Stablecoins have become an integral part of the blockchain ecosystem. For those of you, who are not familiar with the concept — it is a digital token collateralized to the value of an underlying asset, created to solve the volatility & stability issue with the traditional cryptocurrencies. They not only aim to solve the problem of heightened volatility in Cryptos but also act as a popular medium of exchange on various exchanges.
It is due to this usability that the volumes of stable coins often exceed those of Bitcoin and Ethereum. The prior is by far the most borrowed assets on decentralized money markets (27x more USDC is borrowed on Aave than ETH). Also, major trading pairs on Centralized & Decentralized exchanges (CEXs & DEXs) are denominated in stable coins. Most importantly, The stabilized, secure & scalable nature of stable coins provides a bridge between the traditional money market and the digital assets.
The phenomenon has been the biggest enabler of Decentralized Finance. Stable coins design revolves around creating a balance between the stable coin trilemma — Decentralization, Stability & Efficiency. Optimizing all three is a tricky business since trying to achieve it in one metric, usually leads to a degradation in the other. Stable coin design implementations these days usually fall into three main categories.
— This is the oldest, simplest, and most common form of the stable coin in the blockchain space. The top two stable coins, Tether (USDT) & USDC are examples of this, where traditional banks hold cash and cash equivalents in custody to back-issued stable coins.
Collateral Debt Position (CDP) — CDP stable coins are usually issued by decentralized protocols that accept collateral and issue debt in the form of a stable coin. To prevent the protocol from fluctuations in the collateral token price, Collateral backing CDP is often greater than the amount of stable coin debt issued.
Algorithmic (Algo) — And finally, Algo stable coins are the newest form of innovation, having the widest spectrum of implementations. Each algorithmic stable coin employs a combination of game-theoretic and mechanistic systems to ensure the stability of the token. They are considered the superior choice of all three categories, especially when it comes to DeFi. They neither require a trusted centralized partner as in Fiat ones nor do they need over overcollateralization like in CDPs. Current leading Algo stable coins include UST, FRAX, and FEI.
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According to the latest report by , Q4 2021 alone saw the Algo stable coin market cap grow 260% (Figure 2), significantly outpacing fiat and CDP-based stable coins which expanded market caps by 18% and 87% respectively. If this pace of growth continues, Algo stable coins are all set to overtake collateralized debt stables as the second-largest category of stable coins in Q1 2022. As suggested above, we see the superiority of Algo stable coins design playing out here.
Overall, the market caps of the stable coins as a whole and category-wise saw an impressive over successive quarters in 2021 — the market cap grew from $61B to $164B, up 169%. Apart from impressive yearly and quarterly growths, CDP & Algo stables made huge inroads in the stable coin space. Having said that, the supply of fiat stable coins far outstrips the supply of CDP and Algo stable coins currently— Fiat stable coin market capitalization is roughly 10x more than both collateral debt and Algo stable coins.
Nevertheless, this differential does provide a great market opportunity for the two lagging categories to catch up, especially with the efficient scalability properties of Algo stables playing out this year. At the time of publishing the total market cap of stable coins stood at $179.6B
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