Two questions need to be answered very first when analyzing a stablecoin project.

1. What asset does the stablecoin peg to?

2. How does the stablecoin maintain its price?

The first question is much easier to answer. Most of the stablecoin is pegged to fiat currency, which is often USD as long as the USD is the most commonly-used fiat currency in the world. Meanwhile, there are also stablecoins pegged to other fiat currencies, for example, EUR or SGD.

The second question is the core of how a stablecoin differentiates from other projects. Based on the price stabilization mechanism, we can group stablecoins into several categories as below:

1. Fiat-backed

2. Digital asset-backed

3. Algorithmic

4. Fractional algorithmic

Fiat-backed

Fiat-backed stablecoins at are pegged at 1-to-1 with a matching fiat currency and are backed 100% by the reserves of the issuing institution. The reserves usually consist of cash, cash equivalents, short-term bonds, money market products, and other current assets.

Since fiat-backed stablecoins are 100% backed, it is the most “stable” stablecoins. Top fiat-backed stablecoins include $USDT issued by Tether, $USDC issued by Circle, and $BUSD issued by Binance. To maintain the confidence of the market and community, transparency and disclosure are always the keys.

According to Coinmarketcap, the market cap of $USDT is around 83 billion USD, the market cap of $USDC is around 49 billion USD, and the market cap of $BUSD is around 17.7 billion.

Digital asset-backed

$DAI

Built by MakerDAO, $DAI is one of the most influential stablecoin and is famous for its decentralized nature. The price of $DAI is backed by the over-collateralized digital asset which is provided upon minting.

$DAI supports various token collateral, including mainstream assets ($WBTC, $ETH, $MATIC, $USDC, etc.) and tokens of De-fi platforms ($UNI, $YFI, etc.). $DAI gradually accepts LP tokens from other De-fi platforms, for example, $UNIV2DAIETH from Uniswap and CRVV1ETHSTETH on Curve. This is much similar to the mechanism of $MIM mentioned below, which accepts a riskier asset than other collateral.

Although $DAI is “The world’s first unbiased currency. $Dai is a stable, decentralized currency that does not discriminate.” as per MakerDAO’s saying, there are criticisms that near 50% of $DAI is generated by $USDC, a centralized stablecoin.

According to Coinmarketcap, the market cap of $DAI is around 8.7 billion USD.

Algorithmic

$UST

Terra adapts a two-token system consisting of $Luna, the governance token, and $UST, the algorithmic USD stablecoin.

• The protocol of Terra allows users to trade 1 USD worth of $Luna for 1 $UST, and vice versa. The price of $UST can be stabilized based on arbitrage and the supply-demand relationship of the market.

• Consider the following scenarios:

  • Scenario 1: If 1 $UST is traded at 0.9 USD in the market, a user can buy 100 $UST for 90 USD. The user then can exchange that 100 $UST via the Terra protocol, receiving 100 USD worth of $Luna and selling them at the market. (The protocol would mint 100 worth of $Luna) The user’s transaction, buy $UST and sell $Luna, would increase the market demand for $UST, driving the market price of $UST upward.

  • Scenario 2: If 1 $UST is traded at 1.1 USD in the market, a user can buy 100 USD worth of $Luna. The user then can exchange those $Luna via the Terra protocol, receiving 100 $UST and selling them at the market. (The protocol would mint 100 $UST) The user’s transaction, buy $Luna and sell $UST, would increase the market supply for $UST, driving the market price of $UST downward.

  • As long as the above arbitrage opportunity exists, the price of 1 $UST will become closer to closer to 1 USD, achieving the target of “reducing the market volatility.”

• Terra spent hundreds of millions USD in buying $BTC and $AVAX to its reserves to back $UST in the past few months. As $UST becomes larger and larger, it seems that Terra is also seeking another approach to back up $UST, especially after the dump in mid-2021.

• According to Coinmarketcap, the market cap of $UST is around 18.5 billion USD while the fully diluted market cap of $LUNA, the governance token of Terra, is at 61.2 billion USD.

$MIM

Abracadabra is a unique De-Fi lending platform. Users can deposit interest-bearing tokens from other protocols to receive $MIM, the native stablecoin of Abracadabra.

• When a user deposits some digital assets to De-Fi farms (Yearn, Sushi, etc..) to generate yields, those De-Fi platforms may provide interest-bearing tokens (ibTKNs) in exchange. IbTKN (yvUSDT, yvUSDC, wETH, etc.) is essentially an IOU note for those tokens staked in the De-Fi platforms.

• Since the ibTKNs often have poor liquidity, Abracadabra provides an incentive to the users to deposit ibTKNs as collateral and borrow $MIM (better liquidity as a stablecoin) to invest in other projects instead.

• When a user deposits collaterals, $MIM tokens are issued and lent to the user. In other words, new $MIM is added to the market supply. Meanwhile, when the user repays the $MIM loan, $MIM would be burned and decreased the market supply.

• Also, $MIM is backed by the ibTKNs collateral. Therefore, by combining the issue-burned mechanism and collateral mechanism, $MIM can maintain its price stability.

  • Overcollateralize: for each 1U worth of ibTKNs deposited, only less than 1U of $MIM would be lent out to the user. The ratio between $MIM lent out and ibTKN collateral deposited is called MCR (Maximum Collateral Ratio) which is predefined by Abracadabra and varies from pool to pool.

  • $MIM Cap: A cap is set for each ibTKN pool to control the supply of $MIM.

  • Interest carried: When the user wants to take retrieve the deposited ibTKNs, one needs to return $MIM borrowed along with the interest which is the key revenue source of the platform.

  • Liquidation: the user needs to designate a liquidation price when borrowing $MIM. Once the liquidation process is triggered, the user can keep the $MIM after subtracting the liquidation fee.

• It is debatable whether $MIM is an Algorithmic Stablecoin or a Digital asset-backed stablecoin.

• According to Coinmarketcap, the market cap of $MIM is around 1.9 billion USD while the fully diluted market cap of $SPELL, the governance token of Abracadabra, is at 609 million USD.

Fractional algorithmic

$FRAX

Frax Finance also adapts a two-token system consisting of $FXS, the governance token, and $FRAX, the USD stablecoin.

• Besides the two-token arbitrage system similar to Terra, Frax Finance also uses $USDC as the digital asset collateral to back $FRAX, resulting in a mixed approach between algorithmic stablecoin and collateralized stablecoin.

• $FRAX can be minted by providing x% of $USDC and (1-x%) worth of $FXS according to the protocol. If $FRAX is traded at 0.9 USD which is much below the pegged price. The protocol would raise the collateral ratio, implying that each $FRAX is backed by a higher portion of $USDC, the collateralized stablecoin. Thus, driving the price upward closer to 1 USD. Vice versa, if $FRAX is traded at a price higher than the pegged price, the protocol would decrease the collateral ratio.

• When the collateral ratio of $FRAX is equal to 100%, $FRAX can be considered a fully collateralized stablecoin backed by $USDC. On the other hand, when the collateral ratio of $FRAX becomes 0%, $FRAX becomes an algorithmic stablecoin and adapts the mechanism similar to $LUNA-$UST to maintain its price.

• Besides adjusting the collateral ratio, the $FRAX still adapts the arbitrage approach to adjust the price. By combining both approach collateral ratio and arbitrage, $FRAX has provided a unique solution to reduce the market volatility.

• According to Coinmarketcap, the market cap of $FRAX is around 2.7 billion USD while the fully diluted market cap of $FXS, the governance token of Frax Finance, is at 3.6 billion USD.

TLDR

• Stablecoin is the bridge between real-life economic activities and the crypto world.

• Stablecoin can be grouped into 4 categories: Fiat-backed, Digital asset-backed, Algorithmic, and Fractional algorithmic.

• Stablecoin backed by assets is literally stable and depeg events are rare.

• Fiat-backed stablecoins have a wide application scenario and are basically the infrastructure of the crypto economy.

• Algorithmic stablecoins, on the other hand, are less stable. Depeg risk always exists, especially in a bumpy market.

• Observing the price of stablecoins, major fiat-backed stablecoins maintain their price within the ±0.1%~0.2% range while the price of algorithmic stablecoins may fluctuate up to ±1%~2% and face depeg risks.