crypto industry is in its infancy, the liquidity of these digital assets is low which leads to high volatility. This presents a problem for wider adoption as frequent material price movements limit its use cases.

The rise of Stablecoins

This led to the creation of stablecoins which utilizes blockchain technology to create a cryptocurrency that remains stable in value against a pegged external asset class. It reduces the volatility of the cryptocurrency as its value is fixed against an asset like a single fiat currency, a combination (basket) of currencies or a valuable real-life commodity. The first stablecoin, BitUSD was created in July 2014 on the BitShares blockchain with its native BitShares token used as backing for the stablecoin. Tether (originally known as RealCoin), currently the most popular stablecoin went live in November 2014 and have acquired slightly more than 50% of the stablecoin market share to date. The primary purpose of stablecoins is to negate the speculative nature of most cryptocurrencies and help create a more consistent and reliable market environment to increase the adoption of digital assets. The US dollar is the most widely used 1:1 ratio peg for stablecoins, along with other currencies such as the Euros, British Pound, Japanese Yen and Gold. As of writing, the market cap of stablecoins is over USD125billion, with stablecoins denominated cryptocurrencies trading pairs being the most traded. This clearly illustrates the demand for stablecoins and the crucial role it plays in the crypto industry.

Stablecoins allow market participants to move across digital assets without volatility and enable value to be stored temporarily in an asset class (especially when the crypto market is experiencing high volatility), allowing investors/traders more time to evaluate their next move. Increasingly, stablecoins have also been used for cross-border payment and remittance as transacting with digital assets are more efficient, faster and cheaper than current fiat solutions like SWIFT, which takes days to clear and require the costly involvement of intermediary financial institutions and administrative procedures.

Stablecoins have been under intense scrutiny by regulators and the crypto community for varying reasons. Regulators were caught by surprise by the rapid rise of stablecoins within the crypto markets and seek to act quickly to come out with proper regulatory frameworks for stablecoins usage. On the other hand, centralized stablecoins such as Tether and USDC faced community backlash over the treasury reserves these entities hold to back the stablecoins that they are issuing.

One of the main challenges for stablecoins is the ability for them to maintain their peg in times of high volatility, as that was the fundamental intent of the creation of stablecoins, to remain stable in times of volatility. A few weeks ago, the crypto market experienced a steep correction of >20% across the market with some digital assets facing steeper declines. During huge price swings in the market is where stablecoin pegs often come under stress. The screenshot below shows how the top 20 stablecoins performed under these market conditions. When looking at Stablecoin market caps, their performance and the sheer number of them, we can conclude that they are an enormous success fueling the wider crypto market.

Types of Stablecoins

There are three main types of stablecoins, each with a slightly different profile and characteristic.

1. Collateralized off-chain

This is the most popular category of stablecoins where they are backed by real-world assets such as stablecoins pegged against fiat currencies (USD, EUR, JPY, etc) or stablecoins fixed against commodities such as (Gold, Silver, Oil, etc). Stablecoin issuers in this category usually engage auditors to verify their reserves to establish trust and confidence within the community.

Tether, USDC, PAXG are some of the more common stablecoins, utilizing a collateralized off-chain method to mint and issue their stablecoins, which also acts as an on/off ramp into crypto for market participants. Users typically deposit a certain amount of fiat currencies/commodities that they wish to be converted into stablecoins and upon confirming the deposit, these entities will mint the equivalent value in stablecoins into their users’ on-chain wallets which they will then have access to their newly minted stablecoins.

2. Collateralized on-chain

These are stablecoins whose values are backed by other cryptocurrencies, more commonly known for their decentralized design, and governed through decentralized autonomous organizations (DAOs). Dai, one of the most used decentralized stablecoin, is a user-generated currency backed by other digital assets. The goal of the Maker community has always been for Dai to trade at or around one US dollar on average. Its value comes from the market mechanisms of supply and demand, influenced by different monetary parameters as set by Maker governance, powered by smart contract codes, thus eliminating the need for custody to issue the stablecoin, making it decentralized.

3. Algorithmic stablecoins

Stablecoins that use algorithmic mechanisms are based on the concept of Seigniorage shares concept which uses a complex combination of algorithms and smart contracts to keep a stable price, by buying and selling the stable token and manipulating its supply. For example, if too many people sell an algorithmic stablecoin, its price will drop. The stablecoin’s algorithm or “smart contract” will then respond by “retiring” enough coins from circulation so that the price rises again to the mandated peg level. Currently, there are several algo stablecoins in the market such as Terra Money, Fei, Ampleforth, Empty Set Dollar and more.

Central Bank Digital Currency

Countries around the world have come to realise the properties of blockchain technology and the gap that stablecoins are filling within the economy, which led to several jurisdictions actively pursuing the development of Central Bank Digital Currency (CBDC). A central bank digital currency is an electronic record of the country’s official currency built on top of distributed ledger technology and is issued and regulated by the country’s monetary authority. The CBDC have some overlapping characteristics of a stablecoin such that they are both built on blockchain technology, stable in value and facilitates digital transfer of value more efficiently as compared to current solutions. However the similarities end there, while the CBDCs are being built on the blockchain, it is largely operated in a centralized format which enables the government to simplify the implementation of monetary and fiscal policy and encourage financial inclusion in certain economies via CBDCs.

As of writing, more than 81 countries are developing CBDCs with China at the forefront of the development, having introduced its version of CBDCs — Digital Yuan to selected groups of communities to trial its digital currency.

Arkadiko

One of Arkadiko’s flagship products is the USDA, a stablecoin pegged to One United States Dollar, backed by assets on the Stacks blockchain. USDA will initially be backed by STX, the native token of the Stacks blockchain, but as the ecosystem matures other digital assets such as bitcoin and other tokens built on the Stacks blockchain can be used as collateral to mint USDA.

USDA is decentralized by design, powered by clarity smart contract codes and governed by the Arkadiko DAO. USDA is also a yield-bearing stablecoin as the collateral used to mint USDA (STX) by design generates a bitcoin yield through its consensus mechanism; Proof-of-Transfer (PoX). As such, Arkadiko is using the yield to offset users’ cost of borrowing, which makes their USDA loan negative in interest rate. This enables users to supercharge their yield-bearing asset where USDA can further be used to generate additional yield on top of Stacks native reward mechanism. As DeFi on Bitcoin ecosystem continues to grow, users can further utilize USDA through other DeFi applications such as lending, market making, derivatives and many more.

USDA being a native stablecoin to the Stacks blockchain provides additional stability to the ecosystem. Where other applications can build on top of Arkadiko’s USDA product, utilizing its stablecoin properties and yield-bearing mechanism to create revolutionary products and use cases such as novel insurance products with yield-bearing elements, crypto-native financial products, fractionalization of assets and more.

USDA will enable the Stacks ecosystem to grow, as native stablecoins play a crucial role in increasing liquidity, acts as a medium of exchange for users within the Stacks ecosystem, and as a tool for developers to work on. We envisage that many more applications, protocols and projects will leverage USDA in the coming months to introduce innovative products for users, allowing for a vibrant Stacks Ecosystem to take shape. To learn more about Arkadiko Finance, and how DeFi can be built on Bitcoin head over to our discord channel.

We thank you for learning about Arkadiko and hope to welcome you soon to our DAO.