First Digital Launches FDUSD: let’s talk about Stablecoins.

First Digital, a registered trust company based in Hong Kong, has recently unveiled this new stablecoin called First Digital USD (FDUSD). This stablecoin, issued by FD121 Limited and operating under the brand name “First Digital Labs,” will be backed by either one U.S. dollar or an asset of similar fair value, held in regulated financial institutions in Asia, ensuring a 1:1 ratio.

First Digital, a Hong Kong licensed trust company, launches a new USD pegged stablecoin (FDUSD), on #BNB Smart Chain.

— CZ 🔶 Binance (@cz_binance) June 1, 2023

Let’s take an in-depth look at stable crypto assets and all that they entail.

Stablecoins are blockchain-based tokens whose value is tied to an external asset, such as national currencies or precious metals. They function as digital representations of the dollar, euro, and even gold. In other words, they are collateralized assets that can be bought and sold within the crypto market.

Stablecoins were created as a solution to the intrinsic volatility of native cryptocurrencies. While assets like Bitcoin and Ethereum attract users with their various economic benefits, their unpredictable price fluctuations also intimidate potential newcomers.

For instance, when settling a BTC transaction, the value of the currency can be significantly higher or lower than at the time of initiating the transfer, making it challenging to use as a reliable asset.

On the other hand, stablecoin prices tend to vary very little or almost not at all. Stablecoins are a specific type of cryptocurrency designed to minimize price volatility by linking their value to a stable asset, such as a fiat currency or a commodity. Designed to closely track the value of the national currency they emulate, they maintain a price with minimal daily fluctuations, similar to assets like the dollar or the euro. They also have the ability to mimic cryptocurrency features like fast settlement, global transfers, and in some cases, the elimination of intermediaries. As a result, stablecoins have become valuable tools for preserving wealth in highly volatile markets.

Some stablecoins (like DAI) are widely used as collateral in loans and other financial services that have gained popularity in the DeFi (Decentralized Finance) niche, because they have become a key tool for driving decentralized applications (DApps).

A brief history

The origins of stablecoins can be traced back nine years ago, when the first proposals to create stable-priced digital assets emerged. The idea was to provide a payment instrument that would reduce the risks associated with cryptocurrency volatility while offering low operational costs and privacy.

In mid-2014, initiatives such as BitUSD and NuBits were introduced. Around the same time, the launch of one of the most popular stablecoins today, Tether (then known as Realcoin), was being developed, and was officially issued at the end of 2014 on the Bitcoin Omni Layer sidechain.

Other notable stablecoins like DAI entered the market in 2017. DAI, launched on the Ethereum network, operates with smart contracts that use ETH as collateral and replicate the price of the US dollar.

How do stablecoins work?

Stablecoins are tokens issued on multiple blockchain networks and sidechains, and their behavior depends largely on the blockchain to which they belong.

For example, stablecoins launched on Ethereum have their own smart contracts known as ERC-20 tokens. All stablecoin transactions within the network are recorded in the public ledger, similar to transactions with native coins like Bitcoin or Ether. However, unlike these, stablecoins do not have their own blockchain.

Stablecoins depend on a provider, company, or governance system, which determines how many tokens are issued, what units they are linked to, and how their reserves are backed. In other words, these entities play a significant role in the stablecoin economy.

Stablecoins VS CBDCs

Although they may have certain similarities, stablecoins and CBDCs are different. Stablecoins are privately issued digital currencies backed by assets, aiming to maintain a stable value. CBDCs, on the other hand, are digital currencies issued and regulated by central banks, backed by their credibility. Stablecoins focus on efficient transactions and cross-border use, while CBDCs aim to enhance the existing monetary system and provide digital alternatives to traditional cash.

Types of stablecoins and their use Cases

Stablecoins can be categorized into four general types based on how they are pegged to the value of other assets.

1-Fiat-Backed Stablecoins

They are the most popular type in the market. They are directly pegged to a national currency at a ratio of 1:1. For example, each token issued represents one US dollar, euro, or yen. Users deposit fiat currency into a bank account and receive these tokens in return.

These stablecoins typically have a fiat guarantee, which means that the stablecoin provider is responsible for maintaining a reserve of fiat currency proportional to the tokens in circulation.

2-Crypto-Backed Stablecoins

The issuance of these assets solely depends on the smart contract that enables their existence, minimizing the need to trust a third party. In other words: it is programmable money. They use other crypto assets as collateral, even though the stablecoin reflects the price of a fiat currency. One good example is DAI. Users can deposit ETH or other cryptocurrencies into the MakerDAO contract, the company behind DAI, to guarantee the creation of a new token. However, the price of the asset will not mimic ETH but rather the US dollar to which it is pegged!

Due to the absence of a company responsible for issuing and managing the asset, these stablecoins often have their own governance systems where users can participate and vote on monetary policies.

3-Commodity-Backed Stablecoins

They are similar to fiat-backed stablecoins, but they are backed by physically reservable tradable assets such as precious metals. Gold is the most commonly used commodity to create these stablecoins, although there are also coins backed by oil, real estate, and other rare metals. Pax Gold (PAXG) is one of the well-known stablecoins in this category.

The provider of the stablecoin owns the tangible asset, which is kept in custody to issue new tokens on the network. Unlike fiat-backed or crypto-backed stablecoins, they can appreciate over time.

4-Algorithmic Stablecoins

They are the least known stablecoins in the market. The value of these coins is not backed by fiat or other cryptocurrencies but rather linked to them through algorithms that mimic their price. One example is Ampleforth (AMPL), an algorithmic stablecoin that adjusts its supply in response to changes in demand. When the price is above the target price, the supply of AMPL tokens increases, and when the price is below the target, the supply decreases. This mechanism aims to maintain a stable value over time.

Pros and Cons of Stablecoins

While they offer several benefits, they also have drawbacks. Let’s explore the advantages and disadvantages of crypto stablecoins:

Advantages:

• Stability: The primary advantage of stablecoins is their ability to provide stability. By pegging their value to a stable asset, they aim to reduce the price volatility commonly associated with other crypto assets. This stability makes stablecoins more suitable for everyday transactions and as a reliable store of value.
• Swift Transactions: Stablecoins enable fast and efficient transactions, often with lower fees compared to traditional banking systems. This makes them valuable for remittances, cross-border payments, and peer-to-peer transactions, ensuring quick and cost-effective transfers of value.
• Accessibility: Stablecoins increase access to digital financial services, particularly for individuals in regions with limited banking infrastructure. They enable participation in the global economy even without a traditional bank account, promoting financial inclusion for underserved populations.
• Programmability: Stablecoins built on blockchain platforms can leverage the programmability of smart contracts. This opens up a range of financial applications, including decentralized finance (DeFi) protocols, lending platforms, and automated financial transactions, enhancing the efficiency and flexibility of transactions.
• Privacy: Certain stablecoins offer enhanced privacy features, allowing users to engage in transactions with a certain level of anonymity. While privacy is not a priority for all stablecoins, it can be a beneficial feature for those seeking increased transactional privacy.

Disadvantages:

• Centralization and Counterparty Risk: Many stablecoins rely on centralized entities or custodians to maintain the peg and hold reserves. This introduces counterparty risk, as the stability of the stablecoin depends on the trustworthiness and financial soundness of these entities. If the custodian fails or engages in fraudulent activities, it could jeopardize the value of the stablecoin.
• Regulatory Challenges: Stablecoins have attracted regulatory scrutiny, particularly those aiming to replicate fiat currencies. Governments and financial institutions are concerned about potential risks associated with money laundering, fraud, and financial stability.
• Limited Transparency: Some stablecoins lack transparency regarding their underlying reserves. Without adequate auditing and public reporting of reserve holdings, users may have doubts about the actual value and stability of the stablecoin, potentially undermining trust in the system.
• Price Volatility of Underlying Assets: Stablecoins pegged to specific commodities, such as gold or oil, may still be vulnerable to the price volatility of those assets. If the underlying asset experiences significant price fluctuations, it can impact the value of the stablecoin, deviating from its intended stability.
• Scalability and Network Congestion: Stablecoins built on certain blockchain platforms, like Ethereum, may encounter scalability issues and network congestion during periods of high transaction volume. This can result in increased transaction fees and slower transaction times, affecting the overall efficiency and user experience.

Some valuable examples of stablecoins to keep in mind

• Tether (USDT): It is one of the main stablecoins in terms of market capitalization. It is backed by dollars, with its reserves physically held in bank accounts under the name of Tether Limited. In addition to USDT, Tether Limited is also responsible for issuing stablecoins anchored to the euro. Tether has faced scrutiny regarding the management of its dollar reserves. The lack of specific information about the assets and banks involved raised concerns. Nevertheless, Tether USDT remains one of the most widely capitalized stablecoins.

• True USD (TUSD): It is another physically backed stablecoin tied to the US dollar. The token was launched in 2018 on the Ethereum blockchain, using an ERC-20 contract as its foundation. Although True USD is the token issuer, the stablecoin’s reserves are held by a group of accredited financial institutions. True USD is obligated to publish the contents of its bank accounts regularly and undergo monthly audits conducted by third parties.
• Pax Gold (PAXG): Is backed by gold, making it one of the few stablecoins collateralized by commodities. According to Paxos specifications, each PAXG token represents one troy ounce of a London Good Delivery gold bar. These bars, each containing 400 ounces, are stored in Brink’s vaults under the name of Paxos Trust Company.
• Dai (DAI): Developed by the MakerDAO initiative, DAI is one of the most widely used asset-backed stablecoins on the Ethereum network. Unlike Tether, it operates in a decentralized manner with its own governance system, regulated by its smart contract. DAI does not have physical reserves to back its issuance. Instead, users guarantee the minting of new tokens by depositing Ether (ETH) or other cryptographic assets into the MakerDAO smart contract. In return for the deposited cryptocurrencies, they receive a token that maintains a 1:1 parity with the US dollar. DAI plays a significant role in shaping the decentralized finance (DeFi) ecosystem: it serves as a widely utilized asset in lending platforms and decentralized exchanges (DEX).
• Binance USD (BUSD):Thanks to Paxos Standard and Binance, it has been ranked as the third-largest stablecoin by market cap. The BUSD stablecoin maintains a peg of 1:1 with US dollars, which implies that each BUSD is traded for $1 from the reserves. BUSD is a fiat-collateralized stablecoin. Paxos burns your BUSD when you submit it to them, then sends you their fiat substitute.
• USD Coin (USDC): This stablecoin has a 1:1 value correlation with the US dollar. It is accessible on several blockchains, including Ethereum, Algorand, BNB Smart Chain, Solana, Polygon, and Tron, and it provides liquidity to the cryptocurrency markets. In essence, USDC is an ERC20 utility token, which is a protocol for creating smart contracts on the Ethereum blockchain.
• USB: This stablecoin is backed by Bitcoin and is specifically designed to mirror the value of the US Dollar using a unique approach: shorting Bitcoin! By doing so, it eliminates the necessity for traditional bank accounts, providing protection against crackdowns or frozen funds, and enhancing privacy and resilience. You can learn more about USB project here.