The Future of Stablecoins | USDU
A look at this past, present and future, and my favorite stablecoin bet.
What is a Stablecoin?
Stablecoins are just what they sound like, a cryptocurrency whose valued is tied to another currency, most commonly the United States Dollar.
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Stablecoins or stables are useful because they allow for people to transact with crypto while avoiding their highly volatile nature. In order for a currency to successfully be a medium of exchange, its price must be stable. While I argue that we will eventually get there with Bitcoin, it’s objective we aren’t there yet.
As you can imagine, the use of stables are widely debated in crypto. Some believe they are unnecessary, solving a problem that doesn’t exist. “We don’t need stables when we have Bitcoin.” Others maintain it’s helpful to have a stable currency on a blockchain to transact in while avoiding the traditional financial system and central banks.
I’ll leave it for you to decide what to believe.
A Brief History of Stablecoins
Invented in 2013, Tether (USDT) was the first stable coin, and was born out of necessity as arbitragers couldn’t effectively move funds fast enough using the legacy banking system and Bitcoin.
Exchanges initially rejected USDT but ultimately all adopted it due to the efficiency in the speed of transfers.
USDT has another use case, protecting savers. Argentina and Turkey (lira dropped 70% against dollar in a year) and USDT is used in daily transactions by merchants. There are reports of people who save in USDT to be able to pay for their children’s education in the future, as its less likely to be inflated away.
The lack of access to better fiat currencies is forcing people to hold their local fiat, thereby inflating away their savings. Since countries with unstable fiat currencies intentionally limit access to USD (otherwise nobody would hold their local currency), it can be said then that the advent of USDT is effectively serving to dollarize the emerging world.
Current Types of Stablecoins
Several types of stablecoins exist, each with various economic structures. They all have their fair share of pros and cons.
Fiat Collateralized Stablecoins
These stables keep a reserve of fiat (most commonly the U.S. dollar) as collateral, thereby ensuring the stables value. Notably, reserves are kept by independent parties which are then audited. The most popular fiat backed stables are Tether (USDT) and UDSC, which is backed by circle.
Crypto-Collateralized Stablecoins
Crypto-collateralized stablecoins are stables backed by other cryptocurrencies. Since the reserve cryptocurrency almost certainly suffers from extreme volatility, crypto backed stables are over collateralized, meaning there’s more U.S. Dollar value backing the stable than units of the stablecoin in circulation.
The most notable example is MakerDAO's Dai, whose price is pegged to the U.S. dollar but whose reserves are backed by Ethereum. The total amount of collateral they have is 150% or 1.5x the amount of DAI in circulation.
Algorithmic Stablecoins
Algorithmic stablecoins are an experimental type of stablecoins who aim to control their supply through an algorithm. An important distinction is many of these algo backed stables do not maintain reserve assets, but rely strictly on a predetermined formula.
Critics complain this is no different than central banks. However in some instances its worse as algo backed stables don’t have the highly coveted status of legal tender, which gives legitimacy to the currency.
The most famous example of an algo backed stable is TerraUSD (UST) whose price broke the peg and ultimately went to zero, causing billions of dollars in losses for those whom held the coin.
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The Problem with Stablecoins
Each one of the above stablecoins has its limitation.
Fiat backed stables pose an ironic solution to the stablecoin world because they are backing their stablecoin by the U.S. Dollar, and of course, fiat currency is the very problem that crypto was invented to solve.
Second, fiat backed stables require investors to rely on private and centralized institutions to back the stablecoin 1:1. Of course the irony being decentralization is another pillar of crypto. If recent history has taught us anything, it’s trusting third parties with our crypto doesn’t end well, as evidenced in the Celsius bankruptcy.
Crypto backed stables such as MakerDao’s DAI are also backed by USDC in addition to Ethereum. It has recently come to light in the bear market that a whopping 80% of DAI is backed by USDC, which basically renders it at the mercy of Circle, the company behind USDC.
The rest is backed by Ethereum, which means the stablecoin has a single point of failure with ETH. RAI, a stablecoin which is backed 100% by ETH, suffers from the same problem.
Algorithm backed stable coins have failed to work in the past because quite simply, the algorithm sucks. According to CoinDesk:
The algorithm, which is supposed to burn UST and mint LUNA when UST is below $1, hasn’t worked as well; it’s failed to keep up with the extreme conditions.
The Future of Stablecoins
What if there were a stablecoin which solved the above limitations? How would that look?
We can simply rule out a stable being backed by fiat. On principle, few in crypto want to support centralized currency which can be debased by the madness of central banking. It should be obvious at this point that algo backed stablecoins are simply too risky to store large percentages of one’s net worth due to their lack of track record.
A truly great stablecoin would be decentralized and backed by other cryptocurrency. Not just one token, as that creates a singular point of failure, but by a basket of the best crypto assets. Of course, in supreme crypto fashion, the free market would decide which assets and in what quantity.
If only one existed. Enter, USDU. Built atop the Unit Blockchain, a layer 1 on Polkadot, USDU (the U is for Unit) is the only stable tokens backed 100% by a decentralized basket of cryptocurrencies.
USDU: A Decentralized Stable Backed by Crypto
USDU is a decentralized stablecoin backed by a basket of the most liquid cryptocurrencies, from Bitcoin and Ethereum, to Dot and Solana.
Users deposit the crypto of their choosing onto Unit, then purchase USDU. When this happens, new USDU are minted into existence. The crypto the deposited used goes into the USDU Bank to collateralize the stable.
For example, John deposits $10,000 worth of Bitcoin onto Unit and purchases $10,000 USDU. The USDU bank now has $10,000 backing the USDU and is collateralized at 1:1. Four of his friends each deposit $10,000 worth of Ethereum, Solana, Dot and Avax and purchase USDU. There is now $50,000 worth of digital assets backing $50,000 worth of USDU.
Here’s a look at the current USDU bank. Over time I envision this to be more distributed as more users create accounts and deposit onto the network. The market will decide which currencies they prefer to deposit to back USDU.
Purchasing USDU is essentially a long on digital assets and the tokenized economy. If one expects that the value of digital assets rise over time in fiat terms, then one will be able to redeem their USDU for digital assets in the bank once USDU is 1000% (10x) over collateralized.
For example if John deposits $10,000 worth of Bitcoin to purchase $10,000 USDU, and the value of Bitcoin increases by 1000%, then John can redeem his $10,000 USDU for $10,000 worth of Bitcoin. He cannot arbitrage this opportunity, but rest assured that his stable is redeemable for the digital asset of his choice, thereby securing the stablecoin.
I like how USDU is hedged as there is no single point of failure. If market participants deposit the top 20 cryptos to back USDU, and one of them goes to zero, it will represent a small fraction of the overall collateral and shouldn’t, in theory, affect the trust of USDU.
Risks of USDU
For a great article on why crypto backed stables are superior to algorithmic ones, read this article by Vitalik, the founder of Ethereum. I’d argue that the same first principles which apply to RAI are more true for USDU as the risks are less when backed by a basket of digital assets as opposed to a singular one (Ethereum).
Nevertheless there are still risks involved. Owners of USDU are essentially long digital assets. If the value of digital assets decreases dramatically, then USDU could end up under collateralized. So long as the participants believe crypto will eventually recover, this shouldn’t affect trust in the ecosystem, but there is no guarantee.
This happened recently and USDU was rebased to ensure proper collateralization.
Currently USDU is not truly decentralized. The Unit team plans to make the Unit Network a parachain on Polkadot later this year, at which point it will be.
It’s important to note that USDU is not an investment that will rise in value. In other words, if one exchanges Bitcoin for USDU, they should not expect to increase their Bitcoin holdings. USDU is a stable coin whose price is pegged to the U.S. Dollar and therefore its price is meant to stay stable.
Although USDU is currently more than 100% collateralized, there is very little backing as it’s on a new network and has just recently launched. It has not stood the test of time and there’s no guarantee the Unit network will gain sufficient adoption.
In short, in the worst case scenario, USDU could go to zero. Please understand the risks before storing assets in USDU.
Final Thoughts on Stablecoins
Whether it’s USDU or another stable, I ultimately believe the model of having a decentralized stablecoin backed by various digital stores of value is the best model.
USDU seems to be leading the way with this vision, although they still need to prove the model with sufficient adoption. As always, I’ll be watching closely and keeping you updated.
If you have questions about stablecoins, USDU and the tokenized economy being built on the Unit Network, let me know in a comment below.
Alec